Looking at Asia and fixed income in emerging markets, Lombard Odier Investment Managers (LOIM) says the Covid 19 crisis has acutely reduced both the availability of yield and the supply of higher quality assets versus demand, especially given the downward ratings migration. A market commentary by Dhiraj Bajaj, Head of Asia Fixed Income, LOIM.
The structural lack of quality credit globally versus insatiable investor demand had been an issue even before the Covid 19 crisis. The crisis simply altered this trajectory to super-drive. Ultimately, the prolonged zero interest rate cycle, lower trend growth in developed markets and emerging markets weighed down by their own debt should mean that a duration-induced sell-off could be short-lived and provide buying opportunities for long-term investors.
The credit recovery of the various emerging markets will be highly differentiated. While it appears that developed markets have an immediate edge over emerging markets, we expect a significant differentiation within the emerging market universe that will dictate their future in 2021 and beyond. This is likely to be driven by the speed of return-to-trend growth,, the benefit of a resurgence of multilateralism, and the expected feasibility of balance sheet repair. The key to identifying emerging market growth outperformers in 2021 will depend on three main factors: the extent of vaccination readiness, the delta to normalized growth from 2020 levels, and a stabilized level of long-term potential growth that can be achieved upon full emergence from Covid-19.
With regard to the trajectory of country ratings, we expect the worst of the downgrades caused by Covid-19 to be behind us. However, given the balance sheet damage caused by the crisis, we expect the mild downward trend for emerging markets to continue next year.
China’s priorities: Dual Circular Economics and Financial Stability
Looking at China, we assume that the reorientation of priorities could lead to a new long-term structural trend for Asia. Following the successful management of the pandemic, the authorities have switched from firefighting mode to a strategic view of long-term economic development. In the medium term, we believe their top priorities will be: Dual Circular Economics and Managing Financial Stability. Based on these two refocused priorities, China should be able to create structural growth opportunities in a controlled manner that can increase GDP growth by 75% to 100% by 2035. In addition, China’s goal of carbon neutrality could lead to higher investment growth. The three red line policy to control developer debt growth is likely to contribute to a successful cooling of the real estate sector.
India’s growth potential is estimated at 6% due to the impact from the pandemic, balance sheet constraints and the moderate policy response, signifying a slowdown. However, with the government firmly committed to unlocking medium-term growth potential and providing vaccines, we expect rating agencies to take a wait-and-see approach to India’s sovereign ratings. By realizing its growth potential, India could avert a downgrade of its credit rating.