## EMERGING MARKETS IN FLUX

## Source details

**Canonical URL:** [EMERGING MARKETS IN FLUX](https://www.imf.org/-/media/files/publications/fandd/article/2021/june/emerging-markets-in-flux-pradhan-house-lubin.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/fandd/article/2021/june/emerging-markets-in-flux-pradhan-house-lubin.pdf.md)
- [Structured JSON version](/-/media/files/publications/fandd/article/2021/june/emerging-markets-in-flux-pradhan-house-lubin.pdf.json)

---

### Resilience of emerging market assets during COVID-19
- Emerging market assets proved "remarkably resilient" over the past year despite dire expectations at the outbreak of the COVID-19 pandemic.
- Contributing factors:
  - "Very large liquidity injections from central banks in advanced economies" helped lift asset prices.
  - Emerging markets have become a "much more diversified asset class."
  - Ownership is now "mostly domestic": when Richard House started 25 years ago foreign investors dominated; today there are "more than 80 countries to choose from, and average ownership of foreigners is about 20 percent, including corporate debt."
  - Large domestic ownership "limits contagion and has made the whole asset class more resilient."
- Issuance and flows:
  - For the whole of 2020, "Eurobond issuance by emerging economy borrowers was some $800 billion, more than a 10 percent increase over 2019."
  - Many emerging economies saw "their external financing needs go down due to the recession-induced reduction in their current account deficits."

### Global liquidity environment and interest rates
- United States interest rates and capital flows:
  - A collapse of US real interest rates starting in late March 2020 was "critical" in pushing capital toward emerging economies.
  - "Rises in US interest rates have been a threat to emerging markets’ capital flows since the 1970s."
  - A recent small increase in 10-year US Treasuries caused some turbulence, but "by any historical standards, a 10-year US Treasury yield that remains negative in real terms is absurdly low."
  - As long as real yields remain negative, "the threat of significant capital outflows should be contained."
- Interaction of US growth and emerging markets:
  - If long-term rates move up due to stronger US growth, that does not normally offset the impact of higher borrowing costs for emerging markets because tighter US monetary conditions tend to generate capital outflows.
  - Recent drivers of global investment, trade, and commodity prices have been "China" rather than the United States.
  - The "ideal combination" for emerging markets would be "a weaker US, with low interest rates pushing capital toward emerging markets, and a stronger China boosting trade and investment."

### Policy responses in emerging markets
- Unconventional monetary policies:
  - "Every central bank has been unconventional" compared with a few years ago; the narrative that emerging countries cannot do quantitative easing is "long past."
  - There has been "a lot of diversity" in approaches (example: India "has successfully announced expansionary fiscal policy together with caps on bond yields").
  - The difference in policy space often depends on "markets’ confidence about each country’s growth potential" and "how open their capital account is."
- Fiscal policy constraints:
  - Fiscal policy was more difficult for many emerging economies because "many countries did not have the firepower of advanced economies."

### Debt burdens, risks, and adjustment
- Debt trajectory and vulnerabilities:
  - Debt burdens of emerging markets and low-income countries are "rising to unprecedented levels."
  - House: he does "not see debt-to-GDP levels coming down to pre–COVID-19 levels for many years."
  - Lubin: "Accumulating large debt in foreign currency is much more dangerous. However, we’re still far away from that."
  - Key indicators "like the external debt service ratio and debt to foreign exchange reserves ratio don’t look too stretched in historical terms."
  - Low US interest rates "will help keep the debt service cost low."
  - Over the last 20 years many emerging economies "made strenuous efforts to accumulate foreign currency reserves."
  - Domestic debt problems "are more serious in some countries" and represent an area where "investors and the IMF have very little experience."
- Systemic crisis risk:
  - House: pegged exchange rates have been " thankfully consigned to history," so he does not expect "another big systemic emerging markets crisis again" at the sovereign level.
  - Lubin notes experience over the last 40 years has been "mostly with foreign debt," implying uncertainty about domestic debt crises.
- Need for financial assistance and private sector participation:
  - Some countries facing liquidity or solvency issues "will need more assistance from the Fund and potential private sector participation in restructurings."
  - House: "The private sector should definitely participate when debt is clearly unsustainable."
  - Lubin: portfolio managers are paid to do risk assessment; if private creditors expect IMF bailouts, "they’re not doing their job properly."

### Environmental, social, and governance (ESG) issuance opportunities and concerns
- Market size and demand:
  - ESG in emerging markets is "a nascent asset class, but with huge potential."
  - At an estimated "$16 billion, it’s still only 4 percent of total funds under management in emerging markets."
  - "All investors are demanding them now—three-quarters of my client meetings are about our strategies on these investments."
- Roles for the IMF and other public institutions:
  - The IMF "can play a role in helping smaller countries get involved" and "help in monitoring engagement and reporting."
  - Investment banks are "eager to help countries issue these bonds"; the Fund could assist more on "monitoring and engagement, and especially on social and governance aspects."
- Risks and limitations:
  - Fungibility of money complicates verification of use: "A country says it is raising money to invest in this green project or to build schools in rural communities. How can we know for sure?"
  - ESG ratings are "highly correlated to per capita GDP," raising concerns that green and socially responsible bonds could produce perverse consequences whereby "capital flows to lower-income countries could be at risk."
  - Lubin warns that values-based investing could lead to ambiguous effects: "The leverage investors might have could end up perpetuating a situation."

*Emerging Markets in Flux — interview with Richard House and David Lubin, Finance & Development, June 2021.*

---


_Source: https://www.imf.org/-/media/files/publications/fandd/article/2021/june/emerging-markets-in-flux-pradhan-house-lubin.pdf_