Emerging market debt reflections following IMF-World Bank meetings

Soft landing, now almost a consensus. “The battle against inflation is almost won,” were the opening remarks of the Annual IMF-World Bank Meetings in Washington DC. With inflation (nearly) at target, the Federal Reserve can now do its utmost to prevent a recession or significant slowdown. Most likely this will mean a more aggressive easing cycle than the market is currently pricing, easing the pressure on emerging market (EM) countries as the dollar is likely to weaken and encourage renewed capital inflows to EM.

Trump 2.0, market consensus? EM investors and policymakers exchanged views on implied fiscal expansion from the proposals discussed during the US election campaign – on the inflationary effect from fiscal, trade and immigration policies under Trump or Harris. It was conjectured that a Red Sweep with high tariffs and retaliation regime could potentially lead to a global recession and an inflation spike.

A turning point in EM sovereign debt. We were reminded that exactly a year ago, the IMF-World Bank Annual Meetings of 2023 focused on issues surrounding the ability of countries like Kenya and El Salvador to meet repayment schedules, as well as what Egypt and Nigeria would do to address deteriorating external imbalances. These countries have had remarkable turnaround stories since then: in addition to having successfully refinanced their debt obligations and devalued their currencies, as needed, they embarked on ambitious reforms which led to compression of risk premium.

We also recalled that in the Spring Meetings earlier this year investors discussed when to expect the completion of debt restructuring process for Zambia, Ghana and Sri Lanka. The former two exited restructuring and their new bonds are freely trading while it appears increasingly likely that the latter would emerge from default before the end of the year. With no EM default expected in the near term, we see a turning point for EM external debt and sense investor sentiment towards EM debt has improved.

Debt risks are shifting to DM. The IMF warned against continued expansionary deficits and rising debt-to-GDP ratios, especially in the US. While investors continue to believe in US exceptionalism in terms of growth and private investments, we sensed a widespread concern about US fiscal sustainability and potential fiscal expansion under the next government. Fiscal slippages in DM in relation to consolidation plans are substantial compared to EM (see Chart). In stark contrast, the IMF attributed the overall resilience in EM to improved monetary policy credibility and more effective management of fiscal risks.

The narratives around distressed sovereigns remain idiosyncratic: investors were enthusiastic about the higher likelihood of capital controls being lifted in Argentina, potentially with IMF support, while becoming more cautious in the short term on Ecuador as severe droughts and blackouts were thought likely to affect the February election outcomes (although market-friendly President Noboa still has a strong chance to win). Middle East volatility has renewed investor interests in Lebanon, as investors presume a likelihood that, with a weakened Hezbollah, the country would be finally able to form a government and eventually begin a restructuring process.