Emerging Market Bonds

Investing in emerging market debt involves all the same risks as investing in developed country debt, such as interest rate movements, currency movements, and potential defaults. In addition, it poses risks that are, although not entirely absent, less significant in developed markets. These risks fall roughly into two categories: (1) economic and (2) political and legal. A slightly different breakdown would be “ability to pay” and “willingness to pay.”

Economic Risks (Ability to Pay)

Emerging market economies as a whole have characteristics that make them potentially more vulnerable to distress and hence less likely to be able to pay their debts on time or in full, such as the following:

  • Greater concentration of wealth and income; less diverse tax base
  • Greater dependence on specific industries, especially cyclical industries, such as commodities and agriculture; low potential for pricing power in world markets
  • Restrictions on trade, capital flows, and currency conversion
  • Poor fiscal controls and monetary discipline
  • Less educated and less skilled work force; poor or limited physical infrastructure; lower level of industrialization and technological sophistication
  • Reliance on foreign borrowing, often in hard currencies not their own
  • Small/less sophisticated financial markets and institutions
  • Susceptibility to capital flight; perceived vulnerability contributing to actual vulnerability

Political/Legal Risks (Willingness to Pay)

Investors in emerging market debt may be unable to enforce their claims or recover their investments due to:

  • Weak property rights laws and weak enforcement of contract laws are clearly of concern in this regard.
  • An inability to enforce seniority structures within private sector claims is one important example.
  • The principle of sovereign immunity which makes it very difficult to force a sovereign borrower to pay its debts.
  • Confiscation of property, nationalization of companies, and corruption are also relevant hazards.
  • Coalition governments which could also pose political instability problems.
  • The imposition of capital controls or restrictions on currency conversion may make it difficult, or even impossible, to repatriate capital.

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