This means that investors have a safer alternative to developed market fixed income as the world slowly heads towards global monetary policy normalisation. Seen in this light it is unsurprising that developed market central banks continue to err on the side of dovishness.
The average debt burden in EM is 39% of GDP, unchanged from 2012. By contrast, the debt burden in developed countries increased by 5% of GDP to 280% of GDP. The seven times greater indebtedness in GDP terms of developed economies means that EM is relatively better positioned fundamentally to manage a rise in global interest rates.
The fastest growing element within EM fixed income is local currency corporate debt, which has grown on average 17% per year since 1995 compared to 14% for local currency sovereign and dollar corporate debt and 8% for external sovereign debt. However, 2013 was different. Total outstanding corporate dollar debt was up 22% and sovereign dollar debt was up 8% in 2013, more than their local currency equivalents. This was largely in part due to the ‘taper tantrum’ of 2013, which disproportionately impacted local currency markets.
EM fixed income benchmarks continue to represent the asset class extremely poorly and it’s not just in local currency markets. Only 46% of external debt is represented in the most commonly used dollar sovereign index, while index representation is even lower for corporate dollar debt and local currency corporate debt at 24% and 2%, respectively.
India
India’s Finance Minister, Arun Jaitley, published the much awaited budget, which delivered an ambitious fiscal deficit target of 4.1% and a target for FY17 of 3.0% of GDP. This is extremely positive. Excessive fiscal spending has been the main source of macroeconomic imbalance in India in recent years. Tighter fiscal policy will reduce inflationary pressures and give room to the central bank to ease rates.
We note that the government took another step towards opening its domestic bond markets – Indian bonds will now be allowed to be cleared internationally. This should help to remove one of the two major obstacles to index inclusion for Indian bonds, namely cumbersome settlement. India still has quotas limiting foreign access to local bond markets.
Indonesia
The election in Indonesia failed to produce a clear winner and attention now turns to 21-22 July, when the election commission is set to publish its findings. Exit polls suggest that Joko Widodo (Jokowi), the market’s favourite, will win. Golkar, the main opposition party, has already signalled that it does not intend to be in opposition. Jokowi is widely expected to be more reform friendly than his main rival, Prabowo Subianto.
However, the market is likely to overstate the differences between the two candidates, in our view. We think the first order effect of the change of government is that fresh momentum will be injected into the reform process, regardless of who wins. Bank Indonesia left its FASBI deposit rate and reference interest rates unchanged last week at 5.75% and 7.50% respectively.
Mexico
More evidence emerged of the start of a cyclical upturn in Mexico when gross fixed investment rose strongly in April. Investment increased by 1.3% mom seasonally adjusted (sa), which follows an upwards revised reading in March and another strong print in February (1.4% mom sa). Mexico’s economy should be able to grow significantly before encountering inflationary pressure due to recent substantial reforms.
On that note, the Lower House last week passed secondary legislation for recent telecommunications reforms and will now consider legislation associated with a critical reform of the energy sector. Last week CPI inflation was 3.75% yoy versus 3.8% expected. Seasonal factors are likely to lift headline inflation in H2, but we expect core inflation to remain entirely contained.
