EM As An Asset Class in The Post-Pandemic World

Global Emerging Markets
Research
11 September 2020
EM as an Asset Class in the

Post-pandemic World
Emerging Markets Research

Luis Oganes AC
(44-20) 7742-1420
luis.oganes@jpmorgan.com
J.P. Morgan Securities plc
Jonny Goulden AC
(44-20) 7134-4470
jonathan.m.goulden@jpmorgan.com
J.P. Morgan Securities plc
Jahangir Aziz AC
(1-212) 834-4328
jahangir.x.aziz@jpmorgan.com
Bloomberg JPMA AZIZ <GO>
J.P. Morgan Securities LLC
See page 125 for analyst certification and important disclosures.

www.jpmorganmarkets.com
This document is being provided for the exclusive use of dwessel@brookings.edu.
Luis Oganes Jahangir Aziz Global Emerging Markets Research
(44-20) 7742-1420 (1-212) 834-4328 EM as an Asset Class in the Post-pandemic World
luis.oganes@jpmorgan.com jahangir.x.aziz@jpmorgan.com 11 September 2020
Jonny Goulden
(44-20) 7134-4470
Contributing Authors
Global EM Research EM Sovereign Credit Strategy Global EM Economics
Luis Oganes Trang Nguyen Jahangir Aziz
(44-20) 7742-1420 (1-212) 834-2475 (1-212) 834-4328
luis.oganes@jpmorgan.com trang.m.nguyen@jpmorgan.com jahangir.x.aziz@jpmorgan.com
J.P. Morgan Securities plc J.P. Morgan Securities LLC J.P. Morgan Securities LLC
Jonny Goulden Mikael Eskenazi Nora Szentivanyi
(44-20) 7134-4470 (44-20) 7742-9404 (44-20) 7134-7544
jonathan.m.goulden@jpmorgan.com mikael.eskenazi@jpmorgan.com Nora.Szentivanyi@jpmorgan.com
J.P. Morgan Securities plc J.P. Morgan Securities plc J.P. Morgan Securities plc
Milo Gunasinghe Anthony Wong
EMEA EM Local Markets Strategy (44-20) 7134-8063 (44-20) 7742-0985
Saad Siddiqui milinda.gunasinghe@jpmorgan.com anthony.wong@jpmorgan.com
(44-20) 7742-5067 J.P. Morgan Securities plc J.P. Morgan Securities plc
saad.siddiqui@jpmorgan.com Omead Eftekhari
J.P. Morgan Securities plc (1-212) 834-7190 Regional EM Economics
Anezka Christovova omead.eftekhari@jpmorgan.com Sin Beng Ong
(44-20) 7742-2630 J.P. Morgan Securities LLC (65) 6882-1623
anezka.christovova@jpmorgan.com sinbeng.ong@jpmorgan.com
JPMorgan Chase Bank, N.A.,
J.P. Morgan Securities plc EM Corporate Credit Strategy Singapore Branch
Michael Harrison Yang-Myung Hong Ben Ramsey
(44-20) 7134 5720 (1-212) 834-4274 (1-212) 834-4308
michael.p.harrison@jpmorgan.com ym.hong@jpmorgan.com benjamin.h.ramsey@jpmorgan.com
J.P. Morgan Securities plc J.P. Morgan Securities LLC J.P. Morgan Securities LLC
Sean T Kelly Alisa Meyers Nicolaie Alexandru-Chidesciuc
(44-20) 7134-7390 (1-212) 834-9151 (44-20) 7742-2466
sean.t.kelly@jpmorgan.com alisa.meyers@jpmorgan.com nicolaie.alexandru@jpmorgan.com
J.P. Morgan Securities plc J.P. Morgan Securities LLC J.P. Morgan Securities plc
Sanat Shah Haibin Zhu
LatAm Local Markets Strategy (1-212) 834-5230 (852) 2800-7039
Carlos Carranza sanat.shah@jpmorgan.com haibin.zhu@jpmorgan.com
JPMorgan Chase Bank, N.A., Hong
(1-212) 834-7139 J.P. Morgan Securities LLC
Kong
carlos.j.carranza@jpmorgan.com Katherine Marney
J.P. Morgan Securities LLC Index Research (1-212) 834-2285
Gisela Brant Jarrad Linzie katherine.v.marney@jpmorgan.com
(1-212) 834-3947 (44-20) 7134-8717 J.P. Morgan Securities LLC
gisela.brant@jpmorgan.com jarrad.k.linzie@jpmorgan.com Raisah Rasid
J.P. Morgan Securities LLC J.P. Morgan Securities plc (65) 6882 7375
Kumaran Ram raisah.rasid@jpmorgan.com
JPMorgan Chase Bank, N.A.,
EM Asia Local Market Strategy (1-212) 834-4685
Singapore Branch
Arindam Sandilya kumaran.m.ram@jpmorgan.com Jessica Murray
(65) 6882-7759 J.P. Morgan Securities LLC (44-20) 7742 6325
arindam.x.sandilya@jpmorgan.com Nikhil Bhat jessica.x.murray@jpmorgan.com
JPMorgan Chase Bank, N.A., Singapore Branch (44-20) 7742-7749 J.P. Morgan Securities plc
Arthur Luk nikhil.bhat@jpmorgan.com Toshi Jain
(852) 2800-6579 J.P. Morgan Securities plc (91-22) 6157-3387
arthur.luk@jpmorgan.com Rupert Rink toshi.jain@jpmorgan.com
JPMorgan Chase Bank, N.A., Mumbai
J.P. Morgan Securities (Asia Pacific) Limited rupert.rink@jpmorgan.com
Branch
Tiffany Wang J.P. Morgan Securities plc
(852) 2800-1726
tiffany.r.wang@jpmorgan.com
J.P. Morgan Securities (Asia Pacific) Limited

Jonny Goulden
(44-20) 7134-4470
Table of Contents
Executive Summary .................................................................5
EM as an asset class in the post-pandemic world......................................................5
EM growth will slow but diversification benefits linked to China will support EM
capital flows............................................................................................................5
Outlook for EM fixed income returns is lower but Sharpe ratios to stay attractive.....6
Key Takeaways.......................................................................................................8
Impact of slowing globalization and the pandemic on trend
growth in EM ...........................................................................10
Was EM growth in the last two decades the norm or the exception? .......................10
Near-term challenge to EM growth from the pandemic ..........................................10
Near term risks to fiscal deficits, debt and financial stability ..................................12
Interest rate-growth differential has become less favorable.....................................14
Pandemic presents a different kind of EM debt crisis .............................................15
From quantitative to regulatory to credit easing......................................................16
EM trend growth to grind down further..................................................................18
Productivity decline is the key challenge for recovery............................................19
Unfavorable EM demographics isn’t helping .........................................................21
New normal for EM growth will depend on reforms ..............................................24
The urgency of second-generation reforms.............................................................26
Diversification gains to compensate lower EM growth as
supports for capital flows......................................................27
It’s been all about growth (and the USD) so far......................................................27
And growth has been all about trade ......................................................................28
EM-DM growth link no longer what it used to be...................................................29
China now an independent source of global demand ..............................................31
No longer just growth but diversification gains to drive EM capital flows...............33
Impact of the US-China tensions on EM...............................34
Supply chains as a microcosm of US-China relations .............................................34
China's Achilles heel: Access to foundational technologies ....................................36
Divergence in US-China economic cycles..............................................................37
How China changed EM FDI flows .......................................................................39
And will now change financial flows .....................................................................40
Ideology, governance and politics of the US-China conflict ...................................42
Evolution of EM fixed income as an asset class and outlook
for returns ...............................................................................45
The long-term drivers and COVID-19 impact on EM assets ...................................45
A brief history of Emerging Market bond markets .................................................47
EM investible assets have grown, broadened and matured with the shift to local
currency funding for large countries ......................................................................49
Asset class performance has seen hard and local currency EM bonds deliver good
returns when FX-hedged .......................................................................................51
EM risk/reward characteristics have historically been attractive versus DM bonds,
without FX exposure .............................................................................................56

Jonny Goulden
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EM AUM and inflows both show demand of hard currency over local currency .....59
Global fund allocations to EM bonds are still small................................................61
EM Local Markets: The Future is FX-Hedged.......................63
A Lost Decade for EM local markets .....................................................................63
A scenario based approach to expected returns.......................................................67
EM local bond returns drivers and forecasts...........................................................68
Ownership and liquidity: Local for the locals, with international holdings lower and
lower liquidity.......................................................................................................71
EM FX: the challenging part of the asset class .......................................................75
Investment strategies for the future: Hedging FX and diversifying with Frontier
Markets.................................................................................................................78
EM hard currency debt: The rise in defaults is just part of
the cycle ..................................................................................83
In the face of a default wave ..................................................................................83
Estimating EM credit returns over the coming years...............................................85
EM sovereigns have over-compensated for default losses.......................................86
EM sovereign recovery rates have been bi-modal...................................................86
EMBIG and CEMBI ratings: Hovering around IG..................................................88
EM hard currency bond stock has expanded significantly.......................................89
EM sovereign debt composition: More issuers, more IG.........................................90
EM corporate debt composition: More Asia, but less IG.........................................92
Decomposing the EM corporate bond universe ......................................................93
Who owns the outstanding EM sovereign bonds?...................................................96
The evolution of EM debtors: the increasing role of China and official creditors.....97
Who owns the outstanding EM corporate bonds?...................................................99
Growing asset class, but declining liquidity ......................................................... 100
ESG investing and development finance increasingly
overlap in EM space .............................................................102
ESG and SDG worlds collide in EM.................................................................... 102
ESG momentum reaches EM amid a shift from purpose neutral to purposeful ...... 103
Private capital needed to help finance the Sustainable Development Goals ........... 106
Public-private cooperation to help EM issuers attract capital ................................ 112
ESG scoring framework for EM sovereigns tied to development gaps .................. 114
Connecting use of proceeds to outcomes is key for sustainable investment ........... 116
Global regulatory environment still evolving for sustainable investment............... 117
Credit enhancements and stripped yields likely to make a
comeback in EM indices ......................................................120
Déjà vu all over again: Credit-enhanced bonds in the EMBI................................. 120
Multilaterals may require ESG and sustainability commitments in return for future
credit guarantees ................................................................................................. 122
Pandemic-related market disruption has delayed inclusion timelines for new markets
in the GBI-EM .................................................................................................... 123

Jonny Goulden
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Executive Summary
EM as an asset class in the post-pandemic world
We believe the defining characteristics of EM as an asset class in the post-
COVID-19 world will be diminished pull factors coming from lower EM
growth, but combined with increasing push factors coming from a global low-
yield environment. COVID-19 is a unique shock to the global economy and
financial markets, with EM countries seeing an exacerbation of their own specific
challenges that were already undermining growth dynamics before the pandemic.
Some large EM economies have been among the hardest hit by COVID-19 given
their weaker healthcare infrastructure and policy choices, but others—particularly in
North Asia—have led the world in terms of effective measures to tackle the virus and
are correspondingly seeing the fastest recovery. The global macro and investment
outlook—including for Emerging Markets—will be shaped by the impact of
COVID-19 for years to come regardless of the speed of economic recovery.
Although there is hope that an effective vaccine could be developed and distributed
globally within the next couple of years, at this stage the virus and its impact are not
yet under control, so any big predictions about the future that are being presented in
this report or elsewhere face a large degree of uncertainty. Indeed, we are not yet in
the “post-pandemic world.”
In this report, which is an update of our EM as an Asset Class series that we

have been publishing over the past two decades, we take a longer-term look at
how the outlook for EM is shifting and how COVID-19 will impact the trends
already in place. The growth rate of EM economies had already been falling over
the last cycle before the pandemic hit and this is likely to continue to be a major EM
macro marker, along with the rise of the importance of China for broader EM growth
trends. Higher global and EM debt ratios are also bound to be a lasting legacy of the
current crisis as fiscal deficits were increased to cushion the shock, while policy
innovations that have been adopted—including EM QE—are raising questions about
the future trajectory of EM inflation and monetary policy. In the specific case of EM
fixed income assets, the global environment of low yields will likely keep EM bonds
on the radar of investors, although the scrutiny over EM countries that look set to
carry meaningful tail risks post-pandemic will continue. EM hard currency bonds and
EM local currency bonds FX-hedged will still be attractive on a risk-reward basis,
but EM FX is likely to continue to see low average returns and high volatility.
Investor focus on ESG and development finance within EM is also likely to continue
to increase in importance, and old features of EM bonds such as credit enhancement
seem likely to return to help lower-income countries access cheaper financing.
EM growth will slow but diversification benefits linked to

China will support EM capital flows
Over the last two decades, the fortunes of EM economies have been closely tied
to the gyrations of global trade. China’s entry into the World Trade Organization
(WTO) in 2000 led to a significant rise in global trade volumes. However, since the
strong rebound in 2010 that followed that global financial crisis, growth in global
trade has declined steadily due to several factors including the end of the commodity
super cycle, the saturation of global supply chains, the aging of populations in the
developed market (DM) economies that shifted demand from manufacturing to
services, and the rise of anti-globalization sentiment (Exhibit 1). In the absence of
second-generation structural reforms that could create new drivers, EM growth has

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also declined in tandem. The pandemic has added to the woes and while a strong
recovery is underway in 2H20, it is likely that the recovery will be incomplete and
that EM trend growth will decelerate further. This incomplete recovery will require
continued policy support that will increase leverage significantly by 2021.
Consequently, the EM-DM growth differential, which has been one of the strongest
appeal factors of broad capital flows into EM along with the USD dynamics, will
likely narrow compared to the post-2012 period. That said, on current projections the
narrower growth differential will still be sufficient to attract a reasonable pace of
inflows into EM albeit at a lower level in percent of GDP terms.
The growth dynamics of the DM, China and EM ex-China (EMX) blocs, which
used to be highly correlated due to globalization, are now changing. While in the
first decade of the millennium and even as China was becoming the factory of the
world with EMX providing the intermediate inputs, the correlation between growth
of China and EMX and that of China and DM were very strong as the latter was
effectively the end-buyer of the goods produced by EM as a whole. However, in the
past decade China embarked on a path of a policy-induced rebalancing of its sources
of growth. On the demand side, this resulted in a shift away from dependence on
exports towards consumption. On the supply side, we saw a move up the value-added
chain to rely more on productivity instead of inputs as the key growth driver, while
creating employment for the more skilled workers entering its labor force (Exhibit 2).
The upshot of this ongoing rebalancing is that China has now emerged as an
independent source of global demand for EMX such that the correlation between
EMX and DM growth has weakened, while that between EMX and China has
strengthened. This change in cyclical and structural growth dynamics means that, as
opposed to the past when FDI and portfolio investment into EM was driven mainly
by the lure of having exposure to the higher EM growth, diversification of growth
will now be an added reason to invest in both China and EMX.
Exhibit 1: EMX growth and global trade Exhibit 2: China GDP growth and global trade
%oya, both scales %oya, both scales
10 20 China real GDP 30
14 (LHS)
8 15
20
6 10 12 Global real trade
(RHS) 10
4 5 10
2 0 0
8
0 -5 -10
6
-2 EMX real GDP -10
4 -20
(LHS)
-4 -15
Global real trade 2 -30
-6 -20
(RHS)
-8 -25 0 -40
00 02 04 06 08 10 12 14 16 18 20 00 03 06 09 12 15 18
Source: J.P. Morgan, CPB. EMX refers to EM ex. China. Source: J.P. Morgan, CPB
Outlook for EM fixed income returns is lower but Sharpe

ratios to stay attractive
Despite lower Sharpe ratios and persistent idiosyncratic risks in EM in the
aftermath of the COVID-19 shock, EM bond yields will continue to look
attractive in a global environment of low-for-even-longer DM yields. EM fixed
income has been historically attractive from a risk/return perspective, as long as EM

Jonny Goulden
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FX exposure was avoided (Exhibit 3). EM sovereign and corporate credit have had
comparable Sharpe ratios to US HY, which puts them on the efficient frontier of
global asset classes with higher returns. EM local bonds have also been historically
competitive in terms of risk/return, but only on a FX-hedged basis and this puts them
in the lower-risk/lower-return part of the investment spectrum, alongside US
Treasuries and European HG credit. Holding anything with EM FX exposure has
been challenging in the last 10 years, as persistent currency depreciation across many
EM countries results in low Sharpe ratios for EM local bonds unhedged and EM FX
carry positions.
Exhibit 3: EM bonds have had high Sharpe ratios historically, with EM local bonds USD-hedged
competing well with low return/low vol assets, while EM credit compares well within higher return assets
x-axis: Average annual volatility (%), y-axis: Average annual return (%), both since 2003
12.0% EM equities
10.0%
EM sovereign
credit US equities
US HY
8.0% EM corporate
credit EM local bonds
unhedged
US HG
6.0%
Global DM govt.
UST EM FX (broad)
Commodities
4.0% Euro HG EM FX (narrow)
EM local bonds FX-
hedged
2.0%
0.0%
0.0% 5.0% 10.0% 15.0% 20.0%
Source: J.P. Morgan
We expect the best risk-adjusted returns in EM fixed income to come from

bonds rather than FX going forward, with interest likely to remain in hard
currency sovereigns and corporates, as well as local bonds FX-hedged. We
estimate annual returns for EM credit over the medium term (next 5 years) will be
3.7% for sovereigns and 3.4% for corporates, while returns for EM local markets
(averaged across the scenarios we consider) are expected to be 2.8%, split rates 1.9%
and FX 0.9%. While the backdrop of higher debt and lower growth in EM is a
continuation of an existing trend of recent years, the risk/return outlook for EM fixed
income assets will likely change in the next 5 years. First, Sharpe ratios in credit will
likely be lower as the starting risk-free rates are low. A key driver of the higher
Sharpe ratios in EM credit has been the diversification that credit assets have with a
risk premia that tends to overcompensate for losses along with a risk-free component
of US rates exposure. When markets sell off, the rally in risk-free rates often
compensates for the sell-off in spreads, limiting volatility. With 10y UST yields at
only 70bp, the scope for US rates to offset spread moves will be more limited going
forward. The legacy of COVID-19 will be higher sovereign default rates than the last
20 years given the many new issuers in the past decade and risks of overreach from
EM central banks with QE. Yields for EM credit and local bonds will be attractive to
global investors in a long-term zero-yield world. However, as explained above, we

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do not see a strong case for investing in EM FX with an asset class approach since
there has been a lack of mean-reversion for currencies amid a rebalancing of EM
fundamentals. Plus, with carry at all-time lows, Sharpe ratios for EM FX will likely
remain low.
Key Takeaways
 The pandemic will do permanent damage to EM potential growth. Despite
the robust recovery in EM growth envisaged in our 2020-21 forecast, end-2021
GDP levels will remain well below what we expected at the start of 2020;.
Depending on the speed and strength of the economic recovery from the
pandemic, growth potential could fall further as capex decisions are delayed,
labor markets are disrupted and productivity growth takes a further hit. The
incomplete recovery will require continued policy support that will increase
leverage significantly by 2021.
 China will continue to be central to the future of EM, while the evolution of
the US-China relationship will change trade and capital flow dynamics. The
evolution of the bilateral US-China relationship has taken on a more competitive
than cooperative bent and could mean a redrawing of geopolitical alliances. We
expect that the net result of these changes could lead to a multipolar world, with
the emergence of several blocks and its accompanying alliances: US, China, and
possibly the EU or other EMs following less integrated paths.
 The EM asset class is now much broader and local currency debt is a much
larger proportion, with returns ahead likely in the 2.75-3.75% range across
local and hard currency bonds. EM bond markets have broadened significantly
with investible debt now available in around 100 EM countries, while local
currency debt is now 90% of EM government bonds. EM hard and local currency
bonds FX-hedged have delivered returns above DM equivalents, with attractive
Sharpe ratios. EM Sharpe ratios will fall in the period but EM’s higher yields will
still attract interest. However, taking EM currencies exposure lowers returns and
shape ratios.
 For EM local markets, we see the future as being FX-hedged to achieve
better risk-adjusted returns. We expect total returns in EM local markets to be
a modest improvement over the past decade, but FX returns will likely continue
to be disappointing. Additionally, given the low-starting level of yields, the
returns from duration are likely to be capped, with bond carry and roll-down
playing a more significant contribution to returns. Given this prognosis, we think
hedging FX as a default stance is sensible, as is diversifying into fast-growing
local currency frontier markets.
 For EM hard currency debt, the current default increase a part of a usual
cycle and we still expect around 3.5% returns over the medium-term. EM
credit has not seen a default cycle across both sovereigns and corporates for
nearly 20 years, but that was exceptional. Defaults are part of the usual cycle of
boom and bust, the current increase will lead to a better long-term entry point
given good historical risk/return dynamics for EM credit which we see
continuing.
 ESG investment likely to increasingly focus on sustainable development
impact in the case of EM. ESG investing is shifting from purpose neutral to
purposeful, which brings it closer to the concept of sustainable development.
Investor attitudes and fear of “greenwashing” are catalysts for growing overlap
between ESG investing and development finance in EM. Capturing the overlap of

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ESG investing that is more skewed towards development outcomes will be

pivotal to attract new sources of capital flows to EM.
 Credit enhancements and stripped yields likely to make a comeback in the
ongoing evolution of EM fixed income indices. Eligibility of credit-enhanced
securities (if implemented) could be the most material change in EM bond indices
since the inclusion of Sukuk and Gulf co-operation countries (GCC) debt.
Multilaterals may require ESG and sustainability commitments in return for
future credit guarantees. Pandemic-related market disruption may extend
inclusion timelines for new markets in the GBI-EM.

