Emerging markets in good shape

By David Chance

LONDON (Reuters): Emerging markets are in generally good shape as the International Monetary Fund and World Bank head to Prague for their annual meeting and analysts say prospects for most are continuing to improve.

Since the Asian, Russian and Brazilian financial crises of 1995 on, economies from the developing world have benefited from both external factors, such as a benign global economic environment and rising commodity prices, and market-oriented policies from their own governments.

"The external environment is supportive which has allowed emerging economies to make improvements from a position of strength," said Richard Segal, Director, Sovereign Risk at London-based consultancy Emerging Market Economics (EME).

According to EME's latest survey of risk in emerging markets, there are few signs of overheating and there remains plenty of room for the business cycle to gather pace, with the result that it may be 12 months at least before the resolve of policymakers will be tested in earnest.

As a result of lack of debt supply due to limited issuance and a sharp turnaround in countries such as Mexico, which is now on the cusp of attaining a credit rating on a par with developed nations, spreads over U.S. Treasuries have come in from 850 basis points at the start of the year to 670 bp.

Yet despite this relatively bullish scenario, foreign investors remain wary and the premium demanded for investing in emerging market bonds is still above its most optimistic level of the third quarter of 1997 when spreads over U.S. Treasuries were 340 bp.

"After the Russia default, there was a big change in relative spreads among countries. People really paid attention to which were the good ones," said American Express Bank economist John Calverly.

To that end, investors doubt that Ecuador, which defaulted on its debt last year will have access to credit any time soon.

Even though emerging debt has performed well, equities have had a difficult time with the Standard & Poor's/International Finance Corp Composite index of global emerging market stocks down 18 percent year to date.

The difference in performance arises from the fact that although government balance sheets have been restored and there have been moves to repurchase sovereign debt by countries such as Brazil and Mexico, corporate balance sheets remain under severe stress, said Brunswick Direct strategist Paul Luke.

"The Asian crisis left the banking sector and a lot of enterprises in the private sector in a fairly weak condition and banks form a very large part of the stock indices," Luke said.

This was brought home with a vengeance when Ford Motor Co walked away last week from a $7 billion deal to buy indebted South Korean automaker Daewoo Motor.

This news drove Korea's stock market down to an 18-month low with an eight percent decline on Monday alone.

Luke also notes that there has been an increased correlation between emerging market technology-media-telecommunications stocks and those listed in the U.S., which has historically not been the case.

This could mean a period of underperformance from this sector if U.S. monetary authorities decided to slow growth in their own TMT sector, Luke said.

"Apart from that, there has been no new champion for emerging markets. We are just waiting for the next one to emerge and that is going to be China," Luke said.

The Chinese economy is growing in excess of seven percent a year and the country is set for membership of the World Trade Organization, which will open up further markets for exports.

All the hype in Europe over fuel blockades has brought oil back to the front of the political agenda, but Brunswick Direct's Luke said that oil prices alone will not upset the apple cart.

Many analysts believe East Asia is most vulnerable to the quadrupling of oil prices since the start of 1999, but Luke said that with growth in excess of six percent in most economies in the region, a little less growth would do no harm.

"You are not seeing rising real interest rates. During the last oil shock, you had the double whammy of oil prices and higher external interest rates," he said.