Emerging-Market Debt Outlook: Mixed Conditions in 2022

For emerging-market debt (EMD), 2022 is shaping up to be a contest of conflicting forces. Investors will need to pinpoint pockets of resilience among the many macroeconomic challenges facing the asset class.

Among the obstacles in this asset class: a negligible difference in the GDP growth of developed markets (DM) and emerging markets (EM) excluding China; persistent inflation; populist pressures; and moderate near-term growth for China. Among the opportunities: China’s long-term growth plan and less external vulnerability for EM countries.

What does this climate mean for EM investors? For now, hard-currency EMs—sovereign and corporate bonds alike—have more appeal than local-currency EMs. And selectivity is key. Here’s why.

Obstacles: Emerging Markets Lose Their Growth Edge

As economies reopened in 2021, pent-up demand generated strong global growth. We expect more of the same for 2022. Strong global growth satisfies one criteria for strong EMD returns. But another key criteria for strong returns—that EM economies grow faster than DM economies—no longer holds. Instead, developed markets are now growing much faster than before the pandemic, while EM economies continue to chug along at their pre-pandemic pace. The result has been a narrowing of the gap between EM and DM growth (Display). Without a meaningful growth edge, EM has a harder time enticing investors into taking added risk.

What’s more, central bank rate hikes will likely slow EM growth. Inflation has remained higher and more persistent in EM, compelling most EM central banks to begin tightening monetary policy. We estimate that EM countries have completed less than half of their tightening cycle so far, leaving the lion’s share for 2022.

Slow vaccine rollouts across the emerging world are also challenging, and not only from the humanitarian perspective. Crises like the coronavirus pandemic intensify inequality and poverty, which could fuel public discontent and affect political and policy paths. Several emerging countries share features such as a young demographic that make them particularly vulnerable to populist pressures, delayed fiscal consolidation and eroded democratic standards. Investors should therefore take extra care when assessing countries facing elections in 2022—especially where socioeconomic conditions are fragile and economic scarring from COVID-19 is deep.