Jahangir Aziz Toshi Jain Global Emerging Markets Research
jahangir.x.aziz@jpmorgan.com toshi.jain@jpmorgan.com 11 September 2020
Nora Szentivanyi Anthony Wong
(44-20) 7134-7544 (44-20) 7742-0985
nora.szentivanyi@jpmorgan.com anthony.wong@jpmorgan.com
Impact of slowing globalization and the

pandemic on trend growth in EM
 EM trend growth has been declining since 2010

 Slower global trade and productivity growth have driven much of the
slowdown and this trend is unlikely to change
 The pandemic adds to EM woes and threatens to dent trend growth in the
absence of continued policy and regulatory accommodation to allow
economies the time and space to repair damaged balance sheets
Was EM growth in the last two decades the norm or the

exception?
EM economies have enjoyed robust growth over the past two decades. In the
2000s, for the first time, EMs spent more time in expansion and had smaller
downturns than DM economies. However, the past two decades have been the
exception and not the norm in terms of EM growth performance. In the 1970s and
1980s, EMs experienced more frequent and longer lasting downturns. The 1990s
were marked by wide variation across regions—Asia, Mexico and Russia
experienced sharp downturns during the 90s’ crises, whereas much of EM Europe
grew rapidly following their transition-related output collapses. Despite the increased
resilience and improved policy frameworks built up in the wake of the 1990s’ crises,
EMs have remained vulnerable to larger and more frequent downturns than DMs in
times of crises. This is in part because, in contrast to DM business cycles, large
output losses in EM economies often represent declines in trend rather than
fluctuations around a trend.
Just as with previous recession episodes, we anticipate that the pandemic will
have done permanent damage to EM potential growth. And this will have
associated costs for policymakers’ capabilities to address rising debt burdens (even
with low interest rates). But trend growth in EM was already in decline prior to the
pandemic. The GFC led to significant losses in both EM output and potential growth
relative to its pre-crisis path. Our analysis has attributed much of the decline in EM
potential since 2010 to a significant slowdown in globalization that helped these
economies increase productivity in the early 2000s. In addition, secular forces
weighing on potential, including slowing growth in working age populations, were
already under way before the GFC and have worsened steadily in the years leading
up to the pandemic.
Near-term challenge to EM growth from the pandemic

It is now likely that the pandemic will also takes its toll in reducing medium
term growth further. The COVID-19 impact is harder to determine as we are still in
the midst of the crisis and the full economic impact has yet to be measured; however,
it is likely the legacy costs of the crisis will linger. We expect a significant hit to
corporate and household balance sheets that will put EM growth below potential for
the remainder of the forecast horizon. Depending on the speed and strength of the
economic recovery from the pandemic, growth potential could fall further as capex
decisions are delayed, labor markets are disrupted and productivity growth takes a
further hit. Although some of this loss may still be reversed through a late-cycle
10

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phase of above-trend growth, it seems certain that this expansion will end with
incomes significantly lower than prior to COVID-19.
Despite the robust recovery in EMX growth envisaged in our 2020-21 forecast,
end-2021 GDP levels will remain well below what we expected at the start of
2020. In many cases end-2021 GDP will even be below 4Q19 GDP levels—implying
a permanent loss of output (Exhibit 4). The hit to global tourism and other services is
unprecedented due to broad-based lockdowns—nearly every country in the world
imposed some form of mobility restriction during the pandemic. In past recessions,
consumption and services have tended to recover faster than manufacturing;
however, in this crisis the collapse has been far greater in services and will likely be
more protracted.
Exhibit 4: Post pandemic global GDP

%y/y, %pt diff and % change in end-2021 level of GDP
%y/y growth Diff from Jan 2020 end-2021
2019 2020 2021 2020 2021 level diff
Global 2.6 -4.0 5.3 -6.5 2.6 -4.4
DM 1.7 -5.3 4.1 -6.7 2.5 -4.6
US 2.2 -4.2 2.6 -5.8 0.8 -5.1
Euro area 1.3 -6.3 6.2 -7.5 4.7 -3.6
EM 4.0 -2.1 7.1 -6.3 2.8 -3.5
EMX 2.2 -5.7 5.8 -8.5 2.7 -6.4
EM Asia 5.1 -0.3 8.3 -5.5 3.2 -2.3
EMAX 3.3 -5.2 7.9 -9.0 3.7 -6.4
EMEA EM 2.0 -4.1 3.8 -6.3 1.5 -4.3
Latin America 0.6 -8.3 4.2 -9.8 2.0 -8.4
China 6.1 2.5 8.6 -3.4 2.9 0.1
India 4.2 -9.0 15.1 -14.5 9.1 -9.4
Indonesia 5.0 -0.8 5.0 -5.8 0.0 -4.3
Brazil 1.1 -5.2 2.5 -7.3 0.3 -7.0
Mexico -0.3 -10.5 5.5 -12.0 3.8 -8.5
Russia 1.3 -4.0 3.6 -5.6 1.8 -3.3
South Africa 0.1 -7.5 4.4 -8.2 3.6 -5.0
Turkey 0.9 -3.3 3.7 -6.1 0.5 -4.8
EM HY 2.0 -6.6 6.8 -9.6 3.5 -6.9
EM LY (ex. China) 2.6 -4.3 4.1 -6.9 1.2 -5.6
Source: J.P. Morgan estimates. EMX and EMAX refers to EM ex. China and EM Asia ex. China.
11

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Exhibit 5: A lost biennium…EM GDP does not recover above 4Q19 levels in all but EM Asia
Index 4Q19 = 100, sa
102
101.4
100 99.6
98 99.4
96 95.8
94
92
90 EMX
88 EMAX
Latin America
86 EMEA EM
84
4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
Source: J.P. Morgan. EMX and EMAX refers to EM ex. China and EM Asia ex. China.
Near term risks to fiscal deficits, debt and financial stability

Fiscal and monetary discipline in EM in the past 20 years has been key to both
high growth and instilling investor confidence. Following the 1990s’ crises, in the
wake of hyperinflation and debt defaults, EMs steadily increased institutional
restraint on their policy frameworks by adopting some combination of an inflation
targeting monetary regime and legislative limits on fiscal deficits and public debt.
These rules to enhance the policy credibility and discipline helped to lower inflation
that had been previously EM’s Achilles heel. However, the pandemic has raised a
new set of challenges, forcing EM governments and central banks to set aside
restraints imposed by institutional arrangements and implement an array of
unconventional policies, including quantitative easing and regulatory easing. This in
turn has raised concerns that policy discipline that has been hard-earned over the last
two decades could come to an end.
The pandemic-induced collapse in fiscal revenue has created a huge strain on

EM government finances even before accounting for the unprecedented fiscal
support. Fiscal deficits in EM ex. China (EMX) will almost triple from an average
of 3.1% of GDP in 2019 to 8.8% of GDP this year (Exhibit 6). In China and several
high-yielder economies, they will rise above 15% of GDP. The combination of
weaker growth and deficit widening is driving further increases in EM public debt
which was already at all-time highs before the pandemic (Exhibit 7). Even stripping
out the effect of China, EMX government debt will likely reach 57.7% of GDP by
end-2020, its highest on record.
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Exhibit 6: Fiscal accounts have deteriorated significantly Exhibit 7: EM government debt

% of GDP % of GDP
0.0 65
60 China
-2.0 EMX
55
-4.0 50
45
-6.0 -5.4 40
35
-8.0
-7.8 30
-8.9 -8.6
-10.0 Latest 25
Pre-COVID 20
-12.0 -11.0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020F
2021F
EMX Latin America EM Asia EMEA EM GCC
Source: J.P. Morgan. EMX refers to EM ex. China. GCC not included in EMX aggregate Source: J.P. Morgan, IMF. EMX refers to EM ex. China.
Government debt-to-GDP dynamics depend on three factors: the primary fiscal

balance, GDP growth, and the cost of debt service. Cost of debt service, in turn, is
a function of interest rates and the maturity of debt. The government debt burden
goes down/up: (i) the higher/lower is the primary balance; (ii) the smaller/larger is
the interest-growth differential (IRGD); and (iii) the higher/lower is the growth rate.
Of these, the first is a policy choice, while the second and the third are outcomes of the
first and other policy choices and exogenous forces. On average, the EMX primary
deficit (fiscal balance excluding net interest payments) is set to widen 5%-pts to
5.6% of GDP (Exhibit 8). On a regional basis, it will widen most in Latin America
(by more than 7%-pts), followed by EMEA and EM Asia. In 2021, we expect
primary deficits to narrow but remain about 2%-pts wider than before the crisis.
Exhibit 8: EM primary deficit 2019-21

% of GDP, J.P. Morgan forecast
0.0
-0.2 0.0
-1.0 -0.6
-1.3
-2.0
-2.2
-3.0 -2.5
-2.7
-3.0
-4.0
-5.0 -4.6
2019
-6.0 -5.6 -5.6
2020
-7.0
2021
-7.6
-8.0
EMX Latam EMAX EMEA EM
Source: J.P. Morgan calculations. EMX refers to EM ex. China.
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Interest rate-growth differential has become less favorable

The differential between interest rates and GDP growth—a key determinant of
debt dynamics—has taken an unfavorable turn since the GFC. As documented in
the literature and our previous research, EMs have generally enjoyed large negative
interest rate-growth differentials (IRGD) as they are in a growth catch-up phase and
because of extensive financial repression (“A shallow EM tightening cycle”). This
is in contrast to DM economies where the IRGD has either been positive or near
zero. However, while both interest rates and nominal GDP growth have declined
since the GFC, the fall in growth has far outstripped the downshift in borrowing
costs, such that the IRGD has turned from -5.7% in 2009 to a small positive (Exhibit
9). This is the key reason why the public debt burden, after declining since the early
2000s, increased sharply after 2010 (Exhibit 10). Our 2020 growth and interest rate
forecasts suggest that the average IRGD will rise sharply in 2020 and then decline in
2021 (Exhibit 9). Beyond 2021, we project the average IRGD to decline again but to
remain above its 2010-19 average. Similarly, the primary deficit is likely to narrow
over the medium term but remain wider than its pre-pandemic level. Under these
assumptions the EMX debt-to-GDP ratio rises from 47.4% in 2019 to peak just
above 60% in 2024.
Exhibit 9: EMX interest-growth differential

Left scale: %pt; right scale: %p.a.
8 Nominal 14
6 GDP growth (rhs) 12
4 10
2 8
0 6
-2 4
-4 Interest-growth 2
differential Interest rate (rhs)
-6 0
(lhs)
-8 -2
10 12 14 16 18 20 22
Source: J.P. Morgan, IMF. EMX refers to EM ex. China.
Exhibit 10: Main determinants of EMX public debt

2010-19 2019 2020 2021 2022-29
Nominal borrowing cost (%) 6.0 5.6 5.5 5.5 5.2
Nominal GDP growth (%y/y) 8.7 5.4 -2.6 8.6 6.5
Interest-growth diff. (%-pts) -2.7 0.1 8.1 -3.1 -1.3
Primary balance (% of GDP) -0.5 -0.6 -5.6 -2.7 -0.7
Public debt-to-GDP 41.9 47.4 57.6 58.8 60.0
Source: J.P. Morgan. IRGD excludes Argentina.
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Pandemic presents a different kind of EM debt crisis

There is a well-established pattern to economic crises in EM. In the years
preceding the crisis, loose fiscal and monetary policies push the economy into
demand overdrive that spikes inflation and widens the current account deficit,
financed by foreign capital chasing the promise of even higher growth and asset
prices. At some point the overdrive is perceived as unsustainable, which triggers a
sudden stop of capital inflows. Growth collapses and a full-blown economic crisis
follows. The 1980s Latin America debt crisis, the 1995 Tequila crisis, the 1997
Asian crisis, the 1999 Russia crisis, and the 2013 Taper Tantrum all have the same
characteristics.
The present pandemic is not such a crisis. There was little sign of overheating in
EM at the start of the year. On the contrary, barring the CE-4 economies, output gaps
were negative and are expected to remain so even with the modest pickup in growth
envisaged in 2020. Inflation was forecasted to remain benign with monetary policy
continuing to ease. So this is not an instance of a financial crisis turning into an
economic shock because of damaged balance-sheets. Instead, this is a case of an
economic shock that could turn into a financial crisis and delay the recovery if
damaged balance-sheets are not repaired. In this instance, the appropriate response is
for monetary, fiscal, and regulatory policies to provide the needed time and space for
the recovery to take hold that will, in turn, repair the balance sheets rather than the
other way around. As discussed in our earlier research (“This time it’s different”), for
most EMs, the policy choice is between (a) tolerating a high fiscal deficit in 2020-21
and then consolidating, which would allow growth to return to near its pre-crisis
trend but require a medium-term fiscal anchor to ensure credibility and macro-
stability and (b) being forced to consolidate now to ward off fears of instability and
loss of market access, which, in turn, would result in lower growth near-term and
could end up also lowering potential growth.
In Exhibit 11, we illustrate this policy trade-off, under plausible assumptions. In

scenario (a), the debt burden rises initially before converging to the low deficit-low
growth scenario by 2025/26 and moves steadily below it by 2029. While the primary
balance, borrowing cost, and growth are all endogenous and it is difficult to establish
the empirical relationship between the three, small changes in growth have a telling
impact. In scenario (a) if the wider fiscal deficit is not accompanied by stronger
growth it puts debt on an unsustainable path. At the same time, the absence of a
growth drag from a higher primary balance in (b) is enough stabilize debt. To
stabilize debt at its projected 2020 level, by just changing the primary balance
(i.e. keeping the interest rate at its 2019 level and assuming GDP growth returns to
its pre-pandemic trend), implies for some countries (South Africa, Peru, Chile,
China, and Brazil) very large consolidation efforts relative to our 2021 forecasts that
would likely lower growth and be politically unacceptable (Exhibit 12).
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Exhibit 11: EMX debt evolution under different scenarios Exhibit 12: Debt-stabilizing primary balance* minus 2021F
% of GDP % of GDP
65 9.0
7.0
60
5.0
55 3.0
1.0
Scenario (a) Higher deficit, higher growth, higher interest
50
Scenario (b) Lower deficit, lower growth, lower interest -1.0
Philippines
Peru
Thailand
Korea
Poland
Malaysia
Israel
Czech Rep.
Uruguay
Turkey
Hungary
S. Africa
Chile
China
Indonesia
Colombia
Mexico
India
Russia
Brazil
Baseline
45
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Source: J.P. Morgan calculations. EMX refers to EM ex. China. Source: J.P.Morgan calculations. * Primary balance needed to stabilize debt at its 2020 level
assuming borrowing cost at 2019 level and GDP growth returns to its pre-pandemic trend.
Exhibit 13: Medium term interest-rate growth differentials*

%-pts, 2022-2029 J.P. Morgan forecast
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
-5.0
Hungary
Uruguay
Philippines
S. Africa
Peru
Thailand
Chile
Poland
Korea
Malaysia
Romania
India
Brazil
Israel
Czech Rep.
Turkey
Colombia
Mexico
Russia
Indonesia
China
Source: J.P. Morgan. *nominal effective borrowing cost minus nominal GDP growth.
From quantitative to regulatory to credit easing

EM central banks haven taken unprecedented policy actions in response to the
pandemics. So far EM central banks have cut interest rates, even in the face of
currency weakness, injected significant amounts of liquidity and eased regulations to
keep money and bond markets functioning, and undertaken quantitative easing (QE)
in varied degrees to keep bond yields broadly stable (“You can’t always get what you
need”). While QE so far has been limited it is likely to gather pace as fiscal deficits
widen because of sharp decline in revenue (Exhibit 14). As we have discussed
previously, such an uncharacteristic response is appropriate as long as it does not
damage policy credibility.
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Exhibit 14: EM CB government bond purchases

% of GDP (numbers in parentheses show amount bought in lccy)**
Poland (103bn) 6.0

India (1651bn) 4.2
Philippines (800bn) 4.1
Israel (24bn) 3.7
Brazil* (0trn) 3.2
Indonesia (205000bn) 3.1
Turkey (72bn) 2.1
South Africa (30bn) 2.0
Hungary (314bn) 2.0
Romania (5bn) 1.5
Mexico (15bn) 1.0
YTD since March
Thailand (152bn) 0.9
Colombia (3trn) 0.8 JPMe FY 2020 under adverse
market conditions**
Malaysia (9bn) 0.6
Korea (5trn) 0.5
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0
Source: J.P. Morgan estimates, national central banks. *normal monetary operations related to FX sales. **See “A Brave New World?
QE in EM”, Aziz, Szentivanyi et al.
The next shoe to drop in EM, we believe, will be the rise in non-performing
loans and the attendant tightening of credit that could well stymie the recovery.
If this happens, then household and corporate balance sheets will be damaged further.
This will make it difficult for most economies to get back to the pre-pandemic
medium-term growth path, which, in turn, will raise generalized fears over debt
sustainability. The right policy response is to ease regulations and provide credit
easing if needed. Whether undertaken by the central bank or the government, such
interventions will be difficult. Most do not have a framework in place to assess risk
and price bonds efficiently. While capital loss should not be a concern for central
bank as it does not impede any of its functions, the optics of running losses could
well erode public faith and credibility. Of course, the fear of capital loss is a concern
for governments for whom these are contingent liabilities and impact debt
sustainability.
Markets may become concerned about this simultaneous shift to unconventional

monetary, fiscal, and regulatory policies. As with QE, authorities will need to
work overtime to convince the market that the unorthodoxy will be limited and be
time bound. If they do so, then like QE, regulatory easing (RE) and credit easing
(CE) too will be accepted as extraordinary responses to provide the needed time and
space for the economy to recover from the unprecedented shock. If sufficient time
and space is provided for EM economies to recover, then the distress in EM balance
sheets is likely to be limited. If not, then the financial distress will become another
headwind threatening not just near-term growth, but also medium-term economic
prospects.
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EM trend growth to grind down further

With the end of the commodity super-cycle and the slowdown in global trade
EM potential growth had already downshifted in the post-GFC period. Potential
growth cannot be measured directly and all indirect measures involve a range of
theoretical assumptions and statistical approximations due to serious data
deficiencies in EM economies. Consequently, we adopt an agnostic view and take the
average of potential growth based on several approaches. We also compare our
potential growth estimates with the bottom-up estimates provided by our respective
country economists (Exhibit 15). We find that, in both these approaches, the message
is similar and unambiguous: the decline in trend growth is broad-based with the
potential declining in all the regions expect EMEA in last decade. The past decade
was bookended by the GFC and COVID-19—these events led to significant losses in
EM output relative to its pre-crisis path (Exhibit 16). Our preferred measure of
potential growth is that provided by our respective country economists, as they
incorporate various country specific idiosyncrasies and nuances. We use different
approaches to reinforce these estimates and find that the differences are not large.
Exhibit 15: EM potential growth 2005-2019

%
Avg (HP+ BP + PF) Bottom-up
EM
2005-07 6.6 6.2
2011-14 5.2 5.1
2015-19 4.7 4.8
EM ex China
2005-07 5.0 4.6
2011-14 3.4 3.5
2015-19 3.1 3.3
EM Asia
2005-07 8.4 8.2
2011-14 6.9 6.9
2015-19 6.0 6.0
EMEA
2005-07 5.4 4.5
2011-14 2.7 2.5
2015-19 2.7 2.5
LATAM
2005-07 3.8 3.4
2011-14 2.7 2.4
2015-19 0.7 1.4
Source: J.P. Morgan
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Exhibit 16: EM potential GDP growth (bottom-up)

%
6 12
EMX (left) 11
5 China (right) 10
9
4
8
7
3
6
2 5
2005 2007 2009 2011 2013 2015 2017 2019
Source: J.P. Morgan. EMX refers to EM ex. China.
Productivity decline is the key challenge for recovery

To analyze the factors underpinning the growth slowdown, we employ the
production function approach. This method decomposes potential growth into
contributions from inputs (physical and human capital and labor) and productivity—
referred as the Total Factor Productivity (TFP). A detailed description of data and
methodology is available in our Special Report. Using this approach we find that,
pre-GFC, strong EM growth was driven by both input and TFP, with the contribution
of productivity slightly higher than that of input. Specifically, during 2004-07, TFP
contribution averaged 4.4% and input contribution averaged 4% (Exhibit 17).
However, during the crisis EM countries were hit by a massive productivity shock
only to recover sharply, while inputs remained broadly stable. This seems odd that
during GFC, productivity which is driven by supply side factors, had a large swing,
while input (capital and labor), which have large element of cyclicality, remained
broadly unchanged. Indeed, one of the shortcomings of the growth-accounting
methodology is that it does not capture cyclical swings in the input utilization, and as
a consequence they get reflected in the TFP which is the residual part of the growth-
accounting.
Exhibit 17: Contributions to EM GDP growth

%oya
1
TFP
0
Input contribution
-1
2005 2007 2009 2011 2013 2015 2017 2019
Source: J.P. Morgan
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To correctly estimate the contribution of productivity and inputs in growth,

using the approach in the earlier special report, we extract the cyclical element
of TFP. This is done by running a regression of TFP against demand variables such
as global trade, terms-of-trade (ToT) and the fiscal deficit for 21 EM countries using
a panel regression for the period 2005-19. The results in Exhibit 18 show that real
global trade and, to a lesser extent, ToT are statistically significant reflecting that
TFP is capturing cyclical swings of input utilization. To derive true productivity
growth––referred as “adjusted TFP ––TFP needs to be adjusted for impacts. Once
adjusted for the changes in the demand-side variables, the rise in productivity during
the 2000s is less dramatic. Instead, EM growth appears to have been driven mostly
by inputs while productivity remained stuck at depressed levels.
Exhibit 18: Results from 21-country panel GMM regressions, 2005-19

Dependent variable annual TFP
Coeff. p-value
Lagged TFP 0.14 0.00
ToT growth 0.04 0.10
Global trade 0.28 0.00
Prob(J-statistics) 0.40
Note: GMM estimates (orthogonal deviations). Instruments: lagged TFP, Global trade, ToT. Source: J.P. Morgan
In line with our past research (“Emerging Markets: where has all the growth
gone?"), the decomposition exercise reiterates that global trade has been a
significant driver of the input utilizations (Exhibit 19). In the 2000s, when
globalization was at full force and global trade booming, this translated into higher
input utilization, uplifting GDP growth for the EM economies. With the collapse in
global trade since 2010, both input utilization levels and productivity growth
declined, hurting GDP growth. Specifically, global trade which contributed 2.4%-pts
to potential growth in 2005-07 has contributed just 0.7%-pts during 2015-19.
Importantly, going forward, if global trade continues to come under pressure, input
utilization levels are likely to decline. This could hurt future growth prospects of the
EM economies.
Exhibit 19: Decomposition of potential growth based on PF

%pt
2005-07 2015-19
Potential growth 6.7 4.7
World trade 2.4 0.7
Input (Investment + human capital) 3.3 3.3
Real TFP 1.0 0.7
Source: J.P. Morgan
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Exhibit 20: EMX total factor productivity

%, 2y MA
3
2 TFP
Adjusted TFP
-1
06 07 08 09 10 11 12 13 14 15 16 17 18 19
Source: J.P. Morgan
There are some divergences within EM regions. While EM Asia’s real

productivity growth seems to be on a secular decline led by China, it has been
improving in EM EMEA in recent years albeit from a very depressed base. EU
transfers likely play an important role in driving TFP growth in CEE economies
through their impact on FDI inflows, associated technological spillover and increased
participation in global value chains. The real productivity trend is perhaps most
lackluster in Latin America (Exhibit 21).
Exhibit 21: Real TFP

%
4 EM Asia
3 EMEA EM
LATAM
2
0
-1
-2
-3
-4
2006 2008 2010 2012 2014 2016 2018
Source: J.P. Morgan
Unfavorable EM demographics isn’t helping

At the start of the century, EM had benefited from its comparatively younger
population and associated lower labor costs. The surge in growth also increased
participation rates that, in turn, helped to keep wages low for longer. But now the
demographic dividend in EM is shrinking, with EMEA EM on average, aging at a
similar rate to DM countries. The steady expansion of the working age population
across Latin America over the past few decades is also showing signs of plateauing.
Meanwhile, EM Asia has the largest working age population but its share has
declined in recent years and will likely continue to fall as birth rates have slowed and
life expectancy increased—India is one of the few countries in the region bucking
this trend.
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Exhibit 22: Population demographics Exhibit 23: Demographic dividend is shrinking across EM
Total pop. growth, %yoy Age 65+ share of total, % Working age population % of total
2000- 2010- 2019- 2000- 2010- 2019- 76 EM Asia ex. CN, IN
2007 2017 2025 2007 2017 2025
74 EMEA EM
Global 1.0 0.8 0.6 8.2 9.6 11.8
Latam
DM 0.6 0.4 0.3 15.4 17.7 20.7 72
China
US 0.9 0.7 0.7 12.3 13.5 16.6 70 India
Euro area 0.5 0.1 0.1 17.1 19.5 22.2
68
Japan 0.1 -0.1 -0.3 19.0 25.3 30.2
66
UK 0.6 0.7 0.5 15.9 17.0 19.0
EM 1.1 0.9 0.6 6.5 7.7 9.9 64
Latam 1.3 1.1 0.9 5.8 7.3 9.4 62

