- China’s economic slowdown and shadow banking system were cited as the biggest risk factors.
- While private-sector involvement for Ukraine debt appears premature now, a debt exchange to extend maturities shouldn’t be ruled out.
- Risks from higher U.S. Treasury yields, which would make emerging market carry trades vulnerable, weren’t perceived as a current threat.
By Banu Asik Elizondo, Senior Portfolio Manager
Three recurring themes pertaining to emerging markets became apparent during the recent spring International Monetary Fund (IMF) meetings in Washington, D.C.
1. Most emerging markets investors expressed ongoing concerns about China. Both China's economic slowdown and shadow banking system were cited as the biggest risk factors. The IMF mission chief for China and his staff were able to calm these concerns with their presentation, which focused on three key issues - growth, currency and reforms.
- The IMF still has a growth forecast of 7.5% for China for 2014. The mission staff believes that year-to-date weakness in growth momentum is policy-induced. That said, IMF staff believes authorities now are taking targeted pro-growth measures that are better financed because they're less dependent on shadow banking.
- Depreciation of the renminbi in recent months has succeeded in cleaning out speculative trades, according to the authorities. They still expect capital flows into China to continue, given the growth and interest rate outlook.
- IMF mission staff mentioned the ambitious reform agenda as the main near-term challenge for China. They believe fiscal and sector-level reforms will be limited.
2. The situation in Ukraine and Russia remains a big concern for emerging market investors. While IMF mission representatives view private-sector involvement (PSI) for Ukraine debt as premature at the moment, they also noted that a debt exchange to extend maturities should not be ruled out. Overall, emerging market investors seem to be on the same page about seeing better value elsewhere in the high-beta sovereign space. It was also noted that, in case of increased tensions, the IMF would have to lend funds to Ukraine just to pay back its debt to Russian banks, while the U.S. and Europe are increasing sanctions toward Russia.
3. Risks from higher U.S. rates no longer seemed to be a concern. While most investors agreed that consecutive quarters of positive U.S. data could move U.S. Treasury yields up again, making emerging market carry trades vulnerable, the audience did not currently perceive this as a main threat to the asset class at the moment.
For emerging market investors, multiple issues in China, combined with political and financial volatility of the conflict between Ukraine and Russia raise the most concern for the asset class.
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