Enthusiasm around the investment opportunities inherent in emerging markets today continues to grow. Yet, some EM experts have spotted warning clouds on the horizon.
While the BRICs (Brazil, Russia, India and China) come out shining compared to developed countries in terms of public debt levels, is the picture really so rosy?
Some analysts say Brazil and India need to address public debt concerns sooner rather than later. Then, there’s the overriding concern that too much excitement around emerging markets could lead to a bubble.
“The other side is that people are having this feeling right now that perhaps there’s too much euphoria with emerging markets, and perhaps too much pessimism with the U.S.,” says Nicholas Smithie, a global emerging markets equities strategist at UBS AG, Switzerland’s biggest bank.
According to a November 24, 2010 Goldman Sachs report on the BRIC countries, the BRIC’s average debt levels have dropped dramatically over the past decade, while developed markets have risen steadily.
However, there’s a big variation in the evolution of the BRIC’s debt positions. For example, Brazil’s debt burden rose during its period of hyperinflation and has remained high since. India has also had consistently high debt levels, stemming from high and increasing expenditures on salaries, pension and subsidies, says the report.
On the other hand, Russia is in good shape. It brought down its debt level sharply since its default in 1998, primarily on the back of higher oil prices. And China has seen an increase in debt since the early 1990’s, but the official level is still low compared with other countries.
According to the report, during the recent global financial crisis the BRICs enacted large fiscal stimulus measures that led to a subsequent rise in debt. However, it rose less than the developed countries’.
Goldman’s analysts believe that India and Brazil will need some consolidation to bring down their debt levels.
On the other hand, they say “Russia’s debt level currently appears to be sustainable though its recent pro-cyclical pattern is slightly worrying.” As for China, it has seen a large increase in “unofficial” local government debt. Yet, the backstop provided by its large asset holdings suggests that its debt levels “will not prove problematic.”
Smithie agrees that EM debt has certainly been enticing. “If you were buying this debt in the early 2000s, you were buying debt that was very cheap. Over the course of a five to ten-year period, the returns were in the double digits,” he says. “Now it’s to the point where emerging markets are not issuing that much debt.”
In terms of the investment opportunity, Smithie says while investors must always keep in mind that emerging markets can be volatile, opportunities in both EM equities and debt abound. “If you can get six percent in emerging markets with good economic strength and strong creditworthiness, and half of that yield in countries with much less ability to service their debt, why would I buy Euro debt at 3 percent when I can buy EM debt at 6 percent?”