EM Asia 1.1 0.9 0.7 6.1 7.3 9.6 60
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
EMEA EM 0.2 0.5 0.2 10.7 11.5 13.5
Source: J.P. Morgan, UN. Source: Census Bureau estimates, J.P. Morgan
Due to the size and contrasting demographic dynamics between China and
India, it warrants focusing the analysis on these two highly-populated
countries—which together represent over 45% of the EM population. China has
seen a substantial decline in its share of working age population—down over 3%pts
from the peak—due in part to the one-child policy, but also a result of urbanization
and improving health and education (Exhibit 24). One of China’s largest age groups
(50-54) will soon be reaching retirement age, which will significantly increase the
dependency ratio. At the same time, the birth rate (10.5 per 1,000 in 2019) fell to its
lowest in 70 years—despite the government easing the one-child policy and
introducing tax/financial incentives. In contrast, India will be one of the few large
EM countries that will continue to reap the “demographic dividend” of an increasing
working age population over the next decade (Exhibit 25). The youngest age groups
(from 0 through 19yrs) are the largest in India. Significant improvements in reducing
the country's infant mortality rate has contributed to population growth in recent
years.
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Exhibit 24: China’s population is aging quickly Exhibit 25: India’s working-age population is growing
Population by 5-year age grouping, million people (2000 and 2020) Population by 5-year age grouping, million people (2000 and 2020)
Source: Census Bureau estimates, J.P. Morgan Source: Census Bureau estimates, J.P. Morgan
EM participation rates have declined in recent years but also show a mixed
pattern across regions (Exhibit 26). In CEE, labor market reforms and strength in
the export-oriented industrial sector have driven a steady increase in participation
rates which in some cases has even outweighed negative demographics. However,
participation rates have been falling sharply in EM Asia. At the EM aggregate level,
female workforce participation has been also trending downward, driven by EM
Asia. Although the trend varies widely between countries and regions (Exhibit 27).
For example, female workforce participation is around 61% in EMEA EM compared
to 22% in MENA, with the largest gains being made in LatAm over the past two
decades. Within EM Asia, India and China have seen the largest declines, while
female participation has been trending higher elsewhere in the region. The space to
continue improving is ample in MENA and, more broadly, further reforms to
promote inclusive growth would help lift EM potential.
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Exhibit 26: EM labor force participation rate Exhibit 27: EM female workforce participation varies
Cumulative %pt change since 2010 % of female working age population
102 90
1999 2019 77
80
68
101 70
60 60 61
58
60 55 55 54
50
100
50
40 32
99 Latam
30 22
EM Asia 20 22
20
98 CEE
10
MENA
0
97
EM EM Asia EMEA EM Latam MENA China India
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
ex CN IN
Source: World Bank, ILO, Haver and J.P. Morgan
Source: World Bank, ILO, Haver and J.P. Morgan
Economic conditions, access to quality education, child and healthcare access,

availability of credit, legal provisions to protect women in the workplace and
social norms can all influence female participation. Strong growth and public
policy targeting these factors to open doors for women underpin the improvement
seen in recent decades in many regions. However, the progress has been slow.
Women remain the most underutilized source of growth and many public companies
are facing growing pressure to improve diversity, underscoring a greater awareness
of the need to address ESG issues. Gender equality also figures as one of the
seventeen Sustainable Development Goals through which public and private sector
entities hope to spur investment and safeguard gains in women’s economic
advancement (see later).
If left unaddressed, population ageing along with falling participation rates is

likely to be an important factor weighing on EM savings and inflation over the
coming decade. Slowing population growth, a lower working age population and a
higher share of elderly population all reduce savings. However, they also weigh on
investment. The dominant one of these two effects will determine the direction of
aggregate EM savings-investment balances. If the resulting reduction in investment
outweighs the decline in savings then the impact of worsening demographics on the
EM savings-investment balance may well be positive. The ongoing demographic
changes could also have a significant deflationary impact in the years ahead. This is
particularly a risk for EM Asia (ex. China and India)––a region experiencing a
significant ageing of its population and declines in its labor force (“EM Asia's
troubling convergence towards low rates”).
New normal for EM growth will depend on reforms

Looking forward, the medium term growth outlook for EM economies is not
particularly constructive. The current pandemic is the deepest crisis since the Great
Depression and is likely to pull potential growth lower as some productive capacities
are lost for good. This in conjunction with the continued de-globalization––of which
ongoing tensions between the US and China is an example––is likely to have
significant negative impact on EM potential growth, particularly when global trade
has such a disproportionate influence on EM economies.
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To get better sense of magnitudes, we forecast potential growth for the next 5-
years under two different scenarios, leaning on the results from the regressions
in Exhibit 18. We use the 2019 potential growth estimates provided by respective
country economists as the starting point. Under the baseline scenario, unsurprisingly,
potential growth continues to down-drift with EM potential growth falling from
4.6%oya in 2019 to 4.2% by 2024. The fall is broad-based with declines across all
three EM regions (Exhibit 28).
 Baseline scenario: This is a “business-as-usual” scenario with productivity

growth (TFP) and investments remaining at the last five years’ average. For
human capital we rely on ILO estimates of working population growth of
individual countries.
 Favorable scenario: This scenario highlights the importance of world trade for
EM. Under this scenario global trade returns to pre-GFC levels (average 2005-07)
which in turn would mean that investments also revert to their pre-GFC averages.
Exhibit 28: EM potential GDP growth through 2024 (baseline projection)

%
2005-07 2011-14 2015-19 2020-24
EM 6.2 5.1 4.8 4.3
EMX 4.6 3.5 3.3 2.8
EM Asia 8.2 6.9 6.0 5.5
EMEA 4.5 2.5 2.5 2.0
LATAM 3.4 2.4 1.4 1.1
Source: J.P. Morgan. EMAX refers to EM Asia ex. China.
In contrast, under the favorable scenario, EM potential growth zooms from

4.6%oya in 2019 to 6.2%oya by 2024––similar to the pre-GFC level, aided by
leapfrogging in global trade growth. The acceleration is broad-based with all
regions joining the party. This favorable scenario underscores the importance of
global trade to help achieving one of the best growth performances by EM in recent
history. Contrasting the baseline scenario with the favorable one draws out this point
even more clearly (Exhibit 29).
25

(44-20) 7134-7544 (44-20) 7742-0985
Exhibit 29: EM potential GDP growth through 2024 Exhibit 30: Decomposition of potential growth
% %
7.0 7 Investment + Real TFP
Human capital
Baseline 6
World trade
Favorable
5
6.0
4
4.4
3 2.4
3.0
5.0
2
1 0.9 0.9
1.1
0.2 0.7 0.7
4.0 0
2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2019 2020-24 baseline Pre-GFC PG
Source: J.P. Morgan Source: J.P. Morgan
The urgency of second-generation reforms

More realistically, in the present age of de-globalization such leapfrogging in
global trade is very unlikely. In a less supportive environment for global trade, EMs
are no longer able to reap the quick and large benefits of productivity-boosting
reforms focused on external liberalization. Instead, the only viable strategy to boost
potential growth is undertaking productivity enhancing reforms on a massive scale,
the benefits of which can take time to start showing up in higher incomes. The
reforms would crowd-in investments to take advantage of the higher capital returns.
To this end we carry out a thought experiment. We work back the contributions to
potential growth required by productivity (TFP) and investments, for the economy to
get back to its pre-GFC potential growth. We assume that global trade remains at the
last five years' average, and we build in working population growth forecasted by the
ILO. We find that the contributions of reforms and investment would need to jump
from 2.4%-pts to 4.4% for potential growth to achieve pre-GFC potential growth
(Exhibit 30). By all measures this is going to be a tall-order.
The broad areas of EM reforms will need to encompass domestic output, inputs
and capital markets as well as labor markets. Bold structural reforms to mitigate
the perverse effects of the ongoing demographic changes, in particular through
increases in female labor participation, would go a long a way to mitigate a further
slide in EM potential. Reforms should also focus on removing distortions in resource
allocation (including land, financial and human resources) including SOE reform,
administrative reform, and financial reform. However, because these reforms are
domestic-oriented, and will in all likelihood face political challenges or teething
problems, we would expect them to have an effect on productivity growth only after
several years.
26

Jahangir Aziz Katherine Marney Global Emerging Markets Research
jahangir.x.aziz@jpmorgan.com katherine.v.marney@jpmorgan.com 11 September 2020
Nora Szentivanyi
(44-20) 7134-7544
nora.szentivanyi@jpmorgan.com
Diversification gains to compensate lower

EM growth as supports for capital flows
 So far, EM-DM growth differential and the USD have driven capital flows
 With global trade slowing and the pandemic potentially causing permanent
damage to supply, EM trend growth is likely to slow further
 This will narrow the growth differential but still leave it sufficiently wide to
attract a reasonable albeit lower level (in percent of GDP) of inflows
 But the previously closely tied DM, EMX, and China growth dynamics is
changing with the latter's rise as an independent source of global demand
 This has opened up diversification gains as an added reason to invest in EM
 These gains will more than compensate the lower growth differential in
boosting EM capital flows once the pandemic shock has dissipated
It’s been all about growth (and the USD) so far

In a series of notes over the past few years (1, 2, 3, 4), we have demonstrated
that the EM-DM growth differential is an important factor in driving EM
capital flows. Throughout this report we define capital flows as broad financial
account flows (i.e.; current account minus reserve account).This relationship was
strong and held well during the 2002-07 EM growth surge, the adjustment during the
2008-10 global financial crisis (GFC), the decline in 2011-15, and the subsequent
recovery (Exhibit 31). In addition to the growth differential, the only other variable
that has a robust and statistically significant influence on capital flows is the relative
strength of the US dollar. Variables—such as the interest-rate differential, global
liquidity and risk, the cyclical position of the US or global economy—that are often
cited as being important drivers of capital flows turned out to have only weak
influence over the last two decades. That does not mean that these variables should
be ignored (Exhibit 32). It only suggests that that at annual or quarterly frequency
these variables are not the dominant drivers of capital flows. At higher frequencies,
at least some of these variables are often crucial, especially during times of crisis.
Exhibit 31: EMX-DM growth differential and EMX capital flows

Left scale: %pt; right scale: % of GDP
1.5 6.0
5.0
1.0
4.0
0.5 3.0
0.0 2.0
1.0
-0.5 0.0
-1.0 -1.0
Growth diff K flows
-2.0
-1.5
-3.0
-2.0 -4.0
02 07 12 17 22
Source: J.P. Morgan. EMX refers to EM ex. China.
27

Nora Szentivanyi
(44-20) 7134-7544
Exhibit 32: Drivers of EM capital flows

Dependent variable: net EMX inflows (% of GDP); fixed-effect panel regressions (20 countries, 1Q05-4Q18)
Eq. 1 Eq.2 Eq.3 Eq.4
Constant 0.14 0.18 0.15 0.21
Lagged capital flows 0.33 0.33 0.33 0.32
Growth differential 0.06 0.06 0.07 0.06
USDEUR change -0.03 -0.03 -0.03 -0.06
Policy rate differential -0.01
US recession dummy -0.14
Change in global M2 -0.27
Source: J.P. Morgan. EMX refers to EM ex. China. Grey shading refers to pvalue>0.05, M2 carries the wrong sign
EM-DM growth differential still wide enough to attract

capital flows
The COVID-19 crisis tested our capital flows framework by triggering a short-
lived sudden stop in portfolio flows, after countries were hit in rapid succession
by lockdowns that pulled global economies into recession. When growth
differentials went the opposite direction, it was swift and unprecedented deployment
of unconventional monetary policy by DM and some EM central banks that pulled
EM back from the brink of an extended and potentially damaging slowdown in
capital flows. EM capital flows have since recovered to their pre-pandemic pace of
0.1-0.2% of GDP. Even so, as borne out in this paper, lower potential growth in
emerging markets will likely narrow EM-DM growth differentials post-pandemic.
While we still expect its longstanding relationship with capital flows to hold, capital
flows are likely to remain subdued as a result. Assuming EM and DM grow in line
with their potential rates of 2.8% and 1.4%, respectively, EM capital flows over the
medium term should post inflows on the order of 0.3% of GDP (Exhibit 31).
And growth has been all about trade

Over the last two decades, the fortunes of EM have been closely tied to the rise
and fall of global trade. While it is natural to assume that much of this linkage is
due to China’s foray into global trade, the relationship is much more nuanced as
explained later in the chapter as China’s own dependence on trade has declined in the
last decade with its policy-driven rebalancing efforts (Exhibit 33 & Exhibit 34).
While the impact of globalization on EM growth through its dependence on exports
is well understood, the influence of trade goes much deeper. Indeed, even the
"domestic" components of the economy are affected by trade. For example, exports
are the main driver of both investment and consumption in much of EMX (Exhibit
35 and Exhibit 36). This is because much of EM investment, including infrastructure,
is driven by the needs of the tradable sector, while the large direct and indirect
income effects arising from exports and export-related activities have a strong impact
on consumption. The independent influence of domestic growth drivers has been
limited to countercyclical government spending even in most of the larger EM
economies that appear more closed on average.
28

Nora Szentivanyi
(44-20) 7134-7544
Exhibit 33: EMX growth and global trade Exhibit 34: China GDP growth and global trade
%oya, both scales %oya, both scales
10 20 15 China real GDP 15
14 (LHS)
8 15
13 Global real trade 10
6 10 (RHS)
12 5
4 5 11
0
2 0 10
9 -5
0 -5
EMX real GDP 8
-2 (LHS) -10 -10
7
-4 Global real trade -15 -15
(RHS) 6
-6 -20 5 -20
00 03 06 09 12 15 18 00 03 06 09 12 15 18
Source: J.P. Morgan, CPB. EMX refers to EM ex. China. Source: J.P. Morgan, CPB
Exhibit 35: EMX exports and investment Exhibit 36: EMX exports and consumption
%oya %oya, both scales
20 8 20
Consumption
15 Exports 15
6
10
10
4
5
5
2 0
0
-5
Investment 0
-5 -10
Exports
-10 -2 -15
00 02 04 06 08 10 12 14 16 18 00 02 04 06 08 10 12 14 16 18
EM-DM growth link no longer what it used to be

In the last two decades, the EM story has been one dominated by growth led by
China’s entry into the WTO and the subsequent expansion of global trade
alongside increased policy credibility in EMX. How China's economic
development evolves in the next decade will be crucial for EM growth and the
pattern of supply chains and capital flows (discussed in Chapter 3). However, there
are already emerging signs that the EM-DM growth relationship has been changing.
And with that there is now the prospect for investing in EMX, not just for higher
returns (for which the higher growth was needed) but also for diversification gains
that, so far, has been absent as a driver of EM assets. China’s rising share of global
output along with its rising participation in global supply chains has led to increasing
interconnectedness of EM economies. Convergence through the trade channel has
also led EM growth to become more synchronized as evident in EM’s declining
growth dispersion over the past two decades (Exhibit 37). While the pandemic is
expected to raise intra-EM growth dispersion, our forecasts suggest this will be
temporary, with dispersion falling back to its pre-pandemic levels by 2H21.
29

Nora Szentivanyi
(44-20) 7134-7544
Exhibit 37: EM GDP growth dispersion

%-pt standard deviation from the mean
10.0
9.0
8.0
7.0
6.0
5.0
4.0
01 03 05 07 09 11 13 15 17 19
Source: J.P. Morgan
Trade linkage among EM economies has increased significantly. Over the past
two decades, EM to EM trade has risen sharply, mirrored by a decline in EM trade
with DM (Exhibit 38). In particular, China’s share in the rest of EM's total exports
has tripled from 4% to 12%. Of note is the secular decline in EMX trade with the US,
which has broadly mirrored the increasing share with China (Exhibit 39). The Euro
area's share within EMX trade has also come down although the decline hasn't been
quite as steep as for the US. The upshot is that the Euro area has eclipsed the US as
EM’s main DM trading partner. Reliance on global trade is also more pronounced in
EM economies than it is DM. Trade in goods accounts for a much larger share of EM
GDP in part because of a structural shift towards services in DM domestic demand
associated with population ageing. Not only do goods make up a smaller share of
overall DM consumption and capex but the goods that are consumed are increasingly
higher value added. Together this has meant a declining share of DM demand in
overall EM value added and, ultimately, a diminished role for DM in EM external
trade.
30

Nora Szentivanyi
(44-20) 7134-7544
Exhibit 38: EM to EM trade share has risen Exhibit 39: EMX exports by destination
% of EM trade, both scales % of total EM exports
15.0
to US
13.0 to CN
to Euro area
11.0
9.0
7.0
5.0
3.0
96 98 00 02 04 06 08 10 12 14 16 18
China now an independent source of global demand

China growth and EM domestic demand conditions play a more important role
in explaining EMX growth than DM growth in the post-GFC era. To test the
hypothesis of a structural shift in EM growth linkages more formally, we estimated a
panel regression over the period 1Q01-4Q19. We regressed quarterly seasonally
adjusted annualized EM (excluding China) GDP growth on its own lag, DM GDP
growth, China GDP growth and the real policy rate to proxy for domestic financial
conditions. The regression also added country-specific dummies (i.e., fixed effects)
to account for intrinsic growth differences across countries. Over the entire sample
period DM growth, China growth and the EM policy rate are all statistically
significant drivers of EMX GDP growth. However, there is a statistically significant
break in the regression around 2010, raising the question whether there might be a
change in the relationships among the growth drivers. To test this, we split the
regression into two samples, with the first spanning the period between China's WTO
access and the GFC, and the second from 2010-2019.The results are revealing. The
coefficient on DM growth falls sharply in the second period, while the coefficient on
China growth increases. The relationship between EMX growth and the policy rate is
likewise higher in the second period and is just as significant as the changes in the
growth variables (Exhibit 40).
Exhibit 40: EMX growth regression

Dependent variable: EMX GDP growth (%q/q saar)
2001-08 2010-19
Constant 3.54 2.30
Lagged EMX growth -0.01 -0.10
DM growth 0.71 0.21
China growth 0.12 0.46
Policy rate -0.17 -0.52
R-squared 0.52 0.57
DW 2.06 2.00
Source: J.P. Morgan; 20-country panel regression
31

Nora Szentivanyi
(44-20) 7134-7544
EM-DM decoupling is not uniform across DM regions

The decline in EM’s growth sensitivity to DM is not uniform across DM regions.
Given the magnitude of the decline in EM-DM linkages, we dig deeper into what
might be driving this shift. Breaking DM into different regions reveals a number of
interesting results. EM’s weakening growth relationship with DM is driven primarily
by decoupling from the US, whereas the growth relationship with the Euro area has
been more stable in comparison. At the same time, EMX’s growth sensitivity to
China GDP growth has increased sharply since 2012 (Exhibit 41). The increase in
EM's leverage to China’s growth has been similar across EM high-yielders and low-
yielders. But EM high-yielders have decoupled from DM, and specifically the US, to
a greater extent than EM low-yielders since 2010. Looking at the EM-DM growth
relationship over the past five years alone (2014-19) does not alter the result with
respect to EM’s weakened relationship with the US. However, it shows a sharp
increase in sensitivity to Euro area growth—and hence less of a decoupling with
respect to DM overall-—and a smaller increase in sensitivity with respect to China
versus pre-GFC.
Exhibit 41: EMX’s growth sensitivity to China has increased

%-pt response of EMX GDP to 1%-pt higher US, China and EA GDP
0.80
0.70
US
0.60
China
0.50 Euro area
0.40
0.30
0.20
0.10
0.00
Pre-GFC Post-GFC
Source: J.P. Morgan
The results support the narrative that in the post-GFC period EM ex. China has
become more correlated with China’s economic growth and surpassed the
correlation with the US. This is not to say that the US is not an important driving
factor or source of ultimate demand for EM. But China has been the main
incremental consumer of EM commodities, and through supply chains, has supported
EM manufacturing exports. China’s organic slowdown—we expect China's potential
growth will trend down from ~6% to 4% in the next decade—and easing commodity
income impulse will thus weigh on EM growth in coming years. Rising
protectionism and populism along with souring US-China relations is triggering
further reassessment of globalization strategies. In the near-term, this impact is
further magnified by the pandemic growth hit and the accompanying easing in
commodity prices. This slowdown is set to spill over into the rest of EM primarily
through trade channels. Without a sizeable improvement in China’s imports, China’s
growth is thus likely to benefit its EM trading partners to a lesser degree.
32

Nora Szentivanyi
(44-20) 7134-7544
No longer just growth but diversification gains to drive EM

capital flows
Notwithstanding the lower EM-DM growth differential, changes in the linkages
between them have opened up diversification gains as an added driver of capital
flows. Setting aside the nuances between DM, CN, and EMX and the role played by
domestic drivers, we can see that the coefficient of EM growth regressed on DM
growth was greater than 1 in the pre-GFC period and it has fallen to 0.25 in the post
GFC period (Exhibit 42). Consequently, in the pre-GFC period there was little
diversification gains from investing in EM and higher returns was the dominant
driver of capital flows. A one percentage point higher, DM growth widened the EM-
DM growth differential (with the growth beta being more than 1) and this drove
higher inflows into EM. However, with the linkage now weakening (largely
reflecting the rise of China as an independent source of global demand and that of
EM—China trade), while it is no longer the case that higher growth in DM will
necessarily widen EM-DM differential, the lower correlation in their respective
business cycles means that diversification gains have (and will) become an added
driver of EM capital inflows. It is difficult to assess how large this impact will be as
several other factors will simultaneously be at play, But the combination of the large
declines in volatility and correlation (Exhibit 43) are likely to compensate for the
lower growth differential in powering capital flows into EM.
Exhibit 42: EM growth regression

Dependent variable: EM GDP growth (%q/q saar)
2001-08 2010-19
Constant 2.45 3.23
Lagged EMX growth 0.03 -0.02
DM growth 1.13 0.25
R-squared 0.64 0.63
DW 2.06 1.93
Source: J.P. Morgan; 20-country panel regression
Exhibit 43: EM and DM portfolio general drivers: summary statistics

2000-08 2010-19
EM DM EM DM
Average real GDP growth 5.82 1.79 5.07 1.86
Standard deviation 2.32 1.28 1.12 0.94
Correlation (EM-DM) 0.54 0.24
Source: J.P. Morgan.
Clearly growth dynamics are not the only drivers of capital flows. For example,
the correlations between GDP growth, volatility of growth and returns may not be
particularly robust and will vary by asset; in part because different assets have very
different risk characteristics (the relationship has shown to hold most strongly for
EM FX). Such a simplistic framework also fails to take into account many other
variables including risk tolerance, liquidity, policy and regulatory volatility, starting
level of valuations, positioning etc. The direction of causality between growth and
returns is also unclear. However, despite these caveats the exercise points to the
likely increase in EM asset allocation as DM, China, and EMX continue to chart their
own courses.
33

Jahangir Aziz Sin Beng Ong Global Emerging Markets Research
(1-212) 834-4328 (65) 6882-1623 EM as an Asset Class in the Post-pandemic World
jahangir.x.aziz@jpmorgan.com sinbeng.ong@jpmorgan.com 11 September 2020
Haibin Zhu Arindam Sandilya
(852) 2800-7039 (65) 6882-7759
haibin.zhu@jpmorgan.com arindam.x.sandilya@jpmorgan.com
Impact of the US-China tensions on EM

 The US-China conflict has multifaceted effects on EM
 Global Value Chains (GVCs) are changing and are likely to change further
as the conflict expands from trade to technology and possibly finance
 This could have substantial impact on EM ex. China (EMX) business cycles
and trend growth in the coming years
Supply chains as a microcosm of US-China relations

