Institutional flows to emerging-market bonds are likely to shift more toward sovereign borrowers with credible economic reform agendas, such as Indonesia, and away from those where the rule of law is in decline, such as the Philippines, said Baker, investment director for emerging markets at Standard Life Investments in Hong Kong.
Overall institutional demand for emerging-market debt (EMD) remains strong, he said.
The local-currency market is now $7trn in size, although it is fragmented and many markets are hard to access. The hard-currency sovereign market is smaller, at $800bn, and features more borrowers, but this year has seen blockbuster financings, capped by October’s $17.5bn debut sovereign issue by Saudi Arabia.
“Investors like EMD because they fear US interest rate hikes, European negative yields, and political uncertainty in developed markets,” Baker said, adding that the biggest generic risks – currency and commodity price shocks – have already occurred and are unlikely to be repeated soon.
On the positive side, he is overweight markets that are making visible and credible efforts to improve their fiscal positions. Two overweights are India, which is legislating for a general tax on goods and services, and Indonesia, which has a tax amnesty policy that is expanding the government’s tax revenue base.
On the other hand, he remains skeptical of Argentina: “I’m not convinced [the reformist president] Mauricio Macri can both deliver needed change and keep the electorate behind him,” Baker said. This may put Baker in the minority of views: Argentina raised $16.5bn in April on the back of investor enthusiasm over Macri’s assumption of power after many years under the crony capitalism of the Kirchner family.
Baker also is wary of countries whose governments are not adapting to the change in commodity prices, such as Russia and South Africa; the jury is out on Brazil, he said.
He is also cautious on the Philippines, despite its attractive growth rate, balance of payments and fundamentals. But Baker said he doesn’t understand the policy direction under President Rodrigo Duterte. The degradation of rule of law, as Duterte allows vigilante justice to rule instead of due process, does not bode well for governance in the country, Baker warned.
