A significant gap exists between optimistic market pricing and the cautious stance of credit rating agencies. While investors are rewarding frontier economies for recent reforms, agencies are waiting for a stronger, longer-term track record of fiscal discipline and stability before issuing upgrades, particularly in African nations.
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Emerging market credit spreads are tightening while developed markets' are widening. This divergence is not a fundamental mispricing but is explained by unique, positive developments in specific sovereigns like post-election Argentina and bonds in Venezuela on hopes of restructuring.
The CEO advocates to bodies like the G20 and challenges ratings agencies, arguing that the perceived risk of African projects is higher than the data supports. This aims to lower the risk premium, unlocking more capital for the continent.
Beyond larger frontier markets, investors are focusing on specific, compelling reform stories in Uganda and Angola. Uganda's appeal lies in its oil-driven prospects for fiscal and current account improvement, while Angola is gaining credibility for its disciplined fiscal recalibration tied to oil price movements.
Contrary to historical trends, policymakers in key African nations are demonstrating a sustained commitment to economic reforms. This resilience, forged by recent global shocks, is signaling to investors that current reform paths are more enduring, reducing perceived political risk and increasing interest in the region's sovereigns.
Due to compressed credit spreads, investors are shifting their focus from sovereign bonds to local market opportunities like currency and local bonds. They perceive fewer opportunities in credit and are actively seeking value in countries like Nigeria, Egypt, and Kazakhstan, where local stories are more compelling.
While overall EM credit spreads are near post-GFC tights, making value scarce, Argentina stands out. Following positive legislative election results, its sovereign debt has rallied significantly but remains wide compared to its own history and peer countries, suggesting substantial room for further performance in an otherwise expensive market.
Contrary to a simple narrative of improved market sentiment, EM sovereign resilience stemmed from unexpectedly strong macro fundamentals. Better-than-forecast current account balances, export performance, FDI, and portfolio inflows were the primary drivers of stability, exceeding even conservative projections from two years prior.
Despite compressed spreads and improved market access, credit markets are not complacent. Pricing for the most vulnerable emerging market sovereigns still implies a significant 17% near-term and 40% five-year probability of default. This is well above historical averages, signaling lingering investor caution and skepticism about long-term stability.
Despite being at historically tight levels, EM sovereign credit spreads are unlikely to widen significantly from an EM-specific slowdown. The catalyst for a major sell-off would have to be a 'beta move' originating from a crisis in core US markets, such as equities or corporate credit, given the current strength of EM fundamentals.
Unlike the US, emerging markets are constrained by financial markets. If they let their fiscal balance deteriorate, markets punish their currency, triggering a vicious cycle of inflation and higher interest rates. This threat serves as a natural check on government spending, enforcing a level of fiscal responsibility.
