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Stress testing EM sovereign external debt

The Emerging View

01 June 2020



The coronavirus outbreak was an unprecedented shock to the global economy, which experienced the fastest and deepest recession outside times of war. The global economy is also likely to experience the fastest rebound on record in 2020, thanks to the combination of large monetary and fiscal policy expansions worldwide and healthier banking systems. However, an economic bounce from very low levels and a rapid resurgence in asset prices does not mean that all is well. Despite generally better policy management of the coronavirus downturn compared to previous major recessions, the episode is likely to accelerate already widening income and wealth inequalities. Higher inequality will have negative implications not just for the economies of developed countries, but also their financial markets. Against this backdrop, it seems sensible to rotate exposure into Emerging Markets (EM). EM sovereign debt valuations remain extremely attractive. This report stress tests EM external debt using extremely negative assumptions and still finds that returns going forward are likely to be significantly better than the returns on offer in developed bonds markets, given the valuations and the broader economic backdrop in developed economies.

 

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