EM as an asset class in the post-pandemic world

We believe the defining characteristics of EM as an asset class in the post-

COVID-19 world will be diminished pull factors coming from lower EM

growth, but combined with increasing push factors coming from a global lowyield

environment. COVID-19 is a unique shock to the global economy and

financial markets, with EM countries seeing an exacerbation of their own specific

challenges that were already undermining growth dynamics before the pandemic.

Some large EM economies have been among the hardest hit by COVID-19 given

their weaker healthcare infrastructure and policy choices, but others—particularly in

North Asia—have led the world in terms of effective measures to tackle the virus and

are correspondingly seeing the fastest recovery. The global macro and investment

outlook—including for Emerging Markets—will be shaped by the impact of

COVID-19 for years to come regardless of the speed of economic recovery.

Although there is hope that an effective vaccine could be developed and distributed

globally within the next couple of years, at this stage the virus and its impact are not

yet under control, so any big predictions about the future that are being presented in

this report or elsewhere face a large degree of uncertainty. Indeed, we are not yet in

the “post-pandemic world.”

In this report, which is an update of our EM as an Asset Class series that we

have been publishing over the past two decades, we take a longer-term look at

how the outlook for EM is shifting and how COVID-19 will impact the trends

already in place. The growth rate of EM economies had already been falling over

the last cycle before the pandemic hit and this is likely to continue to be a major EM

macro marker, along with the rise of the importance of China for broader EM growth

trends. Higher global and EM debt ratios are also bound to be a lasting legacy of the

current crisis as fiscal deficits were increased to cushion the shock, while policy

innovations that have been adopted—including EM QE—are raising questions about

the future trajectory of EM inflation and monetary policy. In the specific case of EM

fixed income assets, the global environment of low yields will likely keep EM bonds

on the radar of investors, although the scrutiny over EM countries that look set to

carry meaningful tail risks post-pandemic will continue. EM hard currency bonds and

EM local currency bonds FX-hedged will still be attractive on a risk-reward basis,

but EM FX is likely to continue to see low average returns and high volatility.

Investor focus on ESG and development finance within EM is also likely to continue

to increase in importance, and old features of EM bonds such as credit enhancement

seem likely to return to help lower-income countries access cheaper financing.