China has been a key driver of EM growth via trade flows and these have tied
the EM universe closer to China. We expect that China will continue to be a key
driver of EM. However, the evolution of the bilateral US-China relationship has
taken on a more competitive than co-operative bend and how this competition
evolves will have profound implications for the asset class. There are several
dimensions to the evolution of the US-China relationship that could affect EM in a
variety of ways, including a shift in trade and capital flows, with its implications for
the currency and trade and capital flow invoicing and the structure of polities with
the subsequent redrawing of geopolitical alliances. We expect that the net result of
these changes will lead to EMX depending now on two independent drivers of global
growth rather than only one dominant driver.
The changes in the goods supply chain has implications for EM and serves as a
useful barometer of the US-China relationship. A consistent aspect of US-Asia
trade is the large import share from Asia, rising in recent years (Exhibit 44).
However, belying this stability are material shifts in regional shares, which speaks to
the evolving nature of production across Asia. However, even before the escalation
in trade tensions in 2018, there had been an increase in US import shares from EM
Asia ex. China (EMAX), especially Vietnam, Taiwan and other parts of ASEAN
since 2015 (Exhibit 45). For the tech side of the supply chain, the shift in production
from China, which accounts for close to 30% of global exports, appears to underway
albeit gradually (Exhibit 46). Indeed, aside from the push of the rising unit labor cost
structure of China, the trade tensions have added an extra impetus, including access
to intermediates inputs especially technologically sensitive equipment.
34

(852) 2800-7039 (65) 6882-7759
Exhibit 44: China and other Asia share of US imports Exhibit 45: North Asia and South Asia share of US imports
% of US imports, both scales % of total US imports
25 35 20
Japan
20 Korea and Taiwan
30 15
ASEAN and India
15
Other Asia 25 10
10
20 5
5
China and Hong Kong
0 15 0
1990 1995 2000 2005 2010 2015 2020 1990 1995 2000 2005 2010 2015 2020
Source: Census Source: Census
Exhibit 46: Global share of machinery and electronics exports

%
30
25
20 China
US
15
Germany
10 Japan
0
1988 1993 1998 2003 2008 2013 2018
Source: WITS, J.P. Morgan
Tech components as the first casualty

Since the initial escalation of US-China trade tensions in 2018, import shares of
data processing machine parts have plunged (Exhibit 47). These components,
which include high-end servers and communications equipment make up small 5%
of US tech-related imports but are reliant on sensitive dual use high-end tech inputs,
as is the case for much of the tech-related supply chain (Exhibit 48). Thus, their
relative import shares may not fully recover given the increased scrutiny over
security and technology and is likely the first casualty of the US-China trade
tensions. The primary beneficiary of this redistribution of production has been
Taiwan and also to a lesser degree, Mexico.
35

(852) 2800-7039 (65) 6882-7759
Exhibit 47: China share of US tech imports Exhibit 48: China tech products value added by source
% share of same type imports, 3mma, both scales %
50 80 DVA USA Asia ex. China Europe RoW
70
45
36.5%
60
40
50
35 DVA 46.2% FVA
SITC 75, 76 and 77
40
2010-2018 average
30
30
Parts for office and data 9.3%
processing machines (right)
5.2% 2.7%
25 20
2005 2007 2009 2011 2013 2015 2017 2019 2021
Source: Census, J.P. Morgan Source: OECD-TiVA [2011], J.P. Morgan
China's Achilles heel: Access to foundational technologies

Although China's role in the tech GVC is expected to remain central, one of its
key weaknesses is its reliance on foreign inputs, particularly foundational
technologies in semiconductors. Foundational technologies enable the use of
applications in a variety of areas, including military and high-speed network and
communications. And in the case of semiconductors, which remains a critical core of
the tech supply chain, China has yet to provide domestic technology that is on par
with the US and developed Asia. For this reason, China's reliance on imports of
semiconductors remains a key vulnerability to its central role in GVCs. More
recently, given the heightened sensitivity of technology transfer to China,
manufacturing production for tech-sensitive products, including servers and high-end
network communications equipment, have seen a shift away from China into the
region and also to Mexico.
One of the key risks to China and to the further deepening of GVCs in China
materialized in May, when the U.S. Department of Commerce announced it
would modify existing policy to prevent semiconductors from companies
produced using U.S. software and technology from being shipped to Huawei
Technologies. The U.S. policy change is expected to make it harder for companies
producing semiconductor designs or chips to sell those products to Huawei if those
companies are using U.S.-made equipment or software. The move is likely to hamper
the operations of regional semiconductor producers. So far, however, the regulation
has not been widened to include US-related MNCs operating in China. If this were to
occur, the accompanying disruptions to GVCs could increase materially. While these
are still relatively early days, Chinese progress in the semiconductor and
communications space could reduce its reliance on foreign foundational technologies
and could lead to a broader adoption of China's own domestically developed
foundational technologies. If so, this would only serve to deepen and entrench China
as the global tech hub.
36

(852) 2800-7039 (65) 6882-7759
The evolution of US-China trade tensions around access to high-end technology

forms part of a larger set of divergences, along several dimensions. These include
the (1) broader economic cycle, (2) trade and credit linkages with EM, (3) political
and governance principles and (4) access to the USD clearing system. The interplay
of these factors likely will catalyze the formation of a world with two independent
drivers of global growth rather than only one dominant driver; within this world,
Europe could potentially build a stronger alliance with the US, and other Asian
countries with China.
Divergence in US-China economic cycles

From an economic perspective, China’s rise is one of the most important
changes for the global economy after the global financial crisis (GFC). Before
the GFC, China was a key beneficiary of the globalization, and its high growth
largely benefited from its expanded role as the global manufacturer and exporter.
After the GFC, China became an important engine for global economic growth,
contributing on average 28%-pts to global economic growth in 2010-2019, up from
17% in 2001-2006 (Exhibit 49). During the same period, the US contribution to
global economic growth declined modestly (from 19% to 17%) and fell behind
China. Such a shift is reflected in China’s economic transformation as well as the
China-led super commodity cycle. During this period, Chinese growth became
increasingly domestically-led, as reflected its falling net export contribution to
growth as well as China’s falling market share in global trade (Exhibit 50). China’s
massive domestic policy stimulus (known as the 4-trillion stimulus) in 2008-09 not
only drove China’s fast rebound but also help the global economy climb out of
recession. In the years after the GFC, China’s demand dominated the global
commodity market, driving the fourth super global commodity boom.
A subsequent impact of China's rise has been the shift in trade flows in
Emerging Markets towards China from the US in the past couple decades
(Exhibit 51 and Exhibit 52). In the case of EM Asia, this has raised the trade weight
of China and also increased the relative correlation of Asian currencies to the CNY
from the USD.
37

(852) 2800-7039 (65) 6882-7759
Exhibit 49: Contribution to global GDP growth: China vs. US Exhibit 50: Share in global trade
Percent %pt
China US
60 60
40 50 G3
20 40
0 30
East Asia ex. China
-20 20
10 China
-40
-60 0
96 98 00 02 04 06 08 10 12 14 16 18 95 97 99 01 03 05 07 09 11 13 15 17
Source: World Bank, J.P. Morgan Source: World Bank, J.P. Morgan
Exhibit 51: with

EM trade EM trade with
US and US and China
China
% GDP
% EM China US
ex CN 2001 2010 2019 Chg1 2001 2010 2019
India 16% 0.7 3.7 3.2 2.5 2.8 2.9 3.2
Brazil 10% 0.7 2.8 6.2 5.6 5.4 2.7 4.0
Russia 9% 3.5 3.6 6.5 3.0 2.9 2.1 1.6
South Korea 9% 6.6 18.1 17.3 10.8 10.5 7.7 8.2
Mexico 7% 0.3 2.3 4.8 4.5 30.8 37.2 48.8
Indonesia 6% 4.2 5.7 7.1 2.9 7.9 3.1 2.5
Saudi Arabia 4% 2.2 8.2 9.9 7.6 10.5 8.1 3.5
Turkey 4% 0.5 2.0 2.8 2.3 3.1 1.9 2.7
Taiwan 3% 10.8 32.7 37.3 26.5 17.2 13.9 14.0
Poland 3% 0.7 2.3 4.7 4.1 0.9 1.2 2.4
Thailand 3% 6.0 15.5 16.9 10.9 17.2 9.3 8.6
Argentina 2% 0.7 3.0 3.2 2.5 2.6 2.6 2.9
Israel 2% 1.0 3.3 3.7 2.7 14.9 13.8 8.6
Source: National sources; 1. 2019 less 2001
Exhibit 52: EM trade volume with China and the US

% of GDP, sum of exports and imports
30
EM Asia
EMEA
LatAm ex MEX
20
10
0
2001 2010 2019 2001 2010 2019
Trade with CN Trade with US
Source: China Customs, Census Bureau, World Bank-WDI, CSO, J.P. Morgan. Note: Each line represents simple average of the
region
38

(852) 2800-7039 (65) 6882-7759
How China changed EM FDI flows

The change in China’s global role is also reflected in China’s overseas
investment. Since China’s openness policy, China has been a major destination of
global FDI and attracting FDI has been a priority policy. Since the GFC, especially
in recent years, China has emerged as a new global creditor, of which the Belt &
Road Initiatives (BRI) has been a key catalyst. The BRI is a global development
strategy adopted by the Chinese government in 2013. China aims to leverage on its
excess savings and excess capacity to help other BRI countries to improve
infrastructure and achieve sustainable growth. The strategy is also considered as a
centerpiece of China’s foreign policy. Over time, the broad vision and objectives of
the BRI have been revised and several institutions were established, including Sild
Road Fund in China and Asian Infrastructure Investment Bank (AIIB) and New
Development Bank as new international financial institutions, to support the BRI
projects.
China has surpassed Paris Club countries and international financial

institutions (e.g. World Bank) to become the largest new creditor to EM
countries, especially low income economies (LIEs). There are various estimates of
China’s overseas lending. According to the World Bank International Debt Statistics
(2020), China’s overseas lending (stock) rose from $192.8bn in 2008 to $733.7bn in
2018. However, the study by Horn, Reinhart and Trebesch (2020) suggest that about
50% of China’s committed lending is un-reported. Indeed, looking at China’s
International Investment Position (IIP) data reveals much larger stocks, including
outbound FDI ($252bn in 2018), loans ($710bn) and trade credit ($597bn). While
China will continue to be an important global creditor, the COVID-19 outbreak could
slow down the pace of China’s overseas investment. The broadening scale of
COVID-19 and widespread lockdown restrictions brought many BRI projects to a
temporary halt amid transportation bottlenecks, supply chain disruption, and funding
and labor constraints. The viability of these BRI projects is being tested: 102 out of
189 IMF member countries contacted the Fund for emergency funding after the
COVID-19 outbreak, and the G-20 agreed to freeze repayments this year (both
principal and interest) on bilateral government loans for 76 eligible IDA-countries.
Debt increase has been a common theme for EM economies since the GFC. And
the massive fiscal response after the pandemic suggests that EM (and global) debt
will rise sharply in 2020. For China, it is not only the credit quality concern and high
uncertainty in debt resolution schemes that will lead to more cautious
implementation in its overseas lending, but also China’s ability to invest overseas
will become weaker due to the decline in its FX reserves and the challenge in
cleaning up domestic financial sector.
39

(852) 2800-7039 (65) 6882-7759
Exhibit 53: China’s ODI flow to B&R countries Exhibit 54: China’s B&R investment by sector, Jan-Dec 2019
US$ bn %
25 Others
20.17 Real estate 5%
20 18.93 17.89 3%
Entertainment
15.34 3%
12.63 13.66
15 Tech
4% Energy
10 Metals 52%
8%
5
0 Transport
25%
2013 2014 2015 2016 2017 2018
Source: Ministry of Commerce, J.P. Morgan Source: AEI tracker, J.P. Morgan
Exhibit 55: China’s external debt as creditor Exhibit 56: China’s BOP
US$ bn US$ trn
800 Public Publicly guaranteed Private non-guaranteed 2.0
Outward direct investment Loan Trade credit
600 1.5
490
468 1.0
400 443
350
356
0.5
200
102 147 191
114 92 107
28 0.0
64 57 46 55 54 53
0 12 13 14 15 16 17 18
2008 2014 2015 2016 2017 2018
Source: SAFE, J.P. Morgan.
Source: World Bank IDS, J.P. Morgan.
Exhibit 57: External public debt owed to different official creditors by developing countries
USD bn Debt to World Bank
Debt to IMF
400 Debt to all Paris Club gov (ODA)
Debt to China
300
200
100
0
2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: World Bank IDS, Paris Club, Research paper on China’s Overseas Lending by Horn, Reinhart and Trebesch (2019), J.P.
Morgan. ODA=official development assistance.
And will now change financial flows

China's growing footprint in trade and financial flows into EM suggest that a
growing acceptance of the RMB as a form of foreign exchange among its key
trading partners. Limited capital account convertibility and thus
internationalization of the RMB pose near term constraints. However, there are two
evolving developments that bear watching.
40

(852) 2800-7039 (65) 6882-7759
The first is the integration of China's financial markets to global investors via
its entry into global bond and equity indices. China has continued to open access
to global institutional investors, with further relaxation in QFII rules, stock connect
and bond connect schemes. We expect that China will eventually be included in all
three major benchmarks, which will generate an estimated $150-200bn in additional
rebalancing flows. RMB-denominated assets also provide a valuable diversification
benefit due to their divergent performance from DM assets. While 69% of DM
government debt (or more than $32 trillion) yields 0.5% or less, China’s government
bond still generate 2-3% yield. Together with favorable fundamental factors (growth
differentials and modest improvement in current account surplus) that support a
relatively stable CNY, this has driven capital inflows to China.
The second development is the escalation in US-China tensions and its impact
on access to the US$ payments system. The probability of previously unimaginable
scenarios, including financial sanctions to restrict access to USD, has increased from
zero to non-zero. While China continues to push financial openness to avoid a worst-
case scenario, it will also consider a Plan B, namely RMB internationalization. RMB
internationalization took off about one decade ago and experienced a fast-growing
period in 2012-15. By 2014, RMB became the second largest currency in cross-border
trade finance, the fifth largest currency in cross-border payment and the sixth currency
in FX transaction. Since October 2016, the IMF has included RMB in its special
drawing right (SDR) basket starting with a weight of 10.92%, below USD (41.73%)
and EUR (30.93%) but ahead of JPY (8.33%) and GBP (8.09%). However, the pace
of RMB internationalization has since slowed down, driven by CNY depreciation, an
economic slowdown, and tightened restrictions in capital outflows.
Overall, RMB internationalization still has a long way to go. The PBOC needs to
further encourage two-way capital account liberalization, improve the flexibility of
CNY exchange rate, and also deal with domestic financial vulnerabilities. These are
challenging tasks, but the concern about US-China tension may provide a catalyst for
China to start a new round of RMB internationalization. If it happens, it will enhance
the attractiveness of RMB assets for international investors.
Exhibit 58: Foreign investors’ share in China’s onshore equity and Exhibit 59: Interest rate differential in 10Y Treasury yields between
bond market China and the US
%pt, both scales %pt
Foreign holdings in onshore equity market
10 (% of total A shares' tradablemkt caps) 5 2.5 10Y interest rate differential
2.0
8 4
Foreign holdings of CGBs 1.5
(% of total outstanding)
6 3 1.0
0.5
4 2
0.0
2 1 -0.5
2014 2015 2016 2017 2018 2019 2020 2021 09 10 11 12 13 14 15 16 17 18 19 20
Source: Bloomberg, WIND, J.P. Morgan Source: Bloomberg, WIND, J.P. Morgan
41

(852) 2800-7039 (65) 6882-7759
Exhibit 60: Volatility in USD/CNY exchange rate Exhibit 61: Top 6 currencies in international use
Std Dev, in each quarter Ranking Global payment Trade finance FX reserve
0.15
1 USD (43.37% ) USD (85.42% ) USD (57.02% )
2 EUR (31.46% ) EUR (6.47% ) EUR (19.24% )
0.10 3 GBP (6.57% ) CNY (2.80% ) JPY (5.34% )
4 JPY (3.79% ) JPY (1.94% ) GBP (4.33% )
0.05 5 CAD (1.79% ) IDR (0.56% ) CNY (1.84% )
6 CNY (1.66% ) AED (0.43% ) CAD (1.76% )
Source: SWIFT
0.00
10 12 14 16 18 20
Source: Bloomberg, J.P. Morgan
Ideology, governance and politics of the US-China conflict

The fundamental shift in the US’s policy towards China, from engagement to
containment, is driven not only by China’s challenge to the US’s leading role in
economics, trade and finance, but also the US government’s disappointment
with the scope of economic and policy reforms in China over the past two
decades (United States Strategic Approach to the People's Republic of China", May
20). At the same time, the GFC and China’s economic outperformance have
increased the Chinese government's confidence in its own path, theory and
institutions. Hence, the confrontation between the US and China is also about
competition in ideology, governance and institutional arrangements. Indeed, although
trade with China has risen materially, the public perception of China varies across
EM countries, reflecting differences in polity and governance structures (Exhibit 62).
Exhibit 62: Trade and public opinion of US and China

Trade exposure to China/US, % GDP, China less US
15 KOR
POL IDN RUS
ARG
Increasing trade with China
0
BRL TRY
IND
ISR
-15
-30
MEX
-45
-60 -40 -20 0 20 40 60
Pro-US Opinion of China/US Pro-China
Source: Pew Research and national sources
Quantifying differences in governance and institutional arrangements allow us

to assess whether individual countries are closer to China or to the US in their
systems. To do so we use index scores in 10 sub-categories provided by the Global
Economy. For each sub-category, we re-index the score between 100 (strongest) and
0 (weakest), and calculate the unweighted average for each country based on their
scores in the 10 sub-categories. Out of 172 countries, Finland scores the highest
(94.6) and Somalia scores the lowest (6.8). The US ranks 21st with a score of 79.5
and China ranks 125 with a score of 37.5 (Figure 20 and 21).
42

(852) 2800-7039 (65) 6882-7759
Exhibit 63: Distributions of index (range 0-100) of governance and Exhibit 64: Characteristics of governance & institutional
institutional arrangements arrangements
Number of countries (total 172) Index score 0-100
China
35 USA Rule of law
Women in 100 Government
30 Parliaments 80 effectiveness
60
25 40
Civil liberties Controlof Corruption
20 20
0
15
Political rights Regulatory quality
10
5 Corruption Voice &

perceptions Accountability
0 Political Stability
[0, [10, [20, [30, [40, [50, [60, [70, [80, [90,
10] 20] 30] 40] 50] 60] 70] 80] 90] 100]
Source: theGlobalEconomy.com, J.P. Morgan.
Source: theGlobalEconomy.com, J.P. Morgan.
Perhaps not surprisingly, the US and China represent the two blocs of
countries; one is more developed democratic society, with enhanced protection on
political rights and civil rights, effective governance and balance of power, rule of
law and control on corruptions and sources of social instability, and the other
developing economies which generally have room to improve in various aspects. If
we divide countries by the distance to US and China’s political systems, measured by
the sum of absolute difference in sub-index scores, more countries (108) are similar
to China's system than to the US (62 countries). The US bloc (Exhibit 65) mainly
includes developed countries, Central and Eastern European countries, and other EM
countries with relatively high income per capita. By contrast, the China bloc mainly
includes low- and middle-income emerging market economies. As a share of the
global GDP, the US bloc accounts for 61.2% of global GDP (36.8% if excluding the
US) and the China bloc accounts for 36.3% of global GDP (19.9% if excluding
China).
The proximity in governance and institutional arrangement is an important

contributing factor to geopolitical dynamics. Countries with similar political
systems tend to have similar voices, or have closer relationship, such as the Five
Eyes and TTIP (or TPP if not withdrawn by President Trump) for the US, or Belt &
Road Initiatives on China’s side. But geopolitical developments are also affected by
national interests and many other considerations. Some emerging countries may
benefit from the US containment policy on China or be concerned about China's
increasing influence, while some advanced economies may object to certain bilateral
approaches adopted by the current US administration.
43

(852) 2800-7039 (65) 6882-7759
Exhibit 65: Proximity in political system arrangements
Source: theGlobalEconomy.com, J.P. Morgan
Note: This is based on proximity (sum of absolute difference in 10 sub-indices) in political system arrangements. Orange areas refer to
countries that have more similar arrangement to China than to the US, and blue areas refer to countries that have more similar
arrangement to the US than to China.
The upcoming US elections will have a bearing on the future of US-China

conflict, but will likely be limited to changes in tactics rather than in the
fundamental issues. If the current administration is reelected, then trade will remain
the main area of overt conflict and the strategy will continue with assessing the
results of the Phase 1 trade deal and followed by the second phase. If the
administration changes then it could provide space for both parties to step back and
reassess the terms of the engagement. While it is possible that the emphasis on trade
could be dialed back, the focus could shift to other areas such as human rights and
environment. Moreover, a new US administration could well shift to a multilateral
rather than just a bilateral engagement with China. On the technology front, the
election is unlikely to change much the terms and nature of the engagement as these
are driven by specific agency interests and concerns and there is broad bipartisan
agreement on the basic objectives. In the financial sector, one expects continued
cooperation and further integration as it is mutually beneficial. But the risk is that it
could fall victim to the conflict in trade and technology.
44

Jonny Goulden Trang Nguyen Global Emerging Markets Research
jonathan.m.goulden@jpmorgan.com trang.m.nguyen@jpmorgan.com 11 September 2020
Saad Siddiqui
(44-20) 7742-5067
saad.siddiqui@jpmorgan.com
Evolution of EM fixed income as an asset

class and outlook for returns
 From the Brady bonds of the early 1990s, EM bond markets have
broadened significantly in terms of countries with investible debt now
available in around 100 EM countries.
 EM debt markets have also matured for large countries who finance mostly
in local currency debt, which now accounts for 90% of EM government
bonds.
 EM hard and local currency bonds FX-hedged have delivered returns
above DM equivalents, with attractive Sharpe ratios, but taking EM
currencies exposure has lowered returns and shape ratios to unattractive
levels.
 EM AUM and inflow trends both have adjusted to the risk/reward profile
and in the last cycle have shown a clear preference for hard currency EM
debt over local currency.
 Global fund allocations to EM bonds are still small showing room to
increase and access to China’s local government bonds should see demand
from international investors as they have high weights in efficient
government bond portfolios.
 EM Sharpe ratios may fall in the period ahead given the 40 year global
duration rally has less room to extend, but this would be the same for all
bond markets and EM’s higher yields will still attract interest.
The long-term drivers and COVID-19 impact on EM assets

The legacy of COVID-19 for EM (and the world) will be one of a large increase
in debt on top of an already sizeable stock of debt. EM total government debt is
expected to rise by 8.4%-pt of GDP—the largest single-year increase on record—to
reach 59% of GDP (Exhibit 66). Typically this would have meant a path to EM-wide
debt crises, but the outlook is likely to be more nuanced than that. Most of the large
EM countries have learned from the ‘original sin’ of crises past and have shifted
borrowing patterns increasingly to domestic debt (Exhibit 67) which is now by far
the largest part of the asset class. However, this has been replaced by many new
smaller EM countries having issued in hard currency debt over the past decade. This
has led to a large expansion in the number of investible EM countries but leaves a tail
of countries that will likely need debt support and restructurings. The hope is that the
weight of yielding-seeking demand (Exhibit 68) will help push demand to EM bonds
in a world of ultra-low yields/stagnant growth (The Long-term Strategist: What if US
joins the Zero-Yield World?, Jan Loeys). Reconciling these two trends will mean a
two-speed EM asset class where the majority see lower returns but lower volatility
due to yield compression, but the tail-risks remain in both local and hard currency
keeping idiosyncratic risks high.
45

