Inflation can be a boon for debt buyers
ACCORDING to a report released yesterday by the World Bank, too many of the world’s fast-growing developing countries are deploying crisis-fighting policies even though their economies have recovered from the recession, exacerbating inflation. Economic growth in developing countries will slow to 6.3 per cent in 2011 from 7.3 per cent in 2010. China will continue to set the pace, expanding 9.3 per cent this year and 8.7 per cent in 2012.
Developing nations also need more flexible currencies, the World Bank’s Global Economic Prospects report said. At the release of the report, Ardo Hansson, the World Bank’s chief economist for China, said that the government of the People’s Republic is “very unlikely” to meet its 4 per cent inflation target for the year, with the rate set to stay at about 5 per cent for “a few more months.”
With China struggling to bring down its levels of inflation – which have been on a steady ascent since the March 1999 record low of -2.2 per cent – it is likely that the People’s Republic, along with the central governments of other emerging markets, will appreciate its currency in order to try to compensate for inflation.
As the currencies of the majority of emerging market economies are heavily controlled, the best way for investors to get exposure to currency appreciation is through bonds denominated in local currency. Should this inflationary trend continue, it will carry on boosting emerging market debt funds.
According to Robert Stewart, managing director of JP Morgan Asset Management, “Debt funds are a very good way of gaining from emerging market inflation. One of the ways that central banks in emerging markets are dealing with inflation is through currency appreciation. A number of finance ministers in EMs are happy to appreciate their currencies to fight imported commodity price increases and it’s sensible monetary policy.”
A WORD OF CAUTION
Mark Konyn, CEO Asia of RCM Allianz Global Investors, urges some caution as further emerging market currency appreciation is not guaranteed. Still, to date, central governments have been quick to step in at times of a drop off in growth, which suggests the opposite policy. “From a macro and policy perspective, the main risk relates to the sustainability of China’s economic growth,” Konyn says, adding, “a significant growth shortfall would put pressure on the authorities to limit the currency appreciation, and in the worst case the government could consider devaluation, should real economic growth fall below 7 per cent annualised. China’s government has been taking steps for some time and implementing policies to avoid such a negative scenario.”
Blanca Koenig, fixed income strategist for BlackRock’s iShares business, points out that exchange-traded funds (ETF) also give investors exposure to EM currency appreciation: “The bonds will benefit from currency appreciation, which will increase the price of the ETF and therefore benefit the investor. Bond prices will generally benefit from this increased demand and the currency will likely appreciate.” Koenig added: “Currently we see a lot of positive momentum with clients looking to invest in local currency EM bonds.”
CORRECT TIMING
Alan Higgins, head of investment strategy UK at Coutts, says that local emerging market debt is an attractive asset class, providing investors pay attention to the strength of their native currency. “Returns on local emerging market debt are heavily determined by currency and in the current environment this is a positive, as we expect the major emerging market currencies to appreciate versus developed market currencies. Investing in emerging market debt can be complicated by investing from a non-US dollar base, like sterling, as most emerging market currencies are heavily correlated with the dollar,” says Higgins. “Returns can therefore be undermined by the strength of sterling versus the dollar and this must be taken into account when making investment decisions for UK and other non-US dollar-denominated clients.”