Emerging Market Bonds Remain Attractive, As More Countries Improve

From BlackRock: The latest quarterly update of the BlackRock Sovereign Risk Index (BSRI) makes it easier for investors to determine how emerging market bonds stack up. Richard Turnill explains.

Investor demand for emerging market (EM) debt has been strong lately, as the near-term risk of trade wars has faded and income seekers have flocked to the asset class’ higher yields. EM debt funds saw 12 straight weeks of inflows, the longest streak since the U.S. election, according to EPFR Global data through the week ended April 19.

However, it’s important for investors to remember that not all EM debt is created equal. We see selected opportunities in the asset class, especially in local-currency debt among broadening reflation and limiting risks from U.S. dollar appreciation, but high valuations keep us neutral overall.

One tool that we use to help determine how EM sovereign bonds stack up: our BlackRock Sovereign Risk Index (BSRI) rankings of government debt. The latest quarterly update of the BSRI, released this week, makes it even easier for investors to compare the sovereign risk of EM countries.

This quarter we have added 10 additional countries to our rankings, taking advantage of the increasing depth and quality of available data on EM economies. The new members are the Dominican Republic, Ecuador, Kazakhstan, Lebanon, Lithuania, Panama, Romania, Serbia, Sri Lanka and Uruguay. The BSRI now spans 89% of the JP Morgan EMBI Global Core index and 82% of the JP Morgan EMBI Global Diversified index, as well as major developed markets.

Each country’s final BSRI score and ranking is based on four categories. Fiscal Space (40%) assesses whether a country is on a fiscally sustainable path, while External Finance Position (20%) examines how leveraged a country might be to macroeconomic trade and policy shocks outside of its control. Willingness to Pay (30%) gauges how able and willing a country is to pay off its debt, while Financial Sector Health (10%) measures how healthy a country’s financial sector is.

Among the new entrants to our rankings, Kazakhstan was the strongest, debuting in 26th place. Its relatively narrow budget deficit, young population and high domestic share of debt ownership supported a positive Fiscal Space score. That in turn largely offset a poor Willingness to Pay score. Uruguay entered at 33rd place. Its relatively strong Financial Sector Health partially offset a weak Fiscal Space score.

Lebanon was the weakest of the new entrants, ranking 59th out of 60 countries, just ahead of Venezuela. The country’s challenges include high net debt levels, a budget deficit approaching 9% of gross domestic product (GDP), and a gaping current account deficit. Sri Lanka took the 54th spot. It has a significant debt burden, and a weak External Finance Position, mostly driven by a high share of near-term debt maturities.

Among original BSRI members, Japan was a notable mover. Its risk profile improved from last quarter after the International Monetary Fund cut the country’s projected net debt-to-GDP ratio for 2017 to 120% from 131%. This followed a revision to Japan’s national accounts that lifted its estimated nominal GDP. Japan’s Fiscal Space score, the Achilles’ heel of its BSRI profile, rose as a result. Read more about our rankings in the full BSRI update.

The iShares JPMorgan USD Emerging Market Bond Fund ETF (NYSE:EMB) was unchanged in premarket trading Friday. Year-to-date, EMB has gained 4.19%, versus a 6.74% rise in the benchmark S&P 500 index during the same period.

EMB currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 22 ETFs in the Emerging Markets Bonds ETFs category.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

This article is brought to you courtesy of BlackRock.

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