Saad Siddiqui
(44-20) 7742-5067
Exhibit 66: EM government debt expected to spike higher in 2020 Exhibit 67: EMX government debt has become increasingly domestic,
EM and EMX (ex-China) general govt. debt, % of GDP shifting focus to local bond markets
EMX general government debt (% of GDP)
60
50 45%
EM EMX % of debt in external (right)
55 45 General govt ext debt
40 General govt dom debt 40%
50 35
30 35%
45
25
40 20 30%
15
35 10 25%
5
30
0 20%
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020F
Source: J.P. Morgan. EMX refers to EM ex. China. Source: J.P. Morgan. EMX refers to EM ex. China.
Exhibit 68: $15trn of bonds in our govt and corp indices have negative yields which will keep
yield-seeking behaviour
All Govt + Corp index bonds with Negative Yield (US$, trn)
16
14
12
10
8
6
4
2
0
2012
2012
2013
2013
2013
2014
2014
2014
2015
2015
2015
2016
2016
2016
2017
2017
2017
2018
2018
2018
2019
2019
2019
2020
2020
Source: J.P. Morgan
Bond yields falling slowly to zero in Japan did not result in an increase in EM
inflows from there. EM yields may grind lower relative to risk free DM rates but
that does not necessarily mean there will be large inflows into FX-sensitive parts of
the asset class. Japan itself provides a good test-ground to see what happened when
yields fell towards zero (Exhibit 68). Flows into EM bonds from Japanese investors
were largely range-bound showing no trend as Japanese government bond yields fell
over a decade. The parts of EM that were preferred by Japanese investors also shows
us something where assets prefer to go as domestic yields head to zero. Exhibit 70
shows that Japanese flows into EM have switched from being more into LatAm
(which is higher yielding) and more into China (which is lower yielding). It would
seem that the yield seeking behaviour does not go all the way to the highest yielder
and is comfortable with bonds that offer some pick-up to near-zero local yields,
without stretching to the riskiest higher yielders. It is reasonable to argue that
Japanese bond buying had an alternative for many years in the form of US
government and corporate debt, which is now much lower yielding. But even so, the
historical pattern indicates that even if we assume yield seeking inflows into EM as
46

Saad Siddiqui
(44-20) 7742-5067
global yields fall, this does not necessarily mean they will go to those that most need
them where risk premia may stay high
Exhibit 69: Japanese buying of EM bonds does not show any trend Exhibit 70: Japan flows into EM debt have increasingly favoured
increase as JGB yields trend decreased lower yielding parts of EM, namely China
Japan flows into EM debt, % ot total net annual flow, 12mma
Japanese buying of EM debt (JPY bn, 12m rolling)
JGB 10y yield (right, %) EMEA Other EM Asia China and Hong Kong SAR Latam
2000 2
1800 150
1600 1.5
1400
1200 1 100
1000
800 0.5
50
600
400 0
200 0
0 -0.5
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
-50
06 08 10 12 14 16 18 20
A brief history of Emerging Market bond markets

The history of modern EM bond markets starts in the early 1990s with the
Brady Plan that restructured EM loans into bonds. International borrowing by
Emerging Market countries has a long history. For example, the aftermath of the
Napoleonic Wars resulted in a Latin American borrowing spree as Spain lost
substantial territory1. While EM international borrowing was often in loan format, it
was not until the aftermath of the 1980s EM debt crises that the Brady Plan resulted
in an EM bond market through collateralized Brady Bonds. A standardized trading
market started in the early 1990s and J.P. Morgan's EMBI index was launched in
1992 (Exhibit 71). Throughout the 1990s Brady Bonds were eventually phased out in
favour of the more vanilla international bonds we have today.
Risk premia on EM sovereign bonds have transitioned from a more volatile

phase in the 1990s to a lower volatility regime since the mid-2000s. Spreads on
EM sovereigns bonds have seen two distinct phases on modern times: i) An
embryonic period: from early 1990s to mid-2000s as external government debt
workouts were needed; ii) Mid-2000s onwards as large countries lowered external
government debt and the issuers broadened (Exhibit 71). EM currencies have had
three overlapping but varied trends: i) Late 1990s to early 2000s: currency crises and
devaluation; ii) Early 2000s to GFC: EM FX trend appreciation on reforms, China
and commodities super-cycle; iii) EM FX trend depreciation as growth stalled and
country-specific risks rose again.
1
See This Time is Different: Eight Centuries of Financial Folly, Reinhart & Rogoff.
47

Saad Siddiqui
(44-20) 7742-5067
Exhibit 71: A brief history of EM markets since the inception of the EM bond markets
Source: J.P. Morgan
48

Saad Siddiqui
(44-20) 7742-5067
EM investible assets have grown, broadened and matured

with the shift to local currency funding for large countries
The EM tradeable debt stock has seen a massive increase in the last 20 years as
government borrowing patterns matured, with local currency bonds by far the
largest component, although less well-owned by international investors. From
what started in the early 1990s as a predominantly hard currency bond market, EM
debt is mostly now in local currency form. EM bond markets were less than $1trn in
size in 2000 but have grown to $23trn currently (Exhibit 72). Most of the growth has
come from local currency sovereigns and corporates which are $19.2trn in size,
compared to $3.7trn in the hard currency market (sovereigns and corporates).
International investor involvement is still much more concentrated in hard currency
EM bonds. For comparison, the size of DM government bonds is $30trn and the size
of DM corporate bonds is $10.4trn.
Exhibit 72: The EM debt stock has increased to $23 trillion, a nearly 400% increase since the GFC
EM debt stock by asset class, USD trillion
25 23.0
EM hard currency corporates EM local currency corporates EM hard currency sovereigns 22.1
EM local currency sovereigns EM fixed income 19.9
20 18.2
15.9 16.4 10.8

14.5
15
12.6
11.2
9.6 1.3
9.1
10
7.4
5.8 6.0
8.4
4.3
5 3.4
2.8
2.0
0.8 1.3
0.7
2.4
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Jun-20
Source: J.P. Morgan
Persistent EM bond market trends have been the broadening of the investible
universe of countries time and shift to local currency funding; both will likely
continue. The investible universe of EM hard currency sovereigns encompassed just
over 10 countries in the early 1990s but has growth significantly, particularly over
the last decade, to 74 countries in our EM sovereign index (Exhibit 73). This process
of expansion has been facilitated by both the development of EM countries who have
reached a stage at which they can borrow internationally, as well as a long global
economic cycle from the GFC that kept yields low and market demand in place.
Additionally, more EM countries have seen foreign investors participating in their
local market instruments (Exhibit 74), with new ‘frontier’ local markets growth being
notable in the last years of the post-GFC expansion. Low yields look set to continue
and the United Nations has 193 member states, meaning there is still scope for the
number of EM countries with investible debt to grow.
49

Saad Siddiqui
(44-20) 7742-5067
Exhibit 73: The number of EM sovereign issues has expanded Exhibit 74: The number of EM countries with investible local
significantly in the last 30 years markets has also been rising steadily
Number of countries and issuers in the EMBI/G index Number of countries with available pricing on local markets instruments
80 No. of countries 190 50 Number of EM local investible

No. of issuers (right) 45 markets
170
70
40
150
60 35
130 30
50 110 25
90 20
40
15
70
30 10
50
5
20
30 0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
10 10
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
Source: J.P. Morgan
Source: J.P. Morgan
The other persistent trend in EM bond markets has been the shift to domestic
from external debt (Exhibit 74). The EM loan and bonded debt in the decades up to
the Asian Financial crises had been mostly in hard currency and external form,
meaning currency depreciation would lead directly into knock-on impacts on debt
dynamics. This 'original sin' had started to correct during the aftermath to the late
1990s / early 2000s default cycle and continued until the GFC, resulting in the bulk
of EM government debt becoming local rather than hard currency. China’s size
influences this, but most large EM countries also do the bulk of their debt issuance in
local currency. The expansion of issuers has also meant an increasing tail of smaller
countries who have issued in the past decade with most of their borrowing in hard
currency. In recent years, this helps explain the high debt/GDP in many frontier
market issuers who have borrowed internationally and then seen their currencies
depreciate.
50

Saad Siddiqui
(44-20) 7742-5067
Exhibit 75: EM government bonds have become predominantly local markets rather than hard
currency for most large EM countries
EM government bond markets (sovereigns) split into hard currency and local currency, % of outstanding
EM hard currency sovereigns (% of all EM sovereigns

100% EM local currency sovereigns (% of all EM sovereigns)
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Jun-…
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Source: J.P. Morgan
Asset class performance has seen hard and local currency

EM bonds deliver good returns when FX-hedged
EM FX has seen three regimes: i) 1990s high carry & FX depreciation; ii) 2000s
FX appreciation; and iii) Post 2011 trend depreciation and falling carry to
current all-time lows (Exhibit 76). It is useful to start the analysis of EM local
markets returns by looking at EM currency performance. In spot terms, EM
currencies have had three major regimes since the 1990s. i) From 1994-2002 EM
spot FX weakened significantly through various crises involving de-pegging and
depreciating currencies. Very high EM FX carry in this period (Exhibit 77) meant
that EM currency returns were positive despite this spot depreciation. This gave way
to ii) the period that lasted from 2002-2008 which saw China's growth emergence, a
commodity super-cycle peaking, and the benefits from the reforms of the crisis
period contributing to trend EM FX strength. iii) Post 2011, EM currencies have
continued to see depreciation and given the lower carry on offer total returns have
been negative. As we currently stand in the wake of the COVID-19 crisis, EM central
bank rate cuts have put EM FX carry at all-time lows. It is important to see that since
the 1990s there only been one period of trend EM FX appreciation in the 2000s. This
is because much of the analysis of EM bond performance will start in the early 2000s
when local bond markets became more internationally investible, which coincided
with a rare period of EM FX spot appreciation.
51

Saad Siddiqui
(44-20) 7742-5067
Exhibit 76: EM FX has experienced 3 regimes, with spot appreciation Exhibit 77: … EM FX carry over-compensated for spot losses in the
only seen in the 2003-8 period… 1990s but has fallen to current historical lows.
EM FX return indices for spot, carry and total return (TR) EM FX implied yields (%)
100
827 EM FX Implied Yield (%)
90 51
727
80
41
627
70
527 31
60
427
50 21
327
227 40 11
EM FX Carry
127 EM FX TR 30
EM FX Spot Returns (right) 1
27 20 1994 1998 2002 2006 2010 2014 2018
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
Source: J.P. Morgan

Source: J.P. Morgan
In real effective terms, EM currency weakness since 2011 is not very

pronounced with current levels still above 30y averages. As well as looking at
EM FX spot moves versus the USD, traded-weighting and inflation-adjusting
currency moves in REER terms shows less of a depreciation since 2010. EM REERs
are still above 30 year averages, with the 2004-14 period of REER appreciation
standing out as the dominant trend since the 1990s. EM REERs have been moving
lower since 2015, but CPI-based measures in particular are still well above long-term
averages indicating EM’s higher inflation accounts for a fair amount of spot
depreciation pressure.
Exhibit 78: EM REER levels are still above long-term averages

EM Real Effective Exchange Rates (REER)
EM REER (CPI-based) EM REER (PPI-based)
EM REER (CPI-based): average since 1994 EM REER (PPI-based): average since 1994
115
110
105
100
95
90
85
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: J.P. Morgan
EM local government bonds have outperformed DM government bonds, but

rates have been a better driver of returns than FX which has dragged EM local
returns since 2013. Turning to EM local bond markets, the case for EM local bonds
could be made given their outperformance in unhedged terms since 2003. EM local
bonds (unhedged) have returns 198% versus 111% for DM bonds over that horizon
52

Saad Siddiqui
(44-20) 7742-5067
(Exhibit 79). But it is also clear that EM bonds have underperformed in return terms
and been much more volatile than DM bonds since 2011 when EM currencies began
to weaken again. Since the 2013 ‘taper tantrum EM local bond unhedged
performance was -9% versus 16% for DM bonds, while EM local bond volatility was
much higher that of DM. If you had hedged EM FX exposure in our GBI-EM index,
then this profile changes considerably (Exhibit 80). Here we see more comparable
returns of EM bonds versus DM bonds over a long history, with EM bonds
outperforming until 2013 and underperforming until 2019. FX-hedged EM local
bonds have been attractive versus DM government bonds on a risk-adjusted basis.
Exhibit 79: EM local govt bonds have outperformed DM govt bonds Exhibit 80: EM rates have outperformed DM rates but returns are
since 2003 but not since 2011 given EM FX’s drag… much more comparable, with EM volatility reduced
GBI EM and DM Cumulative Total Return Indices ratios, unhedged in USD GBI EM and DM Cumulative Total Return Indices ratios, hedged into USD
02-Jan-03 = 100, GBI-EM is GBI-EM GD; DM is GBI Global 02-Jan-03 = 100, GBI-EM is GBI-EM GD; DM is GBI Global
350 DM EM
DM EM
220
300 200
250 180
160
200
140
150 120
100 100
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
The EM local bond duration rally needs to be seen in the context of secular
decline in global yields, with EM rates more volatile than DM but following the
same overall trajectory lower. EM rates have been a more consistent contributor to
returns but as we look to the future we need to recognize we have just seen a secular
rally in global yields that is nearly 40 years old and has seen 10y UST yields fall
from 15% to 65bp currently (Exhibit 81). EM local rates were born into this rally and
EM yields have fallen since 2002 but only as a function of DM yields falling, with
the EM-DM nominal yield differential largely range-bound over the last 20 years
(Exhibit 82). Global bond yields can stay at these low levels for a prolonged period
of time but they are not going to repeat the 40 year rally we have just seen. This will
mean that EM yields will have to compress to DM yields to fall from current levels.
53

Saad Siddiqui
(44-20) 7742-5067
Exhibit 81: EM bond markets were born midway through a secular Exhibit 82: … with EM local yields staying with a fairly constant pick-
duration rally… up to DM yields over 20 years
Yield (%) Yield (%)
UST 10y yield
Global Developed Market Govt Bond Yields 10 6
16.00
5.5
9
14.00
5
12.00 8
4.5
10.00
7 4
8.00
3.5
6.00 6
3
4.00 5
2.5
2.00
4 2
0.00 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
1960
1963
1967
1970
1974
1977
1981
1985
1988
1992
1995
1999
2003
2006
2010
2013
2017
EM minus DM Govt Bond Yield (right)

EM Govt Bond Yield (GBI-EM)
Source: J.P. Morgan, St Louis Fed
Source: J.P. Morgan, Bloomberg
EM credit markets have been strong historical performers with EM sovereigns

giving returns in line with US HY, while EM corporates have outperformed US
HG corporates; EM equities have significantly underperformed DM equities
over the past decade. Since 2002, when we have data across indices for a like-for-
like comparison, EM and DM credit markets have seen strong annualized returns in
the 6.5-8.5% range (Exhibit 83). EM sovereign credit at 8.4% annualized return has
slightly outperformed US HY credit (7.9% annualized return). In turn, EM corporates
(7.2% return) have outperformed US HG credit (6.4% return). For EM sovereign
credit, the period since the early 2000s has been a benign period of low defaults and
a long period of global risk free rates falling, leading to strong returns which are
likely to be lower looking forward. EM equities have not fared as well compared to
DM equites in the last decade (Exhibit 84). After exceptional EM equities
performance in the 2000s, in nearly 13 years since October 2007 EM equities have
returned just 14% while global equities have made a 90% return and US equities
have returned 196%. Lower EM growth and currency weakness have weighed on
EM equity performance since the GFC.
54

Saad Siddiqui
(44-20) 7742-5067
Exhibit 83: EM sovereign credit and US HY have historically Exhibit 84: … with EM equity markets significantly underperforming
outperformed EM corporates and US HG… US equities since 2011
Credit: EM sovereigns, EM corporates, US HY, and US HG Equities: S&P500, MSCI EM, MSCI World
1-Jan-02 = 100, EM sovereigns is EMBI/G, EM corporates is CEMBI, US HY 01-01-03=100, total return indices in USD
is JPM US HY index, US HG is JPM JULI index. All are in total return.
02-Jan-03 = 100, GBI-EM is GBI-EM GD; DM is GBI Global
500 EM sovereigns 650 MSCI EM S&P 500 MSCI World
450 EM corporates
US HY 550
400
US HG
350
450
300
250 350
200
250
150
100 150
50
50
0 2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
EM credit risk premia normalized from the extreme volatility of the 1990s and
have edged higher since 2007 lows, with the risk free component of EM
sovereign bonds the bigger driver or returns since the GFC. For EM credit
spreads, there was a clear structural break in the 2002 period when the high levels of
volatility of the early decade of the bond market gave way to a more normal range of
spreads and spread volatility (Exhibit 85). This coincides with the default period
from 1999-2001 ending and a period of low defaults taking hold. In addition the
expansion of the asset class and shift to local markets funding has reduced systemic
credit risk, diversifying the EM asset class and reducing volatility. While the credit
component of returns was dominant in the early period of EM bonds (Exhibit 86),
since the GFC it is the ongoing rally in risk-free rates (UST yields) that has
contributed more to returns, although the credit component has still been positive.
This is important in thinking about future returns given risk-free rates are already
historically low and are unlikely to contribute as much in the period ahead.
55

Saad Siddiqui
(44-20) 7742-5067
Exhibit 85: EM sovereign spreads saw a structural shift through the Exhibit 86: With a little help from my friends… Risk Free returns
2000s away from extremely high volatility have been the dominant component for EM sovereign bonds
EMBI/EMBIG Spread, bp EMBIG total return decomposition into Spread (carry + price) return and UST
(carry + price) return
2000
300.00 Spread Return
1800
Treasury Return
1600 250.00
1400
1200 200.00
1000
150.00
800
600 100.00
400
200 50.00
0
1991
1993
1995
1997
1999
2001
2004
2006
2008
2010
2012
2015
2017
2019
Source: J.P. Morgan

Source: J.P. Morgan
EM risk/reward characteristics have historically been

attractive versus DM bonds, without FX exposure
EM local bond FX-hedged and EM hard currency bonds have seen attractive
Sharpe ratios around 1.0 historically, in line with DM credit and US govvies. For
the last 20 years, EM local bonds FX-hedged and EM hard currency bonds have seen
Sharpe ratios around 0.8, making them attractive compared to other asset classes and
comparable with US credit and US government bond markets. EM FX has lagged
with a Sharpe ratio of 0.41 over the full period, which has only been -0.02 since the
GFC. EM equities have seen low Sharpe ratios, below that of DM equities. Going
forward the key for EM fixed income Sharpe ratios will be whether volatility will fall
enough to compensate for the fall in future returns. Given the starting point of yields
near all-time lows for EM and global government bonds, future returns in all bond
markets from carry and price gains are likely to be lower than the last 20 years. Our
expectation is that EM will not see an offsetting fall in volatility, meaning Sharpe
ratios are likely to be lower.
56

Saad Siddiqui
(44-20) 7742-5067
Exhibit 87: Long term return statistics for EM and other asset classes
EM
EM EM
local EM Global
local soverei EM FX EM FX Euro EM US Commo
bonds corpora US HY US HG DM UST
bonds gn broad narrow HG equities equities dities
unhedg te credit govt.
hedged credit
ed
GBI-EM GBI EM
GBI-EM GD EMBIG FX GD GBI MSCI S&P
CEMBI ELMI+ US HY US HG Maggie GBI US JPMCCI
GD USD USD- D (incl. Global EM TR 500 TR
Hedged carry)
2020YTD -5.3% 3.9% 1.8% 3.7% -3.8% -8.4% -1.2% 7.9% 0.9% 7.4% 9.7% 5.4% 7.5% -15.3%
2019 13.5% 9.1% 15.0% 13.2% 5.2% 6.9% 14.1% 14.2% 5.1% 6.0% 7.1% 18.0% 31.5% 14.0%
2018 -6.2% 0.7% -4.3% -1.2% -3.3% -5.0% -2.4% -2.3% -0.8% -0.7% 0.8% -10.1% -4.4% -12.3%
2017 15.2% 4.6% 10.3% 8.0% 11.5% 11.7% 7.6% 6.3% 1.6% 6.8% 2.5% 30.6% 21.8% 8.2%
2016 9.9% 4.7% 10.2% 10.8% 3.5% 7.5% 18.9% 6.1% 4.3% 1.6% 1.1% 9.7% 12.0% 15.0%
2015 -14.9% -2.2% 1.2% 1.2% -7.6% -12.7% -5.0% 0.3% -0.4% -2.6% 0.9% -5.8% 1.4% -27.4%
2014 -5.7% 3.1% 7.4% 3.6% -7.0% -8.9% 2.2% 8.0% 8.3% 0.7% 6.1% 5.2% 13.7% -22.6%
2013 -9.0% -4.2% -5.3% -1.3% -2.0% -4.6% 8.2% -0.7% 1.8% -4.5% -3.4% 3.4% 32.4% -5.1%
2012 16.8% 8.9% 17.4% 15.2% 7.5% 8.2% 15.4% 9.6% 12.4% 1.3% 2.2% 17.0% 16.0% 1.4%
2011 -1.8% 4.5% 7.3% 3.0% -5.2% -6.4% 7.0% 8.6% 3.1% 7.2% 9.9% -12.7% 2.1% -4.5%
2010 15.7% 8.6% 12.2% 12.5% 5.7% 8.0% 14.7% 9.4% 4.8% 6.4% 6.1% 14.1% 15.1% 13.8%
2009 22.0% 5.2% 29.8% 37.5% 11.7% 20.5% 58.2% 18.2% 16.0% 1.9% -3.8% 62.3% 26.5% 20.5%
2008 -5.2% 5.4% -12.0% -16.8% -3.8% -8.2% -26.6% 0.8% 0.1% 12.0% 14.3% -45.9% -37.0% -35.0%
2007 18.1% 5.0% 6.2% 3.9% 16.0% 21.8% 2.6% 5.8% 0.5% 10.8% 9.2% 33.2% 5.5% 23.3%
2006 15.2% 7.2% 9.9% 6.5% 12.3% 14.5% 11.6% 3.7% 1.1% 5.9% 3.1% 28.4% 15.8% 5.8%
2005 6.3% 7.3% 10.2% 6.3% 3.2% 2.1% 2.4% 1.4% 3.9% -6.5% 2.9% 35.3% 4.9% 39.8%
2004 23.0% 7.7% 11.6% 10.3% 14.8% 20.1% 11.1% 6.0% 7.7% 10.1% 3.7% 16.1% 10.9% 23.1%
2003 16.9% 5.5% 22.2% 15.7% 15.8% 16.6% 26.8% 8.2% 8.0% 14.5% 2.4% 46.3% 28.7% 28.8%
2002 29.1% -6.8% 13.7% 11.1% 11.4% 0.0% 3.2% 10.7% 8.4% 19.4% 12.2% -7.3% -22.1% 24.4%
Since 2002
Cumulative
288% 143% 352% 267% 121% 107% 317% 219% 129% 150% 129% 496% 324% 69%
Total Returns
Annualized
7.1% 4.8% 8.8% 7.5% 4.6% 4.7% 8.3% 6.5% 4.6% 5.2% 4.6% 11.5% 9.2% 4.6%
Return
Return
11.8% 4.3% 8.7% 7.9% 7.3% 9.8% 8.8% 5.6% 3.5% 6.3% 4.7% 16.4% 14.7% 18.3%
Volatility
Sharpe Ratio* 0.46 0.75 0.82 0.74 0.41 0.32 0.75 0.87 0.83 0.57 0.65 0.60 0.51 0.16
Sharpe Ratio*
(since 2010) 0.18 0.83 0.79 0.97 -0.02 -0.09 0.93 1.12 0.86 0.41 0.83 0.47 0.96 -0.24
Source: J.P. Morgan. * Sharpe ratio calculated as: excess return (vs risk free) / volatility of excess return. Annualized return and Volatility use monthly data annualized
EM local bonds add more diversification than EM credit,

with China local bonds opening an important development
EM credit has high correlations to DM credit markets, but EM local government
bonds are not as highly correlated to DM government bonds and FX-hedged are a
good diversifier. Cross-correlations within EM assets have been high for those where
returns have primarily been driven by EM FX, namely local government bonds and EM
equities. EM sovereign and corporate bonds have also experienced very high historical
correlations, as corporates spreads are often traded in relation to their government spreads
while their default cycles are closely-linked. EM credit also has quite high correlations to
DM credit being subject to the same broad credit cycle and US rate drivers. EM local
government bonds however have been a good diversifier versus DM government bonds
with correlations that are not high and particularly low versus US Treasuries as EM
government bond risk premia often rise when US Treasuries are rallying.
57

