Emerging markets show resilience on improved fundamentals, search for yield, says IMF

By Reshmi Basu

New York, June 29 - Emerging market debt spreads have remained tight to historical levels, showing resilience amid the recent downturn in the U.S. corporate credit markets, according to the International Monetary Fund's "June Financial Market Update".

During the auto-sector sell-off, emerging market spreads decoupled from their traditional relationship to U.S. corporate high-yield spreads as the differential between the two narrowed, noted the IMF.

Meanwhile, March's modest sell-off in emerging markets resulted in a reduction of a large proportion of leveraged positions, decreasing the "risk of a more disorderly correction." Since the correction, investors have maintained underweight positions, added the IMF.

Even as emerging market equities and currencies saw a short-lived correction in March as well, local-currency bonds were unhurt.

The search for yield, improved fundamentals and a growing long-term investor base has provided stability to the market. The IMF estimates that strategic allocations from institutional investors have reached $5.5 billion by the end of May, compared with $3.4 billion for the same period last year.

Also, that search for yield has laid the framework for a steady pace of issuance this year. The one exception was April, when issuers' were sidelined due to market volatility.

So far, cumulative issuance is comparable to the strong pace recorded in 2004. Sovereign external financing needs are four-fifths completed thus far, said the IMF, with some countries starting their prefinancing 2006 needs.

However, sovereign requirements for 2006 are expected to be less at $50 billion compared to $57 billion in 2005.

But an election-heavy calendar for 2006 means that some sovereigns, particularly Latin America, may choose to prefinance, added the IMF.

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