EM in 2025: What doesn’t break you makes you stronger

December 13, 2024

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Years of macroeconomic and geopolitical headwinds have had an unexpectedly positive effect on emerging market corporates, potentially setting them up for a strong 2025, argues Warren Hyland.

Emerging markets (EM) have weathered significant challenges in recent years, from a global pandemic and interest rate turmoil to US dollar strength and slower Chinese growth.

Geopolitical conflicts in Europe and the Middle East have dampened international investor enthusiasm, leaving EM to fend for itself. However, this has turned out to be the making of many EM companies.

Fundamentals: Survival of the fittest

After four years of crises, the EM corporate universe has been thoroughly cleansed. Companies with deteriorating fundamentals have been downgraded, while those facing liquidity challenges have either restructured or defaulted, increasing the quality of the investible universe. We believe the rating downgrades and default cycles have peaked.

During periods of extensive negative rating activity, investors become pessimistic. This is typically followed by a 12-18-month period of upgrades as ratings normalise when worst-case scenarios fail to materialise.

This normalisation trend has been evident since the third quarter of 2024, when net ratings turned positive for the first time since 2012. Upgrades totalling US$172 billion outpaced downgrades of US$112 billion.¹ Our analysis suggests rising stars will outpace fallen angels in 2025. The upbeat tone is also evident in the sovereign universe, where positive rating agency outlooks outweigh negative ones (Figure 1).

Defaults expected to fall in 2025

Defaults are driven by ratings trends (Figure 2), and the availability and cost of funding, which also appear supportive. Primary markets fully reopened in 2024, and central banks are continuing to ease monetary policy.

As a result, 2025 defaults are likely to be lower than 2024. This can be quantified by recent data suggesting 2.65% of the corporate high-yield universe is at distressed levels.² According to JP Morgan, with historical data indicating c.50% of distressed EM corporate bonds default in the following 12 months, this suggests an implied default rate of c.1.33%, lower than its 2.7% default forecast.³

Moreover, corporate fundamentals appear solid. Sovereign imbalances are smaller, providing greater market resilience and giving policymakers more room to respond to external risks. Corporate leverage remains manageable at 0.9x for investment-grade issuers and 2.3x for high-yield issuers (Figure 3). And consensus estimates suggest c. 90% of EM corporate issuers are expected to post growth in 2025, with revenues projected to increase by 4% and EBITDA by 9%.³

Financials are also in good shape. Bank balance sheets are broadly stable and peak policy rates should support modest improvements in loan provisions. Bank capital bases remain robust, with Tier 1 ratios slightly improving in 2024 to 13.9%.³ The only sector forecast to decline is oil and gas, reflecting falling energy prices.³

With such a constructive fundamental backdrop, the main risk factor and key focus for investors in 2025 will be the external environment which, at first glance, appears supportive. Consensus forecasts project global growth above 3%, with pricing pressures continuing to ease and policy rates falling.⁴ This shift should boost real incomes, supporting consumption and trade.

US tariffs: Much ado about nothing?

The Republican sweep in the US elections and return of Donald Trump as president have raised concerns over the macroeconomic outlook. The fear is that if the US were to impose punitive trade restrictions through tariffs and large-scale deportations, this could lead to a severe global supply shock and threaten global expansion.

The question is whether such fears are overblown. EM credit tends to perform best in a risk-on environment paired with a lower-rate regime - essentially aligning with the blueprint of the Trump agenda. The prospect of reduced risk premia on key geopolitical issues, such as Middle East tensions and the Russia-Ukraine conflict, could have a direct positive impact on EM. Additionally, US deregulation and tax cuts could indirectly have positive spillover effects. This leaves tariffs as the main area of uncertainty.

US tariffs are expected to have the most significant negative impact in Asia, with China at the centre of the storm. While tariffs will weigh on Chinese growth, their primary effects are transmitted through reduced confidence and declining capital expenditure. However, 7 years after the last major round of tariffs, several mitigating factors have emerged.

