China Research

Many private households and financial institutions in our part of the world do not know anymore where and how to invest their money. Saving accounts may even give a negative real return. The German insurance giant Allianz refrains from new investments in bonds because of the low yields. More examples could be mentioned.

Investing in stocks?  Yes – or maybe. But the mood on a number of stock exchanges may be better than the outlook for the real economy. China gives some doubt even what regards the short-term prospects of the economy. So do other emerging economies with working stock markets such as Indonesia, Brazil and Russia.

What about investments in real estate? There is (still) an increasing demand in a number of industrial countries since credits are cheap at many places (e.g. Germany, Sweden). However, not many investors have the resources to be active on this kind of market. The risk of a (new) bubble may emerge in the future.

Could “safe” bonds be something to invest in? In the past, government bonds in many mature countries were regarded as fundamentally safe. The European debt crisis tells us now a different or modified story. For this reason, nobody can be surprised that bonds in emerging markets increasingly are promoted by financial institutions at the expense of bonds in OECD countries. What about the emerging-market alternative?

We know from stock markets that investments in mature economies can fail from a country risk perspective, too. Failures are not an issue that are exclusively related to emerging markets. Despite – normally – major institutional shortcomings, stock market investments in emerging countries may be successful at least in the shorter perspective. But there is, of course, no guarantee for good (trend) developments. Negative turnarounds may show up very suddenly on emerging capital markets. Certain negative events may lead to massive sales by (mainly?) Western investors, and – consequently – to sharp falls of stock prices.

Bond markets in emerging markets usually have even larger structural weaknesses. Normally, bond markets in these countries are institutionally lagging behind modern and transparent models even more than stock markets. China may serve as an illustrative example. It should be kept in mind that most emerging countries do not even have a bond market.

Furthermore, the volume of tradable bonds in emerging countries – if such trading conditions exist at all – tends to be very limited. Before investing in emerging market bonds, it should be a good idea to further analyze the institutional conditions of the relevant country very carefully – turnover/liquidity and transparency of bond markets included. These shortcomings may counteract – on average – more healthy fiscal numbers in many emerging countries compared to traditional OECD countries.  Exactly these favorable fiscal indicators in quite a number of emerging economies serve nowadays frequently as arguments for purchasing emerging market bonds.

Sure, there may be more promising bond alternatives on emerging bond markets I do not know about. In general terms, however, question marks what concerns investments in emerging market bonds should be very large. Macroeconomic indicators do not tell the whole truth. Microeconomic and institutional conditions must be considered as well.

Thus, the run for somewhat higher yields – for instance to emerging economies – is not all in financial life. Memory on financial markets is usually quite short – as the heavy involvement of Swedish banks in the recent Baltic disaster clearly shows – just 15 years after the severe banking crisis in the first half of the 1990s!

And we also get these days reminded again that very low interest rates during a longer period of time many times provoke increasingly risky investments. This may be the main reason for the current strengthening marketing of emerging market bonds.

But have we already forgotten the origins of the American subprime crisis just a few years ago?

Hubert Fromlet
Professor of International Economics
Editorial board

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