Saad Siddiqui
(44-20) 7742-5067
Exhibit 88: Long term cross asset correlations since December 2002
EM
local EM EM
bonds local soverei EM Global
unhedg bonds gn corpora EM FX Euro DM EM US Commo
ed hedged credit te credit broad US HY US HG HG govt. UST equities equities dities
EM local bonds
unhedged
EM local bonds
hedged 80%
EM sovereign credit 79% 73%
EM corporate credit 71% 63% 92%
EM FX broad 93% 57% 68% 64%
US HY 64% 45% 77% 79% 60%
US HG 52% 63% 75% 74% 38% 54%
Euro HG 45% 52% 69% 69% 32% 56% 79%
Global DM govt. 50% 50% 44% 37% 48% 13% 59% 35%
UST 7% 37% 20% 17% -5% -23% 54% 24% 67%
EM equities 79% 51% 66% 65% 81% 71% 38% 37% 23% -20%
US equities 60% 37% 55% 56% 63% 72% 30% 34% 7% -30% 77%
Commodities 50% 14% 44% 46% 60% 53% 18% 19% 17% -24% 61% 48%
Source: J.P. Morgan
China’s government bond inclusion in the global investment universe will give
an efficient alternative to DM government bonds that EM has lacked. While EM
bonds FX-unhedged have not been an attractive alternative to DM government bonds
in the last 10 years given EM FX weakness, the emergence of China as an
international government bond market changes this analysis. An efficient frontier of
DM government bonds, EM local government bonds, and China’s government bonds
shows that a high weight in China would have been historically efficient (Exhibit
89). This is due to China’s relatively high yield and stable currency. If we used the
current yield as a proxy for forward-looking returns (which there is evidence for
doing in DM government bonds, see The Long Term Strategist: 60/40 in a zero-yield
world, J. Loeys) then the allocation to China increases further (Exhibit 90).
58

Saad Siddiqui
(44-20) 7742-5067
Exhibit 89: Optimal allocation of a government bond portfolio using Exhibit 90: Optimal allocation of a government bond portfolio using
historical data historical volatility and current yields for future return estimate
Efficient frontier using historical returns and volatility of DM govt bonds, EM Efficient frontier using historical volatility but current yield as future return
ex-China govt bonds, and China govt bonds, in USD terms estimate of DM govt bonds, EM ex-China govt bonds, and China govt bonds,
3.5% in USD terms
Annualized return
5.0% Annualized return
3.0%
4.5%
2.5% 4.0%
3.5%
2.0% 3.0%
2.5%
1.5%
All permutations of portfolio weights 2.0%
All permutations of portfolio weights
1.0% China bonds (GBI-EM China)
1.5%
EM ex-China (GBI-EM ex China)
China bonds (GBI-EM China)
DM bonds (GBI-Global) 1.0%
0.5% Optimum portfolio (72% China, 28% DM, 0% EM ex-China)
0.5% EM ex-China (GBI-EM ex China)
Annualized vol Annualized vol
0.0% 0.0%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%
EM AUM and inflows both show demand of hard currency

over local currency
Dedicated assets under management to the J.P. Morgan Emerging Market suite
of bond indices now exceed US$800 billion. Since 2013, the lion’s share of EM
dedicated AUM growth has been driven by external debt benchmarks. The EMBIG
index family of EM sovereigns (and quasi sovereigns) comprises 45% of the overall
dedicated AUM. EM hard currency AUM adding up the EMBIG, EM corporate
benchmark (CEMBI) and Asia credit (JACI) comprises nearly 70% of the dedicated
assets benchmarked to EM bonds. This allocation mix of 70% hard currency / 30%
local currency does not reflect the overall size of the underlying markets which is
overwhelmingly local currency bonds. However, we estimate that less than 25% of
local market debt is truly accessible by foreign investors and given EM FX’s
volatility asset allocators have preferred hard currency.
Despite the slow growth in assets managed to the GBI-EM, passive or index
based strategies have grown to approximately 25% of the AUM dedicated to
EM local markets. The EM local government bond index is easier to replicate given
the homogeneity in performance of bonds on the curve. For hard currency we have
seen passive management also increase representing roughly 15% of the overall
EMBI AUM. Conversely, due to the vast number of issuers, coupled with
idiosyncratic risk, passively managed EM corporate funds comprise less than 2% of
the overall CEMBI benchmark AUM.
59

Saad Siddiqui
(44-20) 7742-5067
Exhibit 91: Assets benchmarked to EM Local Sovereign indices have stagnated since 2013
US$ billions
(in US$ billions) 11-Dec 12-Dec 13-Dec 14-Dec 15-Dec 16-Dec 17-Dec 18-Dec 19-Dec 20-May
Local Market (GBI-EM) 146 195 217 217 202 206 228 224 233 222
External Sovs USD (EMBI) 231 293 293 301 296 318 361 360 393 375
External Corp USD (CEMBI) 30 47 63 74 78 81 93 104 121 123
EM Money Markets (ELMI+) 26 25 25 22 19 20 26 26 26 22
Asia Credit (JACI) 44 55 58 61 61 64 74 75 80 75
EM ESG 3 12 15
Total AUM 478 615 655 676 659 692 786 795 869 836
Inflows into EM assets have been increasingly hard currency in the last decade
as FX weakened. We track two types of inflows to EM bond markets: first inflows
into dedicated EM bond funds; second buying by foreign investors of EM local
bonds. Inflows into EM dedicated bond funds have shown a clear preference for hard
currency bonds, as local markets funds have seen no net inflows since 1H11 (Exhibit
92 and Exhibit 93). In the aftermath of the 2013 Taper Tantrum both EM and hard
currency funds saw large outflows but by 2016 inflows to EM hard currency funds
had started to recover well while EM local market fund inflows stagnated. Average
annual EM dedicated inflows since 2010 have been $19bn and 64% of inflows have
gone to hard currency funds, compared to 21% to local currency funds and 15% to
blended currency funds. Compared to the growth in the size of the asset class over
this period, the funds dedicated funds benchmarked to EM are tiny particularly for
local markets, meaning locals and crossover investors are also important in driving
market technicals.
Exhibit 92: EM bond fund inflows per year (split hard / local / blend) Exhibit 93: EM bond fund inflows cumulative (split hard / local /
EM Retail Bond Fund Flows ($bn, yearly, by ccy) blend)
100 Cumulative EM Retail Bond Fund Flows ($bn, by ccy)
Thousands
Hard Local Blend

80 175
Hard Local Blend 157
60 150
125
40
100
20 83
75
0 50
34
-20 25
0
-40
-25
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Source: J.P. Morgan, EPFR. 2020 as of 18-Aug-20 Source: J.P. Morgan, EPFR. 2020 as of 18-Aug-20.
Foreign investor portfolio flows into EM local bonds and equities show a similar
pattern as EM FX depreciation since 2011 seems to have kept portfolio flows
away from EM local assets. We can also look flows coming into EM local bonds
and equities as reported by countries – these are reported officially as portfolio flows
from foreign investors local assets. This will be a more complete set of data as it
encompasses flows coming from EM dedicated funds along with flows coming from
any other types of funds such as global bond funds. We can see from the data
(Exhibit 94 and Exhibit 95) that portfolio inflows into EM local bonds and equities
were strong from 2010 to 2014 but not since. From 2010 EM local bond buying by
foreign investors was flat (+$3bn), while EM equities have seen outflows of $71bn.
It is also clear from this data that EM dedicated bond funds represent only a small
60

Saad Siddiqui
(44-20) 7742-5067
amount of the international investor buying of EM local bonds. From 2010 EM

dedicated local funds had $43bn of inflows and we can assume that all went into
buying EM local bonds. Over the same period, EM local bond buying by foreign
investors was $270bn, meaning the bulk of the demand from international investors
came from investors who were not running EM dedicated funds.
Exhibit 94: Portfolio flows by year into local bonds and equities Exhibit 95: Portfolio flows cumulative into local bonds and equities
$bn, yearly, EM local bonds is sum of South Africa, Turkey, Hungary, India $bn, yearly, EM local bonds is sum of South Africa, Turkey, Hungary, India
(Jul-14 onwards), Indonesia (Jun-09 onwards), and Mexico (Apr-05 (Jul-14 onwards), Indonesia (Jun-09 onwards), and Mexico (Apr-05
onwards). EM equities is sum of South Africa, Turkey (05 onwards), India, onwards). EM equities is sum of South Africa, Turkey (05 onwards), India,
Indonesia, Korea, Malaysia (Oct-09 onwards), Philippines, Taiwan, Thailand Indonesia, Korea, Malaysia (Oct-09 onwards), Philippines, Taiwan, Thailand
(08 onwards), Brazil. (08 onwards), Brazil.
Cumulative portfolio flows into EM local bonds and EM equities
Portfolio flows into EM local bonds and EM Equities ($bn, yearly) 400 ($bn, since Dec-03)
150.0 350
300
100.0
250
50.0 200
0.0 150
100
-50.0
50
-100.0 0
Dec-03
Nov-04
Oct-05
Sep-06
Aug-07
Jul-08
Jun-09
May-10
Apr-11
Mar-12
Feb-13
Jan-14
Dec-14
Nov-15
Oct-16
Sep-17
Aug-18
Jul-19
Jun-20
-150.0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
EM local bonds EM equities

EM local bonds EM equities
Source: J.P. Morgan, Respective Central Banks and National Statistical Offices
Source: J.P. Morgan, Respective Central Banks and National Statistical Offices
Global fund allocations to EM bonds are still small

Crossover investors are under-allocated to EM debt as a percentage of
outstanding bonds. EM debt now represents 27% of the global debt stock, but
global investor holdings of EM debt are significantly lower than that. Mercer’s
European Asset Allocation surveys show that average allocations to EM debt in the
post-GFC era have been stable at 5% (this fell to 4% in 2016). However, the
percentage of plans with an EM debt allocation has dropped from a peak of 28% in
2015 to 18% in 2019 (Exhibit 96). Similar trends can be seen in EM equity
allocations and holdings, suggesting a less favorable view of EM overall by
European asset allocators, rather than of a specific EM asset class. Low EM debt
holdings can also be seen among US-based investors. For US insurers, EM debt
allocations comprise less than 1% of assets ($42.9bn) according to NAIC data. For
US credit investors, US HY investor holdings of EM corporates are at multi-year
lows of 1.47% from highs of around 4% in 1Q15 (Exhibit 97), while we estimate US
HG investors hold nearly 2% of the fixed income AUM in EM corporate bonds
(which translates to as much as 10% of outstanding EM corporate bonds).
61

Saad Siddiqui
(44-20) 7742-5067
Exhibit 96: Average EM debt allocations have been stable around Exhibit 97: US HY investor holdings of EM corporate bonds are at
5%, but allocations to EM debt have fallen multi-year lows
% of plans with an allocation to emerging market debt Market-weighted average EM exposure in US HY portfolios, % of AUM
% average allocation to emerging market debt
4.0%
30 28
3.5%
25 3.0%
21 21
20 18 18 18 2.5%
2.0%
15 13
11 1.5%
10 1.0%
7
4.8 5.0 5.0 5.0 5.0 5.0 5.0 0.5%
4.0
5
2
0.0%
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
3Q15
1Q16
3Q16
1Q17
3Q17
1Q18
3Q18
1Q19
3Q19
1Q20
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: J.P. Morgan, Mercer European Asset Allocation surveys Source: J.P. Morgan
Our analysis of the largest global bond funds shows that two-thirds of funds
hold up to 10% of AUM in EM government debt. To build on the data presented
above, we analyzed EM government debt holdings of some of the largest global bond
funds listed on Bloomberg (USD 64bn of AUM). We filtered for non-ETFs
benchmarked to a widely followed global local and hard currency bond index, with
AUM exceeding USD 100 million and publicly available holdings within the past 18
months. The AUM-weighted average EM government bond holdings of these funds
is 12.4% (6.9% in local currency, 5.5% in hard currency), with the largest allocations
typically in local bonds (Exhibit 98 and Exhibit 99). The largest country allocations
are in China (in line with China’s index weight following inclusion from April
2019), Mexico (particularly Mbonos), Russia, Indonesia and Romania (both more
hard currency focused).
Exhibit 98: Two-thirds of global bond funds hold up to 10% of their Exhibit 99: The bias of global bond funds is to hold large amounts of
AUM in EM government bonds local currency sovereign bonds
Y-axis: % of funds; x-axis: EM government bond holdings, % of AUM Y-axis: % of funds; x-axis: EM government bond holdings, % of AUM
60% EM hard currency sovereign holdings (% of fund)
EM local currency sovereign holdings (% of fund)
50% 38% 38%
50% 40%
29%
40% 30% 25%
30% 20% 17%17% 17%
20% 17% 17% 8%

10%
4% 4% 4%
8% 8%
10% 0%
0%
0% 0.0% to 2.5% to 5.0% to 7.5% to 10.0% to 12.5% to
0% to 5% 5% to 10% 10% to 15% 15% to 20% 20% to 25% 2.5% 5.0% 7.5% 10.0% 12.5% 25.0%
Source: J.P. Morgan, Bloomberg Source: J.P. Morgan, Bloomberg
62

Saad Siddiqui Carlos Carranza Global Emerging Markets Research
saad.siddiqui@jpmorgan.com carlos.j.carranza@jpmorgan.com 11 September 2020
Jonny Goulden Arindam Sandilya
(44-20) 7134-4470 (65) 6882-7759
jonathan.m.goulden@jpmorgan.com arindam.x.sandilya@jpmorgan.com
EM Local Markets: The Future is FX-

Hedged
 EM Local Markets have delivered disappointing returns for dollar-based
investors over the past decade, due to losses from FX and with returns from
local currency bonds unable to surpass DM bond returns.
 We forecast EM local markets returns (proxied by the GBI-EM Global
Diversified index) over a range of plausible scenarios over the next 5-years,
with forecast total returns between -2% to 8% per annum.
 Our baseline is for total returns on the GBI-EM GD index over the next five
years is just under 3% p.a., well below the 6.4% annualized return on the
index since inception, but a modest improvement over the ~2% return over
the past decade.
 The underperformance of EM FX is likely to continue, albeit at a more
moderate pace compared to the past decade. The return on local bonds on
an FX-hedged basis is still likely to be more attractive, particularly on a
risk-adjusted return basis.
 Investors, in a break with the past, should consider fully FX-hedged
portfolios as a default stance for investing in local markets, thereby leaving
the decision to take FX exposure as a purely “active” decision.
 Maturing frontier markets are offering increased opportunities for
diversification with higher yields, although their potential index-inclusion is
unlikely to meaningfully alter the characteristics of the GBI-EM index in
the coming five years.
A Lost Decade for EM local markets

GBI-EM returns have had a long return-drought, with the total return index
currently at around the levels it was at in 2011 for dollar-based investors.
Exhibit 100 shows that, in the post-crisis period, the total return of the GBI-EM total
in USD terms has been largely moving sideways, albeit with significant multi-year
swings. In an era characterised by soaring asset prices amidst monumental shifts in
the global monetary landscape – successive rounds of QE across the G3, yield curve
control; and negative interest rates among other monetary innovations – the lack of
return on a 'fixed income' asset class is striking. While one can point to near-
continuous currency depreciation as the obvious culprit explaining lackluster returns,
it is notable that even FX-hedged bond returns lagged the returns on developed
market bonds over the decade (Exhibit 101).
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Exhibit 100: A lost decade for GBI-EM returns Exhibit 101: EM bond returns lagged DM bonds
Cumulative return. Index to Jan-10 = 0 Cumulative return. Index to Jan-10 = 0
155 170
GBI EM FX Hedged Total Return
GBI-EM FX Total Return GBI EM FX Hedged Total Return
145 160
GBI-EM GD Total Return GBI FX Hedged Total Return
135
150
125
140
115
130
105
95 120
85 110
75 100
Jan 10
Mar 11
Oct 11
Dec 12
Jul 13
Feb 14
Apr 15
Nov 15
Jun 16
Jan 17
Mar 18
Oct 18
Dec 19
Jul 20
Aug 10
May 12
Sep 14
Aug 17
May 19
Jan 10
Mar 11
Oct 11
Dec 12
Jul 13
Feb 14
Apr 15
Nov 15
Jun 16
Jan 17
Mar 18
Oct 18
Dec 19
Jul 20
Aug 10
May 12
Sep 14
Aug 17
May 19
A tale of two eras: before and after the GFC. The EM local currency bond market,
in its current form is young by asset-class-standards; the J.P. Morgan GBI-EM index
history only begins in 2003. It is therefore difficult to use history as a guide for the
future, when available evidence only spans a limited number of market regimes. But
so far there has been two clear visible regimes. (Exhibit 102) The pre-Global
Financial Crisis (GFC) performance (Jan 2003 – Dec 2009) of the GBI-EM Index
delivered annualised returns of 13.2% with an annual standard deviation of 11.6%,
and roughly equal return contributions from FX total returns and bond total returns
(which we define as the return from the FX-hedged component of the index). From
2010, however, annualized returns have been only 2.2%, with a standard deviation of
11.9%. The return contribution has been dominated by FX-hedged bond returns
(3.9% p.a.), with negative contribution from FX total returns of -1.7% pa.
Exhibit 102: GBI-EM GD returns before and after the GFC

%, annualized
Full Sample (Jan 2003 – present) Inception - Dec 2009 Post-GFC (2010-present)
Index Return Std Dev Return Std Dev Return Std Dev
GBI-EM GD Total Return (USD) 6.43% 11.90% 13.15% 11.62% 2.15% 11.89%
GBI-EM GD FX-Hedged Total

Return 4.77% 4.30% 6.01% 4.90% 3.91% 3.81%
GBI EM GD FX Total Return 1.59% 8.88% 6.74% 8.38% -1.69% 9.05%
Source: J.P. Morgan
The key question for investors over the medium term is the prognosis for EM
currencies. As we have seen, EM FX performance has let down the asset class since
the GFC, with total return losses and significant volatility. Given that expectations of
trend FX appreciation potential has been a key plank underpinning the investment
thesis for structural allocations to EM local assets, the disappointing performance
over the past decade is not just a matter of asset prices, but is relevant to the asset
class itself as local markets inflows and AUM have not increased for many years.
The subsequent losses have now justifiably brought into question what role EM FX
should play in EM investor portfolios in the future.
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We see several key themes that present challenges to sustainable EM FX

outperformance:
 The absence of a strong structural growth anchor post-GFC as China’s growth

level and composition shifts;
 Structurally lower productivity has lowered r* which in turn weighs on FX
implied yields as unorthodox monetary policy is pursued. Compared to the period
when EM currencies had attractive returns, the carry at present is low and
expected to stay so, even when adjusting for volatility (Exhibit 103 and Exhibit
104).
Exhibit 103: EM FX implied yields at all-time lows Exhibit 104: … even when vol adjusted
EM general government debt EM ex-China general government debt
16
51 EM FX Implied Yield
EM FX Implied Yield 14
(%) (vol adj, %)
41 12
31 10
8
21
6
11 4
2
1
1994 1998 2002 2006 2010 2014 2018 0
Jan 94 Jan 98 Jan 02 Jan 06 Jan 10 Jan 14 Jan 18
 Lower CPI inflation and a shift towards local debt issuance gives policy makers
more flexibility around how much FX depreciation they can allow;
 The dominance of EUR and USD invoicing explains why it takes longer (if at all)
for REER moves to rebalance the external accounts. Under a “dominant
currency" paradigm for trade, where the majority of imports and exports are
priced in foreign currency (the US dollar or the Euro; Exhibit 105 and Exhibit
106), currency depreciation by itself does not trigger a sustained improvement of
competitiveness. This blunts the ability of currency adjustments to correct
chronic balance of payments problems, and therefore the ability of currency
valuations to mean-revert.
65

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Exhibit 105: Share of exports invoiced in USD & EUR Exhibit 106: Share of imports invoiced in USD & EUR
% share of export in invoicing currency. Annual data, latest available % share of import in invoicing currency. Annual data, latest available
Export invoice percentage shares in USD & EUR Import invoice percentage shares in USD & EUR
100 100
80 80
60 60
40 40
20 20
0 0
Serbia
Colombia
India
Taiwan
South Korea
Kazakhstan
Russia
Turkey
Egypt
Brazil
Israel
Argentina
Ghana
Chile
Indonesia
Ukraine
Romania
Poland
Thailand
Hungary
Czech Republic
Egypt
Israel
India
Ukraine
Serbia
Argentina
Chile
South Korea
Taiwan
Poland
Kazakhstan
Russia
Turkey
Hungary
Czech Republic
Brazil
Ghana
Indonesia
Romania
Thailand
Source: J.P. Morgan, IMF “Boz et al. (2020), "Patterns in Invoicing Currency in Global Trade," Source: J.P. Morgan, IMF “Boz et al. (2020), "Patterns in Invoicing Currency in Global Trade,"
IMF Working Paper 20/126” – see here IMF Working Paper 20/126” – see here
The outlook for local bonds is less complicated, but there are new paradigms to
grapple with too. Although local bonds returns on an FX-hedged basis have not had
the same dramatic twist of fortunes as currencies, the outlook ahead needs to
consider several factors of the current investment environment:
 First, both EM and DM government bond yields are close to historical lows
(Exhibit 107), and inflation is unlikely to fall much further from current
levels, so the scope for duration gains is more limited. This is complicated by
the prospect of “yield chasing” portfolio inflows triggered by G3 central bank
balance sheet expansion (Exhibit 108), which has not yet resulted in outsized
duration gains for EM local bonds.
Exhibit 107: Welcome to the duration party, we’ve already been here Exhibit 108: EM bond inflows and G4 balance sheet expansion
a while
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
EM and DM government bond yields (using J.P. Morgan’s GBI and GBI-
EM), % EM Bond and Equity Fund Inflows, $bn 12m cumulative (lhs, 6000
bottom x-axis)
10 10 300
G-4 Balance Sheet and forecast, $bn 12m chg (rhs, top x-axis) 5000
8 9
200 4000
8
6 3000
7 100
4 2000
6
2 0 1000
5
0
0 4 -100
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
-1000
-200 -2000
DM Govt Bond Yield (GBI) EM Govt Bond Yield (GBI-EM, right)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Source: J.P. Morgan Source: J.P. Morgan, EPFR Global
 Second, to what extent will significantly higher (and growing) debt levels
impede the ability of bond yields in EM to compress? Exhibit 109 and Exhibit
110 suggest that as emerging market debt levels increase, the trend is to finance
an increasing debt burden with domestic debt, with resulting pressures on central
banks to implement "QE-type" policies (Exhibit 111). This leaves local debt
66