Multinational corporations and Chinese manufacturers are now better prepared, having adjusted supply chains to bypass direct exports to the US. As a result, China’s direct exports to the US have declined from 21.8% to 13.5%. ⁵

In 2018, the Chinese government tightened policy, cracking down on shadow banking and imposing measures to rein in the property market. Today, however, China is aggressively loosening monetary, fiscal and regulatory policy to counteract the deflationary spiral driven by weakness in the property sector. Any significant increase in tariffs would be likely met with further monetary easing through a weaker yuan and additional fiscal stimulus, with a stronger emphasis on boosting Chinese consumption.

Notably, there are few, if any, direct exporters to the US among Chinese international bond issuers. During the implementation of US tariffs in 2018, there was no significant credit spread widening observed in Asia high-yield bonds (Figure 5).

We estimate 72.5% of EM corporates are focused on their domestic market and therefore not directly affected. A further 17.4% could be indirectly impacted as part of a broader supply chain, while 4.4% – comprising sectors such as cement, industrials/chemicals, proteins and metals – may even benefit from having direct US operations. Companies specifically impacted by tariffs amount to only 5.7%, mostly in the commodity sectors (Figure 4).

Figure 5: No significant spread widening in China high yield under Trump 1.0

Source: ICE Index Platform, as of 30th April 2019. Time period selected to highlight spread moves during and after the implementation of US tariffs. For illustrative purposes only.

In Latin America, Mexico’s relationship with the US will be closely scrutinised. With the US-Mexico-Canada Agreement trade agreement in effect since July 2020, the US administration may leverage the threat of tariffs as a bargaining tool during the 6-year review process to address its primary concern - immigration. Beyond Mexico, the region’s vulnerabilities are tied to commodity-related sectors, with risks stemming from slowing global demand or shifts in China’s purchasing patterns influenced by trade concessions with the US.

The Central & Eastern Europe, Middle East and Africa (CEEMEA) region is likely to be most insulated, thanks to a significant share of pegged currencies, improving fundamentals, and a higher likelihood of resolutions to the Israel-Gaza and Russia-Ukraine conflicts. However, significantly lower oil prices would pose a risk to MEA.

As for the incoming US administration’s policy agenda, it is worth noting Trump will inherit a significantly different US economy than his first term. Unemployment is low, and sticky inflation poses a greater concern than deflation. Economic growth is losing momentum and global trade activity remains muted. There is far less room for tax cuts, while debt levels are significantly higher and savings rates lower. Additionally, valuations in both equity and credit markets look stretched.

Technicals: Supply/demand imbalance to persist

From a technical standpoint, the supply and demand dynamics that have defined EM corporate debt for the past 3 years are expected to persist, with the shrinking investible universe more than offsetting the impact of modest outflows.

The primary risk to the technical picture remains the potential for investors to remain underweight EM. However, the improved risk environment, coupled with normalized bond curves as policy rates decline, could attract yield-seeking allocators to EM.

Estimates suggest 2025 will see US$10 billion of outflows,⁶ following c.US$13 billion in 2024.⁷

Figure 6: EM corporate gross and net supply forecasts

Source: JP Morgan emerging markets corporate outlook & strategy for 2025, as of 26th November 2024. For illustrative purposes only.

The contraction of the corporate universe for hard-currency debt is not due to an inability to access funding. On the contrary, primary markets were wide open in 2024. Many issuers have simply opted to tap their domestic markets, where funding costs are lower. EM high-yield issuers with external maturities in 2025 raised US$35 billion in local-currency bonds via syndicated or bank loans, asset sales, divestitures or initial public offerings to gain liquidity for upcoming maturities.⁶ 

Valuations: Yields remain compelling despite tight spreads

For investors exploring or reassessing their allocation to EM, we believe hard-currency corporate debt stands out as the most defensive asset class within the EM universe. It has greater diversification and lower duration compared to its hard-currency sovereign peer.

In contrast, local bonds face heightened volatility from their currency exposure, the main release valve to tariff pressure. Equities, being lower in the capital structure and subject to currency fluctuations, are inherently the riskiest EM allocation.

A persistent theme in 2024 has been historically tight credit spreads across all corporate sub-asset classes. Compared to recent history, the risk of spread widening appears greater than the possibility of further tightening. Yet we believe current spread levels can be justified given robust fundamentals, supportive technical backdrop and constructive total return outlook.

However, the current yield, at 6.02% and 66 basis points (bps) above its 10-year average, is a better indicator of total return potential and remains compelling.⁸ From a breakeven perspective, yields would need to rise by 116bps to offset returns. Even under our bearish scenario, where spreads double from current levels, based on the outlined scenario, the index would still deliver positive total returns over a 12-month horizon.⁹ 

Under our base case scenario of stable global growth at 3% – driven by a soft landing in the US, stabilization in China GDP at around 5%, easing geopolitical tensions in the Middle East and Russia-Ukraine, and a steady decline in energy prices – we believe the asset class has the potential to produce a total return of between 6-7%. This is primarily derived from coupon accrual and pull-to-par dynamics, as the asset universe is trading below par. For comparison, Bloomberg consensus forecasts for the next 12-month total returns of the S&P 500 and FTSE 100 are 4% and 3.8%, respectively. ¹⁰

The month in credit

EM credit had a strong month, with spreads tightening as markets reacted positively to the clear US election outcome. Government bond yields moved lower, with European rates significantly outperforming, creating a favourable environment for EM assets as investors sought higher yields. Sovereign debt outperformed corporate credit, benefiting from the barbell structure of the asset class, which includes high-quality long-duration bonds and distressed short-term debt.

Within the corporate world, lower-rated bonds (single-B and CCC) led performance, particularly Ukrainian securities in Eastern Europe. Reduced risk premiums on the Russia-Ukraine conflict under the incoming US administration bolstered these gains. Additionally, the telecommunications sector in Latin America posted notable outperformance. In the investment-grade segment, single-A bonds outperformed, primarily due to their longer duration, which benefited from falling yields.

Past performance is not a reliable indicator of current or future results.

EM corporate primary markets saw just US$17 billion of bonds printed in November, well below the 5-year monthly average of US$27 billion. Regionally, Asia led issuance at US$10 billion, followed by Middle East & Africa (US$3 billion) Latin America (US$2 billion), and EM Europe (US$2 billion). Net financing for October was negative at -US$30 billion, taking YTD net financing to -US$50 billion.¹¹ 

In country-specific events, confirmation of Donald Trump as the next US president caused concerns in Mexico that 25% tariffs would be imposed on all its exports to the US, with reports of potential disagreements between Trump and Mexican President Claudia Sheinbaum.¹²

Sentiment in Argentina was more positive given President Javier Milei’s close relationship with Trump. Argentina also reported positive inflation news, after hitting two key milestones showing prices are falling. Positive news also came from ratings agency Fitch, which upgraded the country’s sovereign debt, citing positive economic reforms and improvement in its ability to meet debt obligations.¹³

The picture in Brazil was less positive, however, after the finance minister’s proposals to cut the country’s budget deficit were received poorly by investors, sending the real to an all-time low against the US dollar.¹⁴

Moving to Europe, the Turkish Central Bank left interest rates on hold at 50% for the eighth consecutive month, after warning inflation remains a concern.¹⁵ Hungary also left base rates on hold at 6.5%. In contrast, the Czech central bank cut rates to 4%, while the International Monetary Fund (IMF) announced the country only has room for another 100bps of cuts over the year ahead.¹⁶

Following a recent visit, the IMF stated South Africa needs more ambitious consolidation to ensure public debt is under control and falling. However, the organisation also stated the country’s economic outlook was improving and activity recovering.¹⁷  The South African central bank lowered rates 25bps to 7.75% as expected.¹⁸

There was also further monetary policy loosening in Asia, as the Bank of Korea (BOK) surprised the market with a 25bps cut to interest rates.¹⁹ Having cut rates by the same amount in October, the expectation was that the BOK would hold in November and provide guidance for 2025. In a move largely seen as pre-emptive against likely trade and tariff headwinds, the focus of the BOK has now shifted towards mitigating risks to growth, with the inflation outlook seen as more benign.

In the Philippines, S&P changed the outlook on the country’s BBB+ rating to positive from stable, citing an improvement in the strength of country’s institutions that should support economic growth.²⁰ Whilst there may be headwinds to slower growth from China and the US, the country is still expected to grow well above average versus its peers. Meanwhile, its credit profile is underpinned by the country’s healthy foreign exchange reserves.

In India, Q2 FY25 GDP growth disappointed, coming in at 5.4%, below the 6.7% posted in the previous quarter and consensus estimates of 6.5%.²¹ The main contributor to slower growth was the industrial sector, with mining, electricity and gas and manufacturing all slowing considerably. High frequency data in October and November suggest there has been a pickup in activity.  This is consistent with Indian PMI data, which continues to be very strong.

What to watch out for

• China: After the disappointing National People’s Congress at the start of November, at which there was nothing new in relation to fiscal stimulus, attention now turns to the Central Economic Work Conference in December. This should set the general policy stance and key objectives for the year ahead. Things to look out for include the official growth target for 2025, any news on additional fiscal stimulus (which may be indicated by an increase in the official deficit), and whether there is any extension of the consumption upgrading and trade-in programmes.

Market Data - Credit

Past performance is not a reliable indicator of current or future results.

Source: ICE data platform. as of 30th November 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

Yield to worst

Source: ICE data platform. as of 30th November 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only.

References

1.JP Morgan Emerging Market Corporate Outlook & Strategy for 2025, as of 26th November 2024
2.ICE Index Platform, as of 30th November 2024. ICE BofA High Yield Emerging Markets Corporate Plus Index (EMHB)
3.JP Morgan Emerging Market Corporate Outlook & Strategy for 2025, as of 26th November 2024.
4.Bloomberg, as of November 30, 2024. Bloomberg Economic Consensus Forecast Index.
5.Morgan Stanley China Musings, as of 6th November 2024.
6.JP Morgan Emerging Market Corporate Outlook & Strategy for 2025, as of 26th November 2024
7.JP Morgan, as of 22nd November 2024. EM Flows Weekly
8.ICE Data Platform, as of 30th November 2024. ICE BofA US Emerging Markets Liquid Corporate Plus Index.
9.Based on Muzinich internal analysis, as of 30th November 2024.
10.Bloomberg, as of 30th November 2024.
11.JP Morgan, as of 2nd December 2024. EM Corporate Supply Technicals
12.Reuters, as of 27th November. Mexican president warns Trump tariffs will kill jobs, hints at retaliation.
13.Fitch Ratings, as of 15th November 2024. Fitch Upgrades Argentina to ‘CCC’
14.Bloomberg, as of 28th November 2024. Brazil’s real hits all-time low as spending cuts disappoint.
15.Euronews, as of 21st November 2024. Central Bank of Turkey keeps key interest rate unchanged.
16.Independent, as of 7th November 2024. Czech central bank cuts key interest rate to 4% as inflation stays low.
17.International Monetary Fund, as of 26th November 2024. South Africa: Staff concluding statement of the 2024 Article IV mission.
18.South African Reserve Bank, as of November 2024. Statement of the monetary policy committee November 2024.
19.Reuters, as of 28th November 2024. South Korea’s central bank unexpectedly cuts rates by 25bps.
20.S&P Global, as of 25th November 2024. Philippines outlook reviewed to positive on improved institutional assessment
21.The Times of India, as of 30th November 2024. Q2 GDP data disappointing, but see bright spots

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Index descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index is the subset of the ICE BofAML Emerging Markets Corporate Plus Index, which includes only securities issued by countries associated with the region of Asia, excluding Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

EMHA – The ICE BofA High Yield Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BB1 and lower with a country of risk within the Asia region.

EMIA -  The ICE BofA High Grade Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Asia region.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

The MSCI EM Index is a free-float weighted equity index that captures large and mid cap representation across emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalisation in each country.

LDMP - ICE BofA Local Debt Markets Plus Index is designed to track the performance of emerging markets sovereign debt publicly issued and denominated in the issuer's own currency.

J0A0 - The ICE BofA ML US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.

HE00 - The ICE BofA ML Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.

ER00 – The ICE BofA ML Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets.

CLCURFGB Index – Global Copper Refined Total Production - Yearly. This sector contains the copper production data for Chile, release by COCHILCO.

You cannot invest directly in an index, which also does not take into account trading commissions or costs. Additionally, indices do not include reinvestment of dividends, and the volatility of indices may be materially different over time.

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

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