IMF bailout euphoria signals spike in pessimism in emerging markets


It may be too early to turn bullish in emerging markets, but a series of bailouts promised by the IMF and China is leading some investors to decide it’s too risky to stay bearish.

Over the past two weeks, the International Monetary Fund has sewn up or moved closer to loan deals with some of the most vulnerable countries – namely Pakistan, Sri Lanka, Zambia, Egypt and Chile – after months of negotiations. Meanwhile, China is overcoming its own reluctance to offer debt relief, saying it will cancel the debts of 17 African countries and redirect its own IMF reserves to help the continent.

While some countries are still waiting, with Ukraine’s prime minister criticizing the IMF’s slow progress on Saturday in agreeing a new aid package for the war-torn nation, the support provided by the IMF has dramatically changed the odds. poorer countries where – even a few weeks ago – a wave of defaults seemed inevitable. Now their distress sagas are being recast as turnaround stories, allowing investors to cautiously dive back into their assets. Downside indicators such as capital outflows and risk premia are fading.

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“We have seen a rebound in emerging market dollar bonds as the IMF appears to be becoming increasingly responsive to the challenges faced by frontier emerging markets,” said Aninda Mitra, head of macro and investment strategy in Asia at BNY Mellon Investment Management in Singapore. . “It helps some investors become more neutral in emerging markets from a very bearish perspective.”

This year’s selling off of emerging market dollar debt has been so strong that it even eclipses losses during the 2008 financial crisis. The Bloomberg gauge for bonds plunged more than 16%, heading for its worst year never recorded. Its 10 biggest losers are all countries that have defaulted or are struggling to repay their debt, including Sri Lanka, Pakistan, Lebanon, Ghana and Belarus.

But since mid-July, the bears have loosened their grip on the headlines, allowing a rebound. The benchmark is up 2.9%, while data from JPMorgan Chase & Co. shows the incremental yield of sovereign debt relative to Treasuries fell 102 basis points from a two-year high of 593. An index that tracks capital flows to emerging markets rose a further 4%.


Bilateral support is also helping to allay default fears. India has given billions in emergency aid to Sri Lanka, while Pakistan has secured $9 billion in investments and loans from the Middle East. Egypt also receives more than $22 billion from its Persian Gulf allies.

Meanwhile, China said it would cancel a total of 23 interest-free loans to African countries and redirect $10 billion in IMF reserves, a big relief for the continent. Beijing accounts for nearly 40% of bilateral debt and private creditors that the world’s poorest countries have to repay this year, according to the World Bank.

As betting on the possibility of defaults becomes less and less viable, assets in troubled countries are benefiting.

The Zambian kwacha is the world’s second best performing currency against the dollar with an 8.5% rise this quarter after the country won approval for a $1.3 billion bailout package. The Chilean peso, with a rise of 3.7%, is not far behind the kwacha in terms of gains. Moreover, the Pakistani rupee jumped 8.2% in August, the best performance in the world, even as the currency of Ghana, a struggling nation that has yet to reach an agreement with the IMF, was the worst drop. Sri Lanka bonds have recovered from the depths of a sell-off as bondholders strategize to get the best possible deal in a restructuring exercise.

Yet until the dollar begins a steady decline and expectations of a Federal Reserve rate hike remain firm, global investors will not fully return to the asset class.

But with the IMF acting to counter some of the pain hanging over emerging markets, others are beginning to give these nations another look.

“We have seen capital inflows in recent weeks with tactical additions from global investors in certain pockets,” said Neeraj Seth, head of Asian credit at BlackRock Inc., which he said is neutral on market assets. emerging and expects to see some interesting opportunities. in the coming quarters. “As we see US rate volatility stabilizing and the dollar stabilizing, we will potentially see global investors revisit allocations to emerging markets.”

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