(44-20) 7134-4470 (65) 6882-7759
investors with a "double whammy" to absorb an ever increasing amount of local

currency denominated debt. So far this dynamic has not resulted in widening
trends for asset swap spreads (the gap in yield between bonds and interest rate
swaps). But it may well begin to weigh in certain countries going beyond
(uncertain) thresholds—the recent relentless curve steepening in South Africa or
Brazil may be a canary in the coalmine in this context.
Exhibit 109: EM government debt has become increasingly Exhibit 110: … even for EM ex-China
domestic… EM ex-China general government debt
EM general government debt % of debt in external (ex.China)
% of debt in external (right) 40.0 General Govt External Debt (% GDP) 45%
50.0 General Govt External Debt (% GDP) General Govt Domestic Debt (% GDP)
General Govt Domestic Debt (% GDP) 35.0 40%
40%
40.0 30.0 35%
30.0 25.0 30%

30%
20.0 25%
20.0
20% 15.0 20%
10.0
10.0 15%
0.0 10% 5.0 10%
2019F
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019F
Exhibit 111: QE across EM

% GDP. Central Bank Purchases of Local Currency (LC) Govt Bonds since March 2020
2.5 2.3
2.0
2.0 1.8 1.8
1.6
1.5
1.0
1.0 0.9
0.7
0.6 0.6
0.5
0.5 0.4
0.3
0.2
0.1
0.0
Philippines
Turkey
Hungary
Poland
Serbia
Thailand
India
Indonesia
South
Malaysia
Romania
Colombia
Korea
Mexico
Israel
Africa
Source: J.P. Morgan
A scenario based approach to expected returns

Given the need to address several regime-shifts concurrently taking place, we
adopt a scenario based approach to calibrating expected returns for local
markets. Specifically, we aim to calibrate what returns may be in a range of
scenarios over the next 5-years. We forecast local bond returns and FX total returns
separately for analytical purposes, which can be justified given the diverging trends
in returns and asset price behavior over the past decade, and then combine the
estimates for each scenario to obtain a total return forecast.
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In what follows below, we consider the following stylized global macro scenarios
over the coming 5 years to inform our forecasts of EM local markets returns in
coming years:
 Muddle-through: This is our modal scenario, and envisages a gradual bounce of

core bond yields from current depressed levels, but settling at relatively low
levels (1.0%-1.20% for 10y UST), with EM inflation and policy rates gradually
moving higher as well, stabilizing at levels consistent with lower r* and a lower
growth backdrop consistent with J.P. Morgan medium term macro views.
 Ultra-low rates/stagnant growth: In this scenario of significantly lower global
growth and inflation, we assume that US bond yields continue to fall and settle
around 0.25%. EM inflation remains depressed and falls from current levels. EM
real interest rates also continue to fall. Crucially, we assume that there is no
generalized "crisis" in highly indebted emerging markets, and that the market
accepts lower yields despite the inevitable deterioration of debt dynamics that
such a scenario would entail for key EM countries.
 Tightening global financial conditions: This scenario envisages a tightening of
global financial conditions led by a stronger dollar, reminiscent of the Taper
Tantrum of 2013. Accordingly, this scenario envisages an overshooting of UST
yields above 2.0%, bear flattening of EM yield curves and upward pressure on
inflation ensuring from currency weakness, before UST yields settle back down
at still-low levels sub-2%. This scenario could occur in coming years, should US
inflation quicken faster than expected, triggering a response from the Fed, as was
the case in 2013. While the Fed’s recent pivot towards a form of average inflation
targeting lowers the risk of a serious tightening of financial conditions, it is still
worth considering such a scenario given the extent of dependence financial
markets have on central banks maintaining very accommodative monetary policy.
 Cyclical growth bounce: The most bullish of our scenarios, this takes the “best of
all worlds” from the above three scenarios. It involves somewhat more rapid
growth without significant inflationary pressures, a very modest increase in UST
yields and a significant reduction of the EM risk premium.
In the sections that follow for local bond and FX returns, we have decided to take a
simple average of our forecasts across the scenarios as our main stated return
forecast, rather than the “modal” scenario. This is because there is significant
uncertainty forecasting over the medium term, particularly from the current starting
unique point of a global recession and pandemic, and we think due consideration
should be given to a wider range of plausible scenarios, rather than heavily biasing
return forecasts to one scenario.
EM local bond returns drivers and forecasts
Forecasting total returns for an asset class with limited history across market
environments and undergoing regime shifts requires some simplifying
assumptions and educated guesswork. There are various methods and frameworks
that could be employed to do this. On one extreme, one could adopt a purely top-down
statistical approach, using historical relationship between total returns and macro or
market factors. These relationships, while good for narrative building and developing
macro anchors, are often inadequate for more precise work of forecasting returns.
Alternatively, one could approach the question from the bottom-up, forecasting
returns for each country using expert analysis and judgement, and aggregating the
results. This approach, while thorough, may be hampered for asset allocation purposes
due to a looser and less intuitive top-down macro anchor to explain results.
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We settle on a hybrid, flexible two-step approach which combines the intuitive

appeal of a top-down approach, with the thoroughness of a bottom up
approach. Since we de-emphasize any one specific world view, and instead focus on
various scenarios, we are not overly-exposed to the weakness of any one set of
assumptions. In summary, we decompose the calculation of returns accruing from
duration, and from bond carry/roll-down. To assess returns from duration, we employ
a top down approach, estimating changes in the index yield based on scenarios for
UST yields and inflation. Second, we forecast carry and roll returns by GBI-EM-
weighting 3m FX implied yields bottom-up across constituent countries.
What has driven and will drive local bond returns?

Historically, returns on the GBI-EM FX-hedged index have come from the global
rates rally, while investors have not been rewarded for extending duration. First,
Exhibit 112 shows that over the past decade, GBI-EM yields have not deviated
meaningfully from UST yields. There is no meaningful trend of EM “alpha” visible
showing increased faith in lower inflation risk premium or central bank credibility.
Deviations from this relationship even during the period of turbulence following the
taper tantrum and the commodity price crash during 2013-2015 were short-lived.
Second, Exhibit 113 shows that EM bond curves have traditionally been flatter than
the US curve: in effect investors buy EM local currency bonds on to the expectation
that the level of rates will fall over time (hence flat/inverted yield curves) rather than
picking up risk premium for extending duration. From these two observations, it is
clear that despite the fact that FX-hedged local bond returns have been better than FX
total returns, the returns have been inadequate for the liquidity and other risk investors
have taken on (as evidenced in Exhibit 101).
Exhibit 112: GBI-EM yields have rarely deviated from US 10y Exhibit 113: EM bond curves have traditionally been flatter than UST
% curve
10 GBI EM yield US 10y yield (right) 6
4.0
9 5
3.0
8 4 2.0
1.0
7 3 0.0
-1.0
6 2
-2.0
5 1 -3.0 GBI-EM slope (yield - 3m fx implied)

-4.0 UST 10y minus OIS
4 0 -5.0
Oct-08
Apr-10
Oct-11
Apr-13
Oct-14
Apr-16
Oct-17
Apr-19
Jan-08
Jul-09
Jan-11
Jul-12
Jan-14
Jul-15
Jan-17
Jul-18
Jan-20
Jan-06
Oct-06
Jul-07
Apr-08
Jan-09
Oct-09
Jul-10
Apr-11
Jan-12
Oct-12
Jul-13
Apr-14
Jan-15
Oct-15
Jul-16
Apr-17
Jan-18
Oct-18
Jul-19
Apr-20
Bond carry and roll to play a more important role for EM in the future. Exhibit
114 shows that, historically, the correlation between the slope of the bond curve and
subsequent bond returns has been low, as total returns have primarily been driven by
changes in yields. However, with policy rates across the EM world around historical
lows, yield curves have steepened. At current levels, Exhibit 113 shows that EM yield
curves at current levels are, in a break with the past, on aggregate steeper than the UST
curve. A simple chart of the GBI-EM yield curve slope on 3m interest rates suggests
that it ‘should’ be even steeper (Exhibit 115). We think steeper curves in EM are likely
to prevail, with policy rates remaining lower for longer in our baseline scenario.
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Exhibit 114: Curve slope has a loose correlation with future FX- Exhibit 115: GBI-EM slope flatter than what is implied by 3m rates
hedged bond returns % monthly data since Jan-03
% 12M change
4
3.00 y = 0.0468x + 0.8672 y = -0.646x + 4.4975
R² = 0.0862 3 R² = 0.7493
Total return on FX hedged GBI-EM GD over
2.50 2
1
GBI-EM slope (yield - 3m implied)

2.00
0
12m (%)
1.50 -1
1.00 -2
-3
0.50
-4
0.00 -5
-10.00 -5.00 0.00 5.00 10.00 15.00 0 2 4 6 8 10 12 14
Average curve slope over preceding 12m (%) 3M implied yield (%)
We draw two key conclusions from the above when calibrating returns for our
baseline scenario on FX-hedged EM bonds:
 First, carry and roll will be a far more important contribution to FX-hedged
bond returns than in the past. Yield curves in EM are steeper and likely to
remain so, especially as higher deficits in many countries are likely to result in
supply-driven pressures, all else equal.
 Second, the gains from duration, which have dominated in the past, are
unlikely to be as large. In part, this is because bond yields are already low, and
our base-line scenario does not foresee further declines in inflation from current
levels (Exhibit 116). Accordingly, the bar for further duration gains over the next
5-years is high, in our view, and our baseline scenario is appropriately
conservative on this.
Exhibit 116: GBI-EM yields are unlikely to fall significantly from current levels
R-square of monthly GBI-EM hedged return regressed on various risk factor a rolling 36-month period
8.0 GBI EM yield Fitted Quaterly forecast profile
7.5
7.0
6.5
6.0
4Q2
5.5
5.0
4.5
4.0
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Jan-18
Jul-18
Jan-19
Jul-19
Jan-20
Jul-20
Jan-21
Jul-21
Source: J.P. Morgan
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We expect annualized total returns on EM local bonds to be between -0.3% -

3.60% over the next 5-years; the average of our scenarios envisages 1.9% total
returns on an FX-hedged basis (Exhibit 117):
 In our modal scenario (“Muddle Through") there are modest duration losses
as inflation bounces from current lows and UST yields modestly move
higher. We do not incorporate any shift in "EM-specific" risk premium, partly
because there is little historical evidence for a shift in this risk premium, and
evolving debt challenges for key EMs will inhibit a significant compression of
this risk premium. This leads to modest annualized losses on duration (-0.7%),
but a persistently steep bond curve leads modest returns from carry and roll-
down.
 In an ultra-low rates/stagnant growth scenario, we assume greater duration
returns as inflation and real policy rates stay lower for longer. We envisage
some compression of GBI-EM yields against UST, but overall steeper curves and
cheaper funding costs result in significant returns from carry and roll down. Total
returns of 3.60% compare well to returns on local bonds (FX-hedged) over the
past decade. This scenario is our most bullish scenario for local bond returns.
 In a scenario of tightening global financial conditions, returns are likely to be
negative. In this scenario, we assume a tightening of global financial conditions
in year 2, leading to higher policy rates, inflation and risk premium for EM
assets, followed by a modest reversal through years 4 and 5. This leads to
significant duration losses of 1.4% annualized over the scenario forecast horizon,
tempered by carry and roll returns of 1.1% pa.
 Finally, in our global growth bounce scenario, we envisage a return to robust
growth for Emerging Markets and a reduction of risk premium. This
scenario still sees some modest duration losses as yield curves are likely to move
higher globally from current depressed levels, but nonetheless a reduction of EM
risk premium and still-low funding rates offer reasonable carry and roll-down
returns.
Exhibit 117: Total returns of GBI-EM FX-hedged bond index under different scenarios
Total returns, compound annual rate (%) over 5-year horizon
Carry & Roll Return Duration Return FX-Hedged Return
Scenario
(annualized)
Muddle through 1.8% -0.7% 1.20%
Ultra-low rates/stagnant growth 3.3% 0.4% 3.60%
Tightening financial conditions 1.1% -1.4% -0.30%
Global growth bounce 3.62% -0.55% 3.10%
Source: J.P. Morgan
Ownership and liquidity: Local for the locals, with

international holdings lower and lower liquidity
On aggregate, banks and financial intermediaries are the largest participant in
local bond markets in Asia and EMEA EM, while foreigners and pension funds
are more important in LatAm. Across EM, banks and financial intermediaries are
the largest holders of local bonds, holding on average around 33% of the amount
outstanding, although there are some differences across regions (Exhibit 118 and
Exhibit 119). In EMEA EM, banks and intermediaries hold an even larger portion of
local debt, while pension fund holdings are not as large as other regions. In Latin
America, international investors and pension funds are the main holders of local debt.
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Foreign investors play an even bigger role if only taking account fixed coupon bonds,
with ownership ranging roughly between 35% and 55%. This makes bonds particular
susceptible to sudden capital outflows, which was the case this year when LatAm
took the worst hit in EM in terms of foreign selling. Finally in Asia, domestic
investors tend to dominate the local bond markets as the region mostly runs current
account surpluses and governments can tap the domestic savings base to fund their
fiscal deficits.
Exhibit 118: Ownership Breakdown of EM Local Currency Government Bonds

% of amount outstanding
Foreign Investors Banks and financial intermediaries Insurance and pension funds Investment funds Households, Non-Financial, Others
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Peru
Philippines
Hungary
Turkey
China
India
Indonesia
Korea
Malaysia
Thailand
Poland
Czech
Romania
South
Africa
Russia
Chile
Colombia
Mexico
Israel
Brazil
Source: J.P. Morgan
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Exhibit 119: Ownership Breakdown of EM Local Currency Government Bonds

% of amount outstanding
Banks and Financial Insurance and Pension Households, Individuals
Foreign investors Investment Funds
Intermediaries Funds and Others
China 9.4% 69.7% 2.4% 7.0% 11.4%
India 2.4% 29.8% 43.2% 1.4% 23.1%
Indonesia 29.8% 40.2% 16.1% 4.4% 9.5%
EM Asia
Korea 15.3% 34.7% 38.1% 2.8% 9.1%

Malaysia 24.9% 31.5% 37.7% - 5.9%
Philippines 3.9% 42.4% 23.7% 9.5% 20.5%
Thailand 14.8% 16.2% 42.7% - 26.4%
Poland 19.4% 57.2% 8.9% 6.7% 7.8%
Hungary 17.7% 40.7% 9.6% 0.0% 32.0%
Czech Republic 35.4% 33.9% 23.8% 3.0% 4.0%
EMEA EM
Romania 17.3% 46.8% 20.2% - 15.6%

Russia 30.6% 31.5% - - 37.9%
Turkey 4.0% 64.7% - 7.3% 24.0%
South Africa 30.6% 22.1% 29.8% - 17.5%
Israel 8.5% 21.7% 47.1% 11.1% 11.5%
Brazil 8.6% 25.5% 21.0% 6.6% 38.3%
Latin America
Mexico 22.8% 10.8% 31.1% 13.0% 22.3%

Colombia 22.7% 16.2% 30.2% 3.3% 27.6%
Peru 51.1% 19.2% 25.0% 4.6% 0.1%
Chile 16.3% - 74.0% - 9.6%
EM local bond liquidity has been declining since 2011, but some countries have
seen liquidity improve. We define liquidity here as local bond turnover normalized
by the size of the respective local bond market, to enable cross-country comparisons.
At the aggregate level (Exhibit 120), EM local bond liquidity has been on a
downward trend since 2011, although liquidity has been relatively stable since 2015.
There are exceptions at the country level however (Exhibit 121). Notably, liquidity
has sharply improved in China as reflected by continued growth in market volumes,
following measures in recent years to make the bond market more accessible to
foreign investors. The MOF has also refined the auction schedules and helped
liquidity of the on-the-run CGBs. Liquidity in Brazil and Singapore is now also
higher than 10y averages. While liquidity has declined in Poland, Hungary and
South Africa, they remain among the most liquid EM local bond markets.
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Exhibit 120: EM local bond liquidity has been on a downward trend Exhibit 121: China, Singapore and Brazil have seen local bond
since 2011 liquidity improve
0.45 EM Turnover/MarketCap EM Turnover/MarketCap (4Qma) Local bond turnover/local bond market size
0.50
Current 10y average
0.40 0.45
0.40
0.35
0.35
0.30 0.30
0.25
0.25
0.20
0.20 0.15
0.10
0.15
0.05
0.10 0.00
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: J.P. Morgan, official sources. EM is a simple aggregate of Hungary, Poland, Romania, Source: J.P. Morgan, official sources.
Israel, South Africa, Turkey, China, Indonesia, Korea, Malaysia, Singapore, Thailand, Mexico,
Brazil and Chile
On the EM FX side, while bid/offer spreads haven't compressed much relative

to their pre-GFC levels, the share of EMFX in world turnover has nearly
tripled. On average in EMFX it is hard to argue that bid/offer spreads have
compressed from their pre-GFC levels. While LatAm FX spreads have managed to
compress back to their pre-GFC lows, both EEMEA and EM Asia spreads are
hovering around their pre-GFC averages (Exhibit 122). A more interesting pictures
emerges when looking at the share of EMFX in total FX turnover (Exhibit 123). This
has nearly tripled since 2001 from 8.6% to 24.4% in 2019 driven by Asia (ex China).
This perhaps reflects the increased trade interconnectedness amongst EM countries
particularly in Asia.
Exhibit 122: Regional bid offer spreads Exhibit 123: EMFX share in world FX turnover by region
% spot. 66d average bid-offer spreads. 1m NDF used for non-deliverable
markets, FX spot elsewhere 25% CNY
3.4%
0.70% Asia excl. CNY
EMEA Asia Latam
20% EMEA 3.4%
0.60% 5.3%
LATAM 4.1%
0.50% 15% 5.5%
2.3%
0.40% 1.9% 6.0%
10% 4.1% 11.3%
0.30% 1.6% 3.4%
1.5% 8.0%
2.2% 2.3%
0.20% 5% 6.5%
7.5%
6.6%
0.10% 4.9% 4.9% 4.0% 4.3%
2.2%
0% 0.0% 0.1% 0.5% 0.9%
0.00%
2001 2004 2007 2010 2013 2016 2019
2003 2005 2007 2009 2011 2013 2015
Source: BIS, J.P. Morgan
Source: Bloomberg, J.P. Morgan
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EM FX: the challenging part of the asset class

Lessons from history for EM FX total returns
EM FX performance has been a drag on the asset class since the GFC,
introducing total return losses and significant volatility. The prospect of EM FX
total return gains was meant to be a key pillar underpinning investment in EM local
markets. The rationale was sound: these economies had more appealing
demographics, growth and productivity potential relative to DM counterparts and
would offer investors a higher nominal and real yield to compensate them for
inflation, political and C/A deficit risks while this potential was being fulfilled. This
worked in the 90s; even as EM FX spot depreciated there was more than enough
yield to compensate investors for the risks. These total return FX gains continued in
the 2000s, as a global commodity boom meant that both EM FX spot and carry were
working in investors’ favour. However, since the GFC, EM FX total return gains
have significantly disappointed. This has justifiably brought into question what role
EM FX should play in EM investor portfolios going forward.
Falling EM growth and productivity, which also coincided with the decline and
changing composition of Chinese growth, has been a drag on EM FX spot
performance post GFC. A key part of the EM FX underperformance story over the
last decade has been driven by the significant decline in EM-DM growth differentials
from as high as 7 percentage points pre-GFC to between 2-3 percentage points at
present. In the 2000s, China’s double digit growth rates and commodity-hungry,
investment-driven growth helped to drive the commodity super-cycle, boosting
relative EM productivity, growth and terms of trade and triggering significant spot
FX appreciation as capital flowed into EM. However, as China’s growth rates have
fallen so has the EM-DM growth differential. Moreover, work from our Economics
team shows that EM’s growth beta to China increased post-GFC and fell versus US
growth (Exhibit 124). This likely exacerbated the negative spillovers into other EM
as China’s growth shift gained pace in 2014/16. All of these factors have weighed on
EM FX spot returns over the last decade.
The drop in FX implied yields in the last decade, as lower EM CPI led to policy
rate cuts, should be analyzed through the lens of global secular stagnation. EM
FX implied yields have fallen from an average of 10.3% pre-GFC to an average of
4.5% (see earlier Exhibit 103). This lower carry has made it much harder to buffer
any EM FX spot depreciation as EM-DM growth differentials declined. This played
an important role in delivering poor EM FX total returns in the last decade. The fall
in EM FX implied yields followed EM’s rate cutting cycle as central banks reacted to
the trend decline in EM inflation post-GFC. However, unlike in the 2000s during
which low EM inflation was likely driven by the significant productivity gains
helped by China's growth model, today’s low EM inflation is occurring in the context
of lower EM productivity.
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Exhibit 124: EMX growth beta to China increased, post-GFC, Exhibit 125: Domestic factors are less important for EM CPI,
exacerbating spillovers from a shift in China’s growth model suggesting that a global components are keeping it contained,
%-pt response of EMX GDP to 1%-pt higher US, China and EA GDP allowing policy rate cuts and lower EM FX implied yields
Coefficient of output gap
0.4 Output gap (pre-GFC) Output gap (post-GFC)
0.3
0.3
0.2
0.2
0.1
0.1
0.0
High CAD Low CAD High Yield Low Yield
Source: J.P. Morgan
In fact, explaining the decline in EM inflation has been difficult. Previous

analysis by our Economics team suggest both domestic factors (Exhibit 125) and FX
pass-through are less important in explaining EM CPI post-GFC. This may suggest
that a global deflationary/secular stagnation component could be at play which is
keeping EM inflation contained over this period, thereby allowing sustained EM
policy rate cuts and lower FX implied yields even in the face of EM FX depreciation.
Forecasting EM FX returns using a scenario based approach

Looking forward, while we think EM FX total return performance will
moderately improve in the next 5 years relative to the recent past, returns will
still be low given the lack of a structural macro case for sustained EM FX gains.
Our framework for forecasting FX returns over the next 5 years leans on two models.
The first is the EM-DM growth differential (which we have forecasted out using our
Economists’ growth forecasts). While in the short term EM FX oscillates around the
EM-DM growth differential (as other transient factors dominate price action, e.g. risk
sentiment, DXY cycles, newsflow) we find that in the medium term, the growth
differential serves as a good anchor for EM FX performance. There is evidence that
systematic strategies that use growth differential metrics backtest well for EM FX.
Our J.P. Morgan macro forecasts suggest that the EM-DM growth differential will
remain between the 2-3%-pt range in the next 5 years. We then use a full sample and
a post-GFC sample beta of this relationship to calculate a range for EM FX total
returns of between -1.3% and 4% annualized (Exhibit 127).
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Exhibit 126: The trend decline in EM FX spot more than offset EM Exhibit 127: A simple growth model suggests EM FX performance
carry gains as FX implied yields fell will be in a range between 1-5% annualized total return
100 10 EM minus DM real GDP (q/q saar) 30%
ELMI FX (% y/y, rhs)
827 9 EM FX y/y Forecast: Full Sample beta 25%
90
8 EM FX y/y Forecast: Post GFC beta
727 20%
80
7
627 15%
70 6
527 10%
60 5
427 4 5%
50
327 3
0%
227 EM FX Carry 40 2
-5%
EM FX TR 30 1
127
EM FX Spot Returns (right) 0 -10%
27 20
-1 -15%
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
1996 2000 2004 2008 2012 2016 2020 2024

