Fitch: EU investors fear strong USD effect on emerging markets

European investors are concerned the strong US dollar will cause country-specific emerging market financial stress, but few see widespread contagion as likely, according to the latest Fitch Ratings investor survey.

An overwhelming 84% of those polled expect the impact of a strong US dollar, the possibility of higher US interest rates, lower commodity prices and weak global trade growth to be focused on emerging markets with weaker policy frameworks or greater external funding needs. Investors also expressed more pessimistic expectations for emerging market (both sovereign and corporates) fundamental credit conditions, issuance volumes and spreads. Only 8% of investors expect contagion and broad-based emerging market financial stress.

Fitch agrees that widespread financial distress in emerging markets is unlikely as an improvement in credit fundamentals over the last decade should make emerging markets more resilient than in the past. Nevertheless, sovereign and corporate credits with greater funding needs will be vulnerable.

Fitch believes that US economic prospects are broadly supportive of emerging market sovereigns, but lower prices of oil and other commodities and tighter US monetary policy may affect emerging market external finances. Higher US interest rates could also expose other emerging market vulnerabilities, such as high levels of leverage, weak policy frameworks and political fragilities. Taking all this into account, the emerging markets that we assess as most at risk to higher US rates are Mongolia, Turkey, El Salvador, Hungary, Lebanon and Jamaica.

Survey respondents identified the emerging market corporate sector as the most exposed to refinancing risk, with 42% of investor votes, ahead of emerging market sovereigns and high yield. This was a sharp rise from 33% who said so in our October survey. It is also the least favoured marginal investment choice.

In an emerging-markets stress scenario, US dollar bond investors may not be willing to refinance maturing debt. This would leave corporates either having to rely on shorter-dated dollar bank lending, or to convert devalued local currency to meet dollar repayments.

Among EMEA emerging markets, Turkish non-financial corporates would be most at risk in an FX stress scenario because of their relatively high level of foreign-currency borrowing and lack of FX hedging. Russian commodity exporters on the other hand, have coped relatively well with the new environment of a contracting economy and a weak rouble. This is in part due to their better natural hedging of FX risks and their response to an economic slowdown by focusing on deleveraging. Currency depreciation across Russia and Ukraine will, however, have an adverse impact on the credit metrics of domestically-focused companies with foreign-currency borrowings, or companies less able to pass-on cost increases to customers.

Fitch's 1Q15 survey closed on 23 February. It represents the views of managers of an estimated EUR8.2trn of fixed income assets. We will publish the full results next week.