External debt: intact attractiveness

In the external EM debt universe, among others, we like Morocco (fiscal consolidation, positive reform momentum), Georgia (sustained growth, diversified economy, sharp improvement in ‘doing business’ ranking), Sri Lanka (oil importer, sustained growth, limited budget and current account deficits, political reforms) and Namibia (non-oil country, sustained growth).

Local debt: the carry rewards the volatility

Following the Q4 correction, local currency emerging bonds offer a yield that offsets a good portion of the duration and forex risks (Chart 8). We still prefer countries with the most solid fundamentals and where reforms are already well under way, such as India. We are not too concerned by the fall in commodity prices and especially oil prices. EM countries are different from each other and not all are negatively sensitive to the fall in oil prices (Chart 9). Actually, oil exporters represent only about 25% of the widespread EM indices.
Conversely, we have negative biases on South African, Malaysian and Philippine debts considering the low level of their carry. In addition, the hawkish tone of their Central Banks could lead to rate hikes this year.

Forex: valuation are close to fair value

Currencies have hugely depreciated since May 2013. The sharp drop in oil prices over the last couple of months has triggered further depreciation of oil-linked currencies. Overall, we consider however that 2015 should not be as bad as 2013 and 2014 were. According to us, valuations are now close to fair value overall given that at the same time, current accounts have improved and real rates have risen. Typically, INR and PHP represent this trend. Moreover, their respective countries are oil importers. We are therefore positive on both currencies. Conversely, we are are cautious towards currencies linked to oil prices such as PEN and COP.

Opportunities in Eastern Europe, despite Russia

As to Russia, we believe it is still too early to go long Russian fixed income assets. The game changers would be a credible sign from the oil markets of potential stabilization (e.g. cut in supply by one of the major suppliers) as well as reasonable hopes that some of the US and EU sanctions could be lifted. On the monetary front, although the Central Bank could ease rates to support growth, rate hikes are not excluded in the short term to support ruble and counter rising inflation. Turkey has received increased attention from investors in general since geopolitical problems and the risks rose in Russia. It is a good play for investors looking for yield. Many of the macroeconomic factors for Turkey are improving, which is aided by falling oil prices because it is big importer of energy. Furthermore, inflation and current account deficit are in a downward trend. The country will continue to benefit even if the oil price shows some strength. Elsewhere in the region, we are buoyed by opportunities in Poland, Romania and Hungary.
We like Serbia as well. Macro-economic figures are not that great at the moment and they still need a lot of reforms, but the signing of the IMF deal is encouraging and we think valuation of the bond is interesting.
However, we are keen to limit exposure to the Czech Republic both in debt and currency terms. This market was particularly unattractive given the prospect of monetary stimulus in the euro zone. The countries we focus on have relative flexibility in monetary policy but the Czech Republic has rates at 0.05%, so there is no room to change that position if the rest of the Eastern European region lowers rates. The CNB will have to use the exchange rate as a monetary tool. Any move from the ECB will only reinforce the need to ease.