Notable decline in default rates since the start of 2024

Durrant Pate/Contributor

Improving credit quality of emerging markets (EMs) and the expected easing in financing conditions globally are signalling opportunities for bond investors, according to the latest NCB Capital Market-Market Guide.

Resilient economic activity, contained inflation rates, solid domestic demand, and falling interest rates are fueling this positive shift. Over the last four years, EMs have endured a downturn in economic activity and a deterioration in credit conditions as the effects of the COVID-19 pandemic and the Russia-Ukraine crisis led to a surge in global prices. 

This triggered a tightening of monetary policy across many of these economies. However, emerging economies are gradually regaining their growth momentum in comparison to their developed counterparts.

Inflation trending down across most EM regions 

In addition, inflation rates across most EM regions are now trending broadly within local central banks’ comfort zones. As a direct response to these stabilising conditions, some central banks in EM have initiated rate cuts that are bolstering their economic prospects and reducing the cost of the refinancing of existing debts for these issuers. 

This trend has also contributed to a notable decline in default rates since the start of 2024 with the latest data showing the S&P’s 12-month trailing EM speculative-grade default rate falling to 2.6% in June, down from 2.8% in December 2023. In Latin America, where all EM central banks have commenced rate reductions, the default rate amounted to 3.4% in June, down from its 2023 peak of 3.9% in November 2023. 

According to S&P Global Ratings, EMs with strong trade ties with advanced Europe and US are benefiting from a modest recovery in household spending, with positive effects on manufacturing production (trade). According to S&P Data, median industrial production across EM’s is currently trending in line with historic levels (2011-2019). 

Improving credit outlook 

With the improving credit outlook and the general outlook for interest rates to begin to decline, NCB Cap Market says EM bonds stand to become increasingly appealing to investors. This increase in demand should support higher returns from a total return perspective as prices begin to appreciate. 

Importantly, several emerging economies have reported economic growth that has exceeded initial estimates for 2023 with global activity and trade experiencing a resurgence. This is being supported by supply chain normalisation, strong exports, easing commodity prices, and low unemployment rates. 

With the stabilisation of economic trends, financing costs for EM issuers are anticipated to fall benefiting corporates through the favourable effects of lower interest rates and inflation on demand, consumer purchasing power and ultimately profitability and liquidity. Concurrently, many EM sovereigns will likely require less funding to sustain fiscal activity as increased tax revenue, lower unemployment rates and increased economic growth reduce the need for government-funded initiatives. 

This should support ongoing consolidation efforts and alleviate debt burdens, which could restore their credit quality. These possibilities have resulted in an increasingly optimistic outlook for EM, with rating agencies expressing greater confidence in the evolving landscape. 

It is also expected that 2024 will be the first year since 2020 that EM corporate default levels will fall below the historical average. Moreover, Moody’s EM corporate speculative-grade default rate is anticipated to fall to 3.9% by the year’s end and further to 3.3% by Q1 2025, far below the peak of nearly 15% at the end of 2022. However, this is contingent on continued interest rate declines, economic stabilisation, and no escalation of geopolitical tensions.