Emerging Markets Credit Risk Highlights

A selection of Moody’s latest comparative insights on global emerging market research. For a complete list of EM reports on Moodys.com click here.

 

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Policy shifts loom as Colombia’s presidential election heads to a run-off

Colombia will hold a pivotal runoff election on Sunday June 19 amid rising social tensions, not only in Colombia but across Latin America and other emerging markets, as rising inflation erodes household living standards and economic scarring from the pandemic clouds the growth outlook. The outcome may be a useful bellwether to see how these forces will reshape the political landscape for other major emerging market sovereigns.

The two candidates in Colombia’s election – Gustavo Petro, a former mayor of Bogota, and businessman Rodolfo Hernández – have both pledged to make significant changes to the country's economic and political system amid rising social tensions. Petro has proposed policies that could weigh on investor sentiment, including altering the central bank's mandate, imposing import tariffs, and renegotiating the country's free trade agreement with the US. Hernández has stated that his government would be austere and seek to reduce spending by decreasing the size of the government workforce. Both intend to implement policies that accelerate carbon transition, impacting the oil and gas sector. However, either candidate will likely have to moderate their manifesto once elected to secure the support of the legislature.

As the exhibit below shows, Colombia's risk premiums have widened compared with those of similarly rated regional peers since May 2021, at which point large-scale protests contributed to the government withdrawing its initial fiscal reform proposal. While we expect that Colombia’s legislative and judicial checks and balances will prevent the more radical policy changes from being implemented, If the policies of the next administration weigh on investor confidence, this could result in permanently lower investment in the country and hence lower potential GDP growth.

Stresses continue to build amid China’s property sector, despite increasingly active government policy guidance

Chinese developers have continued to experience liquidity stress, particularly in the offshore market, with rated developers issuing only $8.5 billion and $2.5 billion of bonds in the onshore and offshore markets respectively in the first five months up to 24 May. This marks a significant decline from $15.1 billion and $16.9 billion issued during the same period last year. Weak sales continue to weigh on confidence, with the national contracted sales value declining by 34.4% in annual terms in April 2022, an acceleration from 25.6% in March 2022.

Domestically, we expect Chinese banks will remain cautious about financing property developers – especially those in distress – despite recent policy guidance to stabilize the sector. Central government policy guidance toward supporting the sector has become increasingly active (see exhibit 1), and since April, a number of municipal governments have followed suit by easing property purchase regulations, such as through relaxing sales and purchase restrictions, lowering the down payment ratio, as well as increasing the quota of loans for home purchase.

However, funding conditions will remain tight in 2022 as supportive policies will take time to substantially ease the funding constraints faced by developers. Our Asian Liquidity Stress sub-indicator (ALSI) for rated high-yield Chinese developers increased to a record high of 47.6% in April 2022, driven primarily by a deterioration in operating cash flow for three rated developers. However, rated developers’ refinancing needs remain high over the next 12 months, with around $29.5 billion of onshore bonds and $34.3 billion of offshore bonds maturing of subject to put options in the next 12 months from 1 June 2022. Given that government policy measures will to take time to take effect, the ALSI is likely to remain elevated over the coming months.

As carbon transition accelerates in emerging markets, sectors with limited decarbonization options will face the most risk

Net-zero carbon commitments are no longer limited to advanced economies: most of the largest EM countries including China, India, Brazil, Indonesia and Saudi Arabia have announced a target. However, efforts to meet these commitments will increase carbon transition risk for the most exposed issuers in these regions, especially those in hard-to-abate sectors. While emerging markets will reap myriad health benefits from the transition to a low-carbon economy, including curbs in pollution-related mortality rates and health issues, adjusting to a low-carbon economy will require balancing economic considerations against decarbonization efforts.

Exhibit 1: Net-zero emissions targets across the globe

Our analysis shows that most of the investable universe in EMs is from carbon-intensive sectors: around half of the Eurobonds issued last year by emerging market issuers were from carbon-intensive sectors such as oil and gas and utilities. Consequently, a sharp increase in investments is needed to finance a transition to a low-carbon economy: more than $1 trillion in annual clean and energy efficiency investments will be needed in emerging market economies under the IEA’s Net Zero Emissions by 2050 scenario. Moreover, raising this level of capital investment from concessional and market based financing sources will be challenging, and the commitments made to date from multilateral development banks fall well short of most emerging markets’ climate-investment requirements.

Exhibit 2: Emerging market debt issued by sector

The level of differentiation between companies in emerging markets and advanced economies is contingent on a sector’s inherent exposure, business model and policy mix. Emerging market companies in hard-to-abate sectors like oil and gas, steel and airlines are more exposed to transition risks than those in sectors with scalable technologies, such as electric utilities and auto manufacturers.

In some of these sectors, emerging markets have some advantages over their advanced economy counterparts. For example, in the oil and gas sector, emerging market oil refiners are better positioned for carbon transition because middle distillates and petrochemicals are less exposed to carbon transition risk than light distillates like gasoline. However, in other sectors like steel production, less energy efficient furnaces place the Chinese and Indian steelmakers in a more vulnerable position to carbon transition than their peers with a greater share of efficient electric arc furnaces (EAF) in the United States. That said, in the short-term, the surge in scrap metal prices arising from the Russia-Ukraine crisis puts steelmakers with higher EAF capacity at disadvantage.