The economic woes in Turkey and Argentina have created an attractive entry point into emerging markets, according to Ashmore Group’s Jan Dehn, who said economic fundamentals look robust across the majority of the sector. 
The global head of research (pictured) added that although the two countries have dominated the recent news flow on emerging markets, they represent a small part of the sector’s debt indices.
“Amidst all the noise over Argentina and Turkey, it is easy to forget that the emerging markets fixed income universe now comprises 156 individual indexed bond markets,” he said.
“Moreover, these 156 indexed markets only make up about 9 per cent of the total emerging market fixed income universe, which today measures $24trn, or 22 per cent of global fixed income.”
He added: “There is a tendency to lump all these disparate markets together during bouts of risk aversion, and even to extrapolate onto the majority what is happening in the few.
“Much of this dumbing down happens because herd instincts are still strong among investors, wherefore many easily fall prey to speculation about contagion and other nonsense.”
Dehn pointed out Turkey and Argentina account for just six of the 156 indexed markets in the emerging market bond universe and are “far from the largest”, noting that the remaining 96 per cent are for the most part doing fine. The head of research added that their “boring robust economic fundamentals and sensible economic policies ensure that they never make the headlines”.
One such example of a “non-headline grabber”, is India, which saw real GDP grow by 8.2 per cent year-on-year in the second quarter, exceeding consensus expectations of 7.8 per cent.
“The key driver of Indian growth in Q2 was domestic demand, with financials and construction also playing a very big role in the stronger than expected growth number,” he continued.
“Domestic demand in general is going to be an important theme in emerging markets in the coming years.
“Exports to developed markets, especially the US, are going to face challenges due to protectionism and eventually weaker developed market currencies versus emerging market currencies, so emerging market countries, which can rely more on consumption as a source of growth, will do well.
“The shift to consumption is already evident in China and other large emerging market economies, such as Indonesia, Brazil and India.”
In China, domestic demand is likely to add 0.7 per cent to economic growth following an increase in monthly personal income tax exemption, which Dehn said should offset any impact of the trade tariffs introduced by US president Donald Trump.
He added that despite the ongoing trade disputes with the US, the Chinese economy looks stable and robust.
Another beneficiary of domestic demand – Indonesia – has also been buoyed by lower-than-expected inflation, despite increased pressure on emerging market currencies from a stronger US dollar over the past six months.
“Investors often think that currency weakness leads to higher inflation in emerging markets, but such pass-through is often not evident, because credible central bank policies have successfully anchored inflation expectations,” he said.
“In general, inflation remains very low in emerging markets apart from Argentina and Turkey. The 18 countries in the JP Morgan GBI EM Global Diversified index today have roughly 4 per cent inflation on average, but 3 per cent if one excludes Argentina and Turkey. This is down from 5 per cent on average in 2011.”
Returning to Argentina, Dehn noted that it continues to face issues despite working on new fiscal measures designed to restore investor confidence.
The moves follow failed attempts at gradual adjustment after more than a decade of extreme populism under successive Peronist administrations.
Efforts to tackle the Argentinian government’s deficit include a central bank rate hike to 60 per cent, with president Mauricio Macri facing further difficult political choices such as whether to impose fiscal measures on his base in Buenos Aires or levy taxes on the remaining two-thirds of the population living in the provinces.
The government has targeted a new deal with the International Monetary Fund (IMF), but Dehn said the country may have more structural issues preventing it from tackling its problems.
“Argentina’s recurring fiscal problems are rooted in the country’s constitution, which guarantees that the central government is too weak to withstand spending pressures, let alone reverse them,” he said.
“While IMF disbursements can help the government to buy some time, the IMF is powerless to solve the constitutional problem. That is why Argentina is a serial defaulter.”
Performance of indices YTD
Source: FE Analytics
As the above chart shows, the Argentina fixed income market has significantly underperformed emerging markets during 2018.
In sterling terms, the JPM Argentina bond index has fallen by 46.55 per cent year-to-date, compared with a fall of 7.11 per cent for the JPM GBI Emerging Markets Diversified Composite index.
Indeed, the poor performance of the Argentinian debt market – rather than signalling issues for the asset class – highlights what could be an interesting opportunity for potential investors.
He concluded: “Buying into general emerging market weakness when troubles are confined to just two countries gives extremely good odds of making money on the trade.”