Our second model focuses on EM’s real effective exchange rate relative to its
3yr average. This metric backtests positively for EM FX historically and currently
suggests there is potential for some mean reversion back to fair value of around 3.5%
in spot terms (Exhibit 128 and Exhibit 129). Interestingly, this model suggests EM
FX has attempted to mean revert back to fair value from undervalued levels several
times since 2016, but has failed to remain at fair value (and never moved into
overvalued territory), instead moving back into undervalued territory. This may
indicate an asset class that is still trying to find its post-commodity boom growth
model.
Exhibit 128: EM REER cheap to 3yr average suggesting around 3% Exhibit 129: A simple trading rule on EM REER to 3yr averages
appreciation potential to fair value in REER terms reveals promising out of sample backtest results (including trans.
USD/BRL rolling S/T regression; Out of sample IR: 0.3 (incl. TC) costs)
8% +ve: BRL longs; -ve: BRL shorts; BM&F USD futures; as % of Open Interest
6% 120%
4% 100%
80%
2%
60%
0%
40%
-2%
20% OOS BACKTEST (incl TC):
-4% TR (ann): 5.7%
EM REER to 3yr Avg (normalised, OOS) 0% Vol (ann): 9.6%
-6% Stdev IR: 0.59
Stdev -20% MDD: 51% (GFC)
-8%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 -40%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
While our modal forecast is for 1.5% annualized EM FX total return gains over
the next 5yrs, we see a range of between -2% to +5% in our scenario analysis,
with an average of 0.90% (Figure 130).
 Our Muddle-Through (modal) forecast takes the mid-point of our EM-DM

growth differential model, suggesting around 1.5% in annualized total return
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gains over the next 5 years. In this scenario EM FX spot will struggle to move
back to fair value sustainably and is likely to moderately depreciate, eroding
some of the still low EM FX carry earned. But importantly, total returns should
be marginally positive in contrast to the small losses post-GFC.
 Our most bullish global growth bounce scenario calls for 5% EM FX total returns
gains: this would be consistent with the upper range of our EM-DM growth
model coupled with a more sustainable move towards fair value in our REER
model and a modest increase in EM FX implied yields.
 In our ultra-low rates/stagnant growth scenario we look for -1% total return EM
FX losses. We think returns will track the bottom of the EM-DM growth
differential range, while EM FX spot continues on a depreciation trend (-3.75%
annualized) though milder relative to the post-GFC period given already cheap
REER valuations.
 Finally our tightening global financial conditions scenario is our most bearish,
and foresees -2% annualized TR losses for EM FX as the EM-DM growth
differential is revised even lower (due to EM rate hikes) and portfolio capital
flows back to the US.
Figure 130: Total returns of GBI-EM FX index under different scenarios

FX carry FX Spot FX Total Return
Scenario
(annualized)
Muddle through 4.25% -2.75% +1.50%
Ultra-low rates/stagnant growth 2.75% -3.75% -1.00%
Tightening financial conditions 5.40% -7.40% -2.00%
Global growth bounce 3.25% +1.75% +5.00%
Source: J.P. Morgan
Investment strategies for the future: Hedging FX and

diversifying with Frontier Markets
Based on our analysis, we recommend two paths of action for EM local
currency bond investors. First, to consider fully hedging FX exposure as a default
option, with FX exposure being a pure active decision. Second, to diversify with
exposure to frontier local currency markets.
Fully hedging FX by default

Our GBI-EM total return scenarios for the next 5 years implicitly suggest that
GBI-EM investors should hedge their EM FX exposure as a default. Putting
together our EM hedged bond and EM FX total return forecasts and taking an
average across our various scenarios puts our GBI-EM total returns at 2.78%
annualized over the next 5yrs (Figure 131), this compares to 13.2% pre-GFC and
2.0% post-GFC. The slight improvement in returns relative to the post-GFC period is
driven by slightly better, but still low, FX returns. However, even with this slight
improvement on the EM FX side, a key message from our returns profile is that on a
risk-adjusted basis, it benefits investors to fully hedge their EM FX exposure going
forward. Adopting such an approach would be an evolution from the way EM
investors have approached trading the asset class. We discuss below how structural
changes in the asset class provide a sensible rationale for why GBI-EM investors
should consider a new and bold approach to their EM FX exposure.
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Figure 131: Total returns of GBI-EM FX-hedged bond index under different scenarios
FX-Hedged Return FX Total Return GBI-EM GD Total
Scenario
(annualized) (annualized) Return
Muddle through 1.20% 1.5% 2.70%
Ultra-low rates/stagnant growth 3.60% -1.0% 2.60%
Tightening financial conditions -0.30% -2.0% -2.30%
Global growth bounce 3.10% 5.0% 8.10%
Avg. of Scenario Returns 1.90% 0.88% 2.78%
Stdev. Of Scenario Returns 1.79% 3.12% 4.25%
Source: J.P. Morgan
The correlation between FX and rates for large FX moves has fallen post-GFC,
likely driven by lower FX pass-through to CPI and a higher share of local
currency debt. An important development within EM Local Markets post-GFC has
been the decline in the correlation between FX and rates. Exhibit 132 shows that for
FX moves larger than 2 standard deviations, the correlation between EM FX and EM
rates has declined from -0.7 pre-GFC to -0.5 post-GFC. Several factors could be at
play in explaining this decline:
 First, the fall in EM CPI post-GFC and in particular the significant reduction of
EM CPI's sensitivity to EM FX pass-through (Exhibit 133);
 Second, the increase in the share of local currency debt within total government
debt.
Both of these factors provide central banks greater ability to accommodate FX

depreciation. We think these factors are likely to continue to exert downwards
pressure on the correlation between FX and rates in the coming years, potentially
allowing a more consistent separation between EM rates and FX markets. The
dynamic in this correlation is key for investors looking to hedge their EM FX
exposure.
Exhibit 132: The correlation between EM FX and rates had declined Exhibit 133: …perhaps due to the reduced sensitivity of EM CPI to
post-GFC for large FX moves….. FX-pass-through....
Correlation between EM FX and rates for FX moves >2stdev Coefficient of FX
0.00
-0.05
-0.10
-0.15
FX (pre-GFC)
-0.20
FX (post-GFC)
-0.25
EM EM Asia Latam EMEA EM CEE
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With QE policies gaining popularity in EM, the asymmetric risk-reward around

EM FX returns is poor relative to rates. The apparent reduction in the correlation
between EM FX and rates has also allowed EM central banks to experiment with the
idea of their own QE programs, helping them to lower real rates, risk premia and
support debt sustainability. With a higher tolerance for EM FX depreciation relative
to before, central banks could have some more room to expand these QE programs,
which up to now have been small in size. This would further reinforce the
decorrelation between EM FX and rates, as the former is sacrificed for the later. It
remains to be seen just how much room the markets allow before excess central bank
liquidity will trigger non-linear currency depreciation, but it seems likely that central
banks will attempt to expand programs slowly, specifically to avoid this outcome. In
any case, these dynamics further strengthen the case to take EM local rates exposure
FX hedged.
GBI-EM investor returns suggest that funds have struggled with their EM FX
exposure post-GFC. Exhibit 134 shows that between 2010-18 GBI-EM fund excess
returns co-moved with the DXY, increasing on DXY strength and decreasing on
DXY weakness. After 2018, the relationship between excess returns flipped (not
shown), suggesting that GBI-EM investors have been getting the wrong side of the
cyclical dollar trade post-crisis. Given the lack of a strong EM FX structural macro
narrative that investors can use as an anchor, we don’t see these dynamic changing in
the years ahead, with much of the volatility in EM FX returns being caused by dollar
cycles and risk sentiment rather than structural EM stories.
Exhibit 134: GBI-EM funds have struggled to call the dollar correctly Exhibit 135: Simple EM growth related systematic strategies can
GBI EM Fund Cuml excess return vs DXY really help bolster EM FX total returns
JPM EM FRI systematic strategies
We therefore think there is a strong case for EM investors to hedge their FX

exposure as a default on their long EM rates position going forward. We think
EM FX exposure should be taken only selectively, with GBI-EM funds making more
use of systematic strategies in their FX selection process to supplement their
discretionary analysis. This can help EM investors better navigate the dollar and risk
cycles that can push EM FX away from its fundamental anchors. Trading
JPMorgan’s EM growth forecast revision index for example would have delivered
6.5% annualized returns since 2003 and an information ratio of 0.7 (excluding
transaction costs - Exhibit 135). We think blending systematic and discretionary
approaches will be key for total return gains in EM FX.
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Frontier Markets as diversifiers

Over time the GBI-EM index is likely to evolve with the inclusion of frontier
markets. As a relatively small and undiversified index, the addition of even a small
number of countries can have a significant impact in adding to available
opportunities. The number of countries in the index has increased since inception
from 12 to 21; in coming years it is reasonable to expect further increases. In
particular, frontier markets have gained traction, both as potential future index
members or as off-benchmark diversifiers (Exhibit 136 and Exhibit 137).
Exhibit 136: GBI-EM number of countries Exhibit 137: What might the GBI-EM yield look like with the inclusion
Number of countries in GBI-EM of some frontiers?
Current GBI-EM GD yield and duration, and projected if following four
22 markets were to be included into the GBI-EM and weights in other markets
adjusted accordingly
20
Four new
18 Upon China’s full markets and
inclusion (Dec With four new ‘mature’
16 Current 31st 2020) markets weights*
Yield: 4.35 4.26 4.42 4.74
14 5.41 5.38
Dur: 5.41 5.51
12 Potential weights if incl. in GBI-EM GD index
India - - 6.65% 10.00%

10
Egypt - - 0.80% 3.08%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Serbia - - 0.25% 0.60%

Source: J.P. Morgan Ukraine - - 0.11% 0.42%
Over the next five years these markets, including Serbia, Egypt, and Ukraine,
could enter the index, their weight at the outset is likely to be small and hence
will not change our return forecasts for the GBI-EM index significantly.
However, over a longer period (5-10 years), they may well grow to become far more
significant, and in the interim offer higher prospective uncorrelated returns (Exhibit
138 and Exhibit 139).
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Exhibit 138: Foreign holdings of EMEA frontier local debt nearly Exhibit 139: Investors have increased exposure to several Frontier
quintupled ahead of COVID-19 Markets as measured by our EM Client Survey
$bn, non-resident holdings of EMEA EM frontier local markets. Nigeria is Average client responses in EM Client Survey Rates and FX component
OMO bills only (estimate pre 2018); Egypt is T-bills; Serbia is RSD Ghana Egypt Kazakhstan
denominated SERBGBs; Ukraine is UAH government securities; Pakistan is 80
Nigeria Serbia Ukraine
T-bills and bonds.
Nigeria Egypt Serbia Ghana Ukraine Zambia Pakistan 60
50.0
40.0 40
30.0
20
20.0
0
10.0
Jul-16
Oct-16
Jan-17
Apr-17
Jul-17
Oct-17
Jan-18
Apr-18
Jul-18
Oct-18
Jan-19
Apr-19
Jul-19
Oct-19
Jan-20
Apr-20
0.0
Source: J.P. Morgan EM Client Survey
Jul-17
Jul-18
Jul-19
Jan-17
Apr-17
Oct-17
Jan-18
Apr-18
Oct-18
Jan-19
Apr-19
Oct-19
Jan-20
Apr-20
Source: J.P. Morgan, Respective Central Banks.
82

Jonny Goulden Yang-Myung Hong Global Emerging Markets Research
jonathan.m.goulden@jpmorgan.com ym.hong@jpmorgan.com 11 September 2020
Trang Nguyen
(1-212) 834-2475
trang.m.nguyen@jpmorgan.com
EM hard currency debt: The rise in

defaults is just part of the cycle
 EM credit has not seen a default cycle spanning sovereigns and corporates
for nearly 20 years, but that was exceptional; defaults are part of the usual
cycle of boom and bust seen in credit markets.
 While there is an EM default cycle to work through now, hopefully it will
give a better long-term entry point and enable funds to better attract new
inflows on the other side of the cycle.
 We estimate that over the next 5 years returns for EM sovereign credit
would be 3.7% per annum and 3.4% for EM corporates, given low starting
global yields.
 The growth of the EM credit asset class has been a defining feature of the
last decade and looks set to continue – EM hard currency bonds are now
$3.7trn in outstanding stock, with corporates double the size of sovereigns.
 The composition of the hard currency bond universe has also evolved: EM
sovereigns have seen an increasing number of issuers and the emergence of
“super issuers"; for corporates, Asia has increased its share due to China’s
dominance in EM corporate new issuance, with China now 1/3 of EM
corporates.
 The EM sovereign bond market has a large dedicated EM fund investor
base, whereas EM corporates are held more by locals and crossover
investors.
In the face of a default wave

EM and DM credit markets are experiencing a default wave in the wake of
COVID-19’s impact, with EM sovereign defaults likely to reach the highest level
since the late 1990s, while corporates should fare better. EM sovereign defaults
over the past 20 years have been more episodic, with the COVID-19 shock inducing
the first systemic default wave in 20 years. EM sovereigns have already seen three
large defaults this year (Lebanon, Ecuador, and Argentina), amounting to a default
rate of 9% of the asset class. We still project more defaults to materialize,
concentrated in frontier markets (see EM Sovereign Repayment Risks 2.0, 10 June
2020). EM corporate defaults are forecast to be more contained, with the YTD
number at only 2.5%, less than half of US HY's 6.0% (Exhibit 140). EM corporate
defaults have shown high correlation with US HY defaults, which have peaked every
10 years or so (Exhibit 141). We have EMBIG default rates at the index level going
back to 2001, and a list of EM sovereign defaults going back to the late 1990s in
Exhibit 146.
83

Trang Nguyen
(1-212) 834-2475
Exhibit 140: Credit defaults are a cyclical phenomenon and are Exhibit 141: US HY defaults have peaked every 10 years or so
correlated globally Historical US HY default rates (as a percent of the HY par amount)
Historical default rates (as a percent of the HY par amount)
EM Corp HY (ex. 100% quasis) 14%
16% 15.8%
EMBIG HY
12%
14% US HY
12% 10%
10%
8%
8%
6% 6.0% 6%
4% 4%
2% 2.5%
2%
0%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020YTD
0%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Source: J.P. Morgan. Source: J.P. Morgan.
EM corporate defaults are forecast to be more contained compared to both EM

sovereigns and US HY. We expect EM corporate HY default rate this year at 4.5%
due to an improvement in commodity prices, somewhat lower than expected hit to
earnings and small size (not number) of observed defaults/distressed exchanges. This
would be materially lower than in US HY (8% expected for 2020) and EM
sovereigns. Indeed, the main theme expressed in our expectations for EM corporate
defaults this year has been that a material share of defaults will be from
smaller/marginal companies that are under further stress from COVID-19 related
closures and companies with past ailments/repeat defaulters. Additionally, with
issuers attempting to revise, extend, or defer payment terms, we have seen a higher
contribution of distressed exchanges to default rates. This means that while there are
more frequent defaults/distressed exchanges, those are not from major or sizable
issuers, many of which are not big enough for traditional international investors or
not index eligible. As such, our CEMBI HY 2020 index level default rate forecast at
3.9% is lower than that for the broader EM corporate HY asset class.
Exhibit 142: EM corporate default projections are fairly benign considering the macro backdrop
Default rate % of 2020YTD 2020F
Global EM corporate HY bond stock 2.5% 4.5%
Asia 2.2% 4.0%
EM Europe 2.2% 4.0%
Latin America 3.5% 5.7%
Middle East & Africa 1.8% 4.5%
CEMBI HY bond stock 2.0% 3.9%
Source: J.P. Morgan; Moody’s
While there could be concerns that an elevated EM sovereign default cycle will
reverberate in EM corporates, a number of mitigating factors make us
comfortable that we will not see a default rate close to that of sovereigns. Many
of the sovereigns experiencing stress presently have minimal or no external corporate
bonds. Secondly, the stock of Asia HY non-100% quasi-sovereign bonds ($370bn at
YE19) is just a touch shy of the roughly $400bn outstanding across EM Europe,
Latin America, Middle East & Africa combined. This is mainly concentrated in
China and to a lesser extent Korea, India and Indonesia, with none of these
sovereigns expected to come under stress. The only segment with a more material
share of corporates where a sovereign default took place this year is Argentina.
84

Trang Nguyen
(1-212) 834-2475
While we are still expecting some corporate defaults there, we have actually reduced
the forecasted volume of Argentine corporate defaults/distressed exchanges for this
year from around $5bn to under $3bn (link).
Estimating EM credit returns over the coming years

We estimate that over the next 5 years returns for EM sovereign credit will be
3.7% per annum and 3.4% for EM corporates. To estimate future returns on EM
credit, we leverage the work of our Long-Term Strategy team on long-term returns
for government bonds and credit (see The Long-term Strategist: 60/40 in a zero-yield
world and The Long-term Strategist: Bonds time diversify much better than you
think, Jan Loeys). The starting point is to use the starting yield as a guide to future
returns – which works well for USTs and US HG credit – and then subtract expected
credit losses. For EM sovereigns the relationship between starting yields and
historical returns has not been as strong as for USTs (Exhibit 143) but has been better
at lower yields and so is a reasonable place to start. The yield on the EMBIGD is
currently 4.90%.
Exhibit 143: EM sovereign starting yields are an initial guide to future returns particularly at lower yields
x-axis: Starting EMBIG/EMBI yield (%); y-axis: Next 10 years average annual return
x-axis: Starting Yield; y-axis: 10y ave annual return
45 degree line
17%
Linear (x-axis: Starting Yield; y-axis: 10y ave annual return)
15%
13%
11%
9%
7%
5%
5% 7% 9% 11% 13% 15% 17%
Source: J.P. Morgan
The second step is to estimate the future losses from downgrades (for the IG
portion) and defaults (for the HY portion) of the EMBIGD (EM sovereign)
index. The rating distribution for the EMBIGD index is shown in Exhibit 144. If we
use the long-term average ratings transition and default history from this starting
point, we estimate we would have 65bp of losses annually from defaults and
downgrades (6bp losses from IG to HY downgrades and 57bp for defaults), giving an
annual expected return of 4.90% yield minus 65bp, i.e. 4.25%. But our starting point
is likely worse than the long-term average as we have clearly started a default cycle
in EM which we think will continue through 2021. We can see that ratings
downgrades increase as defaults increase at the end of cycles, as they did in the late
1990s and post-GFC (Exhibit 145), pushing the ratings drift to -0.4. We therefore
cyclically adjust the forward-looking downgrades and defaults for the next 2 years in
line with this view that they will be worse than the long-term average. This gives an
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estimate of 120bp of losses annually from defaults and downgrades, giving an annual
expected return of 3.70% (4.90% yield minus 120bp, with the losses 20bp from IG to
HY downgrades and 100bp for defaults). For EM corporates, the expected return
over the next 5 years using the same methodology is 3.35%, which starts with the
current CEMBI yield of 4.39% and subtracts 105bp annually, 65bp from downgrades
and 40bp from defaults.
Exhibit 144: Starting ratings distribution for the EMBIGD Exhibit 145: Ratings drift shows that downgrades increase at the end
x-axis: Rating; y-axis: % of EMBIGD index in rating category of cycles as defaults increase
Moody’s rating drift, defined as Ave. no. of notches upgraded per issuer
35% minus ave. no. of notches downgraded per issuer
0.4
30% Rating Drift
0.3
25% 0.2
0.1
20%
0.0
15% -0.1
-0.2
10% -0.3
5% -0.4
-0.5
0%
1990
1991
1993
1994
1996
1997
1999
2001
2002
2004
2005
2007
2009
2010
2012
2013
2015
2016
2018
Aaa Aa A Baa Ba B C D NR
Source: J.P. Morgan Source: J.P. Morgan, Moody’s
EM sovereigns have over-compensated for default losses

Long-term analysis of EM sovereign returns shows they have over-compensated
for realized defaults, which could be part of the wider “credit spreads puzzle”
phenomenon in credit markets. Why EM credit offers a more permanent risk
premia to DM can be seen as an EM branch of the broader “credit spread puzzle”
phenomenon (see The Credit Spread Puzzle, Amato & Remolona, 2003), where
credit spreads are observed to persistently offer excess compensation beyond their
experienced default risk. This may be due to the challenge markets have in assessing
the probabilities of unlikely events. In DM corporates, the market is largely assessing
the ability of a company subject to a predictable legal framework to pay. For EM
sovereigns, the market also needs to assess the willingness of a government to pay
debts it has incurred with only limited recourse of investors to the country’s assets.
This adds an additional credit risk assessment that markets need to make for EM
countries. The persistence of long-term risk premia in EM credit vs. DM could be
seen as evidence of an overestimation of this downside for EM-specific credit risk
(see Interpreting sovereign spreads, Remolona et al, 2007).
EM sovereign recovery rates have been bi-modal

Recovery rates for EM sovereigns have been determined as much by
bondholder negotiations as by fundamental conditions, with recoveries
clustering around 30 and around 60. Average recovery values of around 40 do not
accurately reflect the outcomes of EM sovereign restructurings, as they tend to
cluster around 30 or around 60 (Exhibit 147). Recent debt restructurings in Argentina
and Ecuador are concluding with recovery values which are higher than what their
economic fundamentals would otherwise suggest, particularly in light of the COVID-
19 crises both countries are facing. Both are focusing on coupon reductions rather
than principal haircuts, leaving both countries with an FX debt overhang which
remains unresolved. The paths of both debt negotiations have been hugely influenced
by bondholder negotiations which tend to focusing more on maximizing NPVs.
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Exhibit 146: There are several ongoing sovereign debt restructurings Exhibit 147: Despite small sample, recoveries have been bi-modal
taking place around 30 and 60
Sovereign restructuring, year of default and recovery price Distribution of recovery rates
Country Default Recovery
Russia 1999 17.8
Ecuador 1999 44.3 6
Pakistan 1999 52.3
Ukraine 2000 69.1
Ivory Coast 2000 18.1 5
Argentina 2001 27.5
Moldova 2002 60 4
Uruguay 2003 66.3
Grenada 2004 65
Dominican Republic 2005 95.2 3 3 3
Belize 2006 75.5
Seychelles 2008 30
Ecuador 2008 25.8 2
Ecuador 2009 30.5
Jamaica 2010 90.7
Greece 2012 27 1 1
Belize 2012 39.5
Grenada 2013 35.5 0
Argentina 2015 93.7
Argentina 2014 66.2
Ukraine 2015 80.2
≤10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 ≥90
Mozambique 2016 87.8 Source: Moody’s, J.P. Morgan
Mozambique 2017 60.8
Belize 2017 65
Congo 2017 80.8
Venezuela 2017 Ongoing
Venezuela 2018 Ongoing
Barbados 2018 55
Argentina 2020 Ongