European credit investors see more possibility of contagion from emerging market risks via Brazil than other major emerging markets (EMs), according to Fitch Ratings' latest senior investor survey.
Seventy-six percent of respondents to the survey, which closed on 2 July, selected Brazil when asked to choose two countries from a list of five where they felt the wider contagion threat of EMs facing imbalances, political challenges, and rising US rates was most acute. This was twice as many as Russia (38%). Thirty-six percent selected China and 30% Turkey. Just 7% identified an acute risk of contagion via India.
EMs face various challenges heading into 2H15. Commodity prices have fallen, an approaching Fed rate rise points to a less favourable external financing environment, and some EMs face structural growth challenges.
Brazil (BBB/Negative) and India's (BBB-/Stable) sovereign credit profiles are cushioned from external shocks by robust international reserves, and the authorities in both countries have taken policy measures aimed at reducing imbalances. Reliance on portfolio inflows to finance the current account deficit is not significant in either country.
The front-loaded macroeconomic adjustment programme adopted by Brazil's Rousseff administration in its second term could gradually help improve policy credibility, confidence, and investment prospects. But weak political and economic backdrops (we forecast a GDP contraction of 1.5% this year) may hinder implementation.
Meanwhile, Latin American non-financial corporates, led by those in Brazil, have significantly increased their dollar borrowing while US rates have been low, increasing their exposure to a rising dollar. As the Central Bank of Brazil has tightened policy and allowed the real to depreciate, Brazilian issuers face rising internal and external interest rates during a recession.
Forty-six percent of our 2Q15 survey respondents think EM corporates will face the greatest refinancing challenge over the next 12 months - more than twice the next-highest category (EM sovereigns, with 20%).
"We think India has made more tangible progress in reducing its exposure to Fed-driven market volatility since the 'Taper Tantrum' two years ago. Foreign-exchange reserves have grown and are high in terms of current exchange payments relative to peers. The current account remains in deficit, but has narrowed, initially helped by temporary gold import curbs, but also due to the fall in international oil prices and lower inflation reducing investment demand for gold", point out Fitch.
Structural reforms and the resulting pick-up in investment support India's growth outlook, and we forecast growth to accelerate to 8.1% in FY17. But Fed tightening will not be risk-free for India, due to the possibility of large foreign outflows from its debt and equity markets
Fitch's 2Q15 survey represents the views of managers of an estimated EUR7.8trn of fixed-income assets. We will publish the full results later in July.