EM defaults foreseeable

The IMF released its Global Financial Stability Report yesterday, in which it confirmed what was suspected from long. Emerging market corporates since 2008 massively increased their leverage at better terms (lower rates and longer tenors) despite having relatively constrained balance sheets..."

Despite weaker balance sheets, emerging market firms have managed to issue bonds at better terms (lower yields, longer maturities) with many issuers taking advantage of favourable financial conditions to refinance their debt". 

Interestingly the report illustrates that global factors (QE) were largely responsible for the decline in borrowing costs for firms, rather than the oft touted improve-ment in EM 'fundamentals'. 

The implication for investors is that as developed markets normalize their respective monetary policies, those emerging market firms with currency and interest rate mismatches are likely to experience difficulty in rolling over debt at best, and defaults at worst. 

"In common terms the tide is going out and the emerging market universe will be exposed. From a currency and CDS perspective increasing correlations can be once again expected as idiosyncratic country risk comes to the fore once again", says Commerzbank.