Observations in Emerging Markets: No Sign of Banking Contagion

Observations in Emerging Markets: No Sign of Banking Contagion

Elle Wu:          I’m Elle Wu, a client portfolio manager here at Thornburg Investment Management.  Today, I’ll be speaking with Josh Rubin, Co-Portfolio Manager of the Emerging Market Equity Strategy.  He’ll be discussing his observations in emerging markets as well as his recent trip to Saudi Arabia.  March has been dominated by news around the US and Swiss banks.  Have you seen anything similar in emerging market banks?

Josh Rubin:     That’s a really important question, and the most important part of the answer is no, we really haven’t.  We’ve looked at banks across all regions, and really, we have not found any wobbles or instability caused by recent events in California or in western Europe, and I’d say, I think a few reasons for that are emerging market banks, after learning a lot of lessons in the late 90s, learned additional lessons during the financial crisis, and the first real test was 2013, the so-called Taper Tantrum where interest rates began rising.  Share prices of emerging market banks did sell off during that time, but really, the fundamentals never wobbled.  In 2018, when interest rates also began to rise, uh, emerging market banks sailed through that test very well, and so as we’ve been investigating, what we’ve really found is leverage ratios, i.e., how much banks are loaning relative to the capital they have on hand.  Their equity or other forms of capital are very low in emerging markets relative to developed markets, and so, sort of the combination of good underwriting standards, good credibility with depositors and low leverage seems to mean that the current instability in developed financial markets is not translating into instability across emerging markets.

Elle Wu:          Speaking of learning from past mistakes, emerging market central banks have not been behind the curve in terms of their monetary policies.  When you’re looking at the region’s policy rates and inflation, what are your main takeaways?

Josh Rubin:     Emerging market central banks seem to be striking a very important balance right now.  On one hand, because they began raising interest rates earlier than developed market central banks did, they don’t have to be pushing as aggressively in today’s inflation environment compared to what we’re seeing in the west.  But more important than that, they’ve created a few different structural elements of the financial systems, um, across countries, whether Latin America, Europe or Asia, that are really improving the transition through the current environment.  One element that is much more common in emerging markets than we see in developed markets are floating interest rates, and the result of that is, depositors have been paid a reasonable yield for the last several years, and borrowers, borrowed at floating rates, which means, during this rising rate environment, banks are still balancing the net interest margin or the spread between deposits and loans as interest rates rise.  So, what we see from a central bank standpoint is they’re really able to focus on the capitalization of the banking system.  They’re able to focus on the credibility of the financial institutions in the eyes of consumers and all of that really wraps up into central banks being able to manage inflation first and foremost, have eh, employment be a second derivative of that.  So, as we look forward, inflation really does seem to have peaked across almost every emerging market.  We see economies often subdued because of higher interest rates that they’ve been absorbing for the last 12 to 18 months.  From here, central banks across emerging markets are more likely than not to be cutting interest rates, which should provide a nice tailwind for the general economic momentum as well as employment.  So, we really think by following orthodox monitory policy for the last decade and a half, emerging market central banks are able to walk the tightrope balancing inflation and economic growth in a way that western countries are much more challenged to do where the west, the push to contain inflation does seem to be squeezing economic growth, but in emerging markets, it’s more likely to accelerate rather than be decelerating from here.