Since the Asian crisis sovereign risk in the region has reduced dramatically as the devaluations led...
Since the Asian crisis sovereign risk in the region has reduced dramatically as the devaluations led to export-led recovery and domestic slowdown.
Countries' balance sheets turned around, with perhaps the strongest example being South Korea, whose reserves went from near zero to more than $90bn. Bond spreads narrowed as a consequence, and the recent global slowdown has not dented this macroeconomic achievement.
The challenge ahead lies in the structural reforms needed to reallocate economic resources more efficiently, namely the restructuring of bank and corporate debt obligations.
Indeed, the negative global environment in recent months has aided these restructuring processes as countries, banks and firms have seen that they have no option but to bite the bullet. As these debt obligations are restructured, banks can once again start to lend and companies can plan investment and business strategies.
The distressed debt investor gains value by buying assets early in the process at deep discounts and selling as the restructuring event occurs. Not only are returns attractive, they are also little correlated to global events, providing diversification benefits.
Although the underlying restructuring work continues, the market price of distressed assets has been hit by global risk aversion, so valuations are currently low. Irrespective of whether global sentiment does turn more positive, however, value realised on a restructuring event is the same, so low valuations merely increase the attraction of these assets.
Market technicals for global emerging market debt are very favorable for new inflows. First, Mexico is expected to be upgraded to investment grade by S&P, releasing dedicated funds for other emerging markets, including for Asian debt.
Secondly, planned emerging sovereign issuance is less than repayments and interest payments in 2001, so more money will be chasing the existing opportunities. Thirdly, fixed income mandates are shifting to the Lehman Universal index as their benchmark, with a 4% allocation to emerging debt. Lehman's estimates this will lead to additional allocations to emerging debt of between $20-$40bn.
There are always risks. A worse global downturn than now expected could delay an upturn in current market values of distressed Asian assets. For the restructuring process to slow, there would have to be major political reversals, and these are unlikely to happen in several countries at once. Minor setbacks are possible but reform delay is the real risk, rather than reform programmes being derailed.
On the face of it, there would appear to be some risk from Japan, where the economy is slowing and the near-term response may take the form of a weaker yen.
Jerome Booth is head of research at Ashmore Investment Management Limited
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