Emerging Market Credit Shows Resilience amid Energy Shock

When the Iran war triggered a surge in oil prices this year, many investors may have expected credit markets in the developing world to slide into a selloff. 

Instead, emerging market sovereign and corporate bonds weathered the shock with a newfound stability and solid performance for investors. 

The development is a key sign that emerging market credit is maturing into a resilient asset class, according to Anupam Damani, co-head and senior portfolio manager of emerging market debt at Goldman Sachs Asset Management. At the same time, investors are rethinking their approach to the market, which has trillions of dollars in outstanding debt.

“Emerging market credit is now unrecognizable, and I mean that in a good way,” Damani says. “These bonds used to come with a crisis label, but this market is no longer monolithic. In my view, it has become a more diverse and resilient asset class, though risks remain.”  

To be sure, emerging market bonds run the gamut in terms of risk, and investors must be selective about what they trade in a marketplace with myriad issuers, she adds.

We spoke with Damani about the changing dynamics in the asset class, including the growth of emerging market corporate bonds and a less binding US dollar. 

Emerging market credit used to be a byword for volatility. What has changed and what opportunities does the asset class now offer investors?

For a long time, emerging market credit (EM credit) was considered a risk-on or a risk-off trade. Now, there are what we like to call more dispersed opportunity sets, or more names to choose from. We believe this reflects fundamental improvements that may have reduced binary tail risk—the all-or-nothing quality that used to define EM credit.  In our view, this has become an asset class where credit selection really matters. The market has matured.

In the sovereign space, for example, you’ll see deep local-currency markets with stronger reserve buffers. This means more liquidity. There are also more credible inflation-policy frameworks and deeper domestic investor bases. 

This policy shift seems significant.

It is, and this trend is unfolding across regions, from Asia to Latin America, Eastern Europe, and Africa. I believe these changes have anchored the market very differently than in the past. There used to be only a few countries in the EM sovereign space. Now, there are more than 80 countries offering a far wider range of potential opportunities.

How are investors responding to these changes?

Well, it’s been an evolution. There are countries that are developing strong institutions, and there are always going to be a few countries that are moving backward. This isn’t a linear progression across the asset class. But on an aggregate level, I think there has been a greater focus on fiscal orthodoxy and monetary orthodoxy. 

And to see the results, look at how many major emerging markets are running close to their inflation targets, with significant GDP growth, even in the face of the energy supply shock this year. When you look at developed markets, investors are struggling to see the same kind of discipline. Indeed, investors are increasingly demanding a higher risk premium to own some developed market assets. 

In my view, what’s interesting is that in emerging markets, there has always been a demand for higher risk premiums because of perceived notions around governance and weakness in policy frameworks. I think this has moved quite a bit. 

And corporate bonds? Has that market changed as well?

EM credit used to be largely a sovereign-only market. Today, we have a rapidly evolving market for corporates. And issuers are companies with footprints that extend beyond their borders—they are globally competitive, industry leaders that deal in hard currency. They are supported by local markets, with domestic consumer investor bases that have become larger and deeper in recent years.

In fixed income, we believe emerging market corporates have historically offered attractive Sharpe ratios, or risk-adjusted performance, relative to many other sectors. In our view, this reflects the bonds' strong resilience, credit quality, and lower duration.  

Has the role of the US dollar changed in emerging market debt?

Yes. The US dollar constraint is less binding than it used to be in previous cycles. In the 1990s, for instance, issuance was overwhelmingly dollar-driven, so when the dollar appreciated massively, your payment capacity was reduced as the local currency cost of servicing the debt rose. Now that effect is decreasing with the growth of local-currency sovereign debt markets. Emerging market countries are also issuing more debt in euros and renminbi.

Fixed income investors need reliable data to size up credit risk. Are issuers improving the quality of information?

We believe this is an underappreciated development in the EM credit story. There used to be a transparency discount for investors because data on issuers was considered too opaque. If you look at the investable universe in EM corporates today, disclosure looks much closer to what we see in developed markets. 

There is standardized reporting of data under International Financial Reporting Standards (IFRS) or IFRS-aligned frameworks. This improves comparability across regions and sectors, which we didn’t have in the past. Balance sheet transparency is also far stronger.

Issuers have also improved communications with investors—quarterly reporting, presentations, earnings calls, roadshows—just as we see in developed markets. When there are negative developments in a country or broader industry, those communications tend to pick up. You didn’t see this type of healthy dialogue between issuers and investors in the past.  

Global markets have recently sustained two shocks: US tariffs and the Middle East energy supply crunch. What is the fallout for emerging market credit?

It’s a pertinent question for the asset class. In our view, what’s important is the convergence around institutional frameworks, orthodox policies on inflation, and stronger fiscal reserve positions. These developments may have increased the ability of emerging markets to better absorb these types of shocks. In this cycle, for example, we have not seen uniform stress across the market but rather a dispersion across credits.

This is an important point. If you look at what’s happening in the Middle East, we have oil prices shooting up. In emerging market credit, we have energy exporters and importers, right?  This creates greater differentiation across issuers in the marketplace rather than the broad-based selloffs seen in some prior EM crises. 

And it shows that over the years, many developing economies have learned from their mistakes and tried to make changes that make them more resilient. So returns are increasingly driven by fundamentals and valuations, and that is a very different proposition from simply owning what we used to call the EM beta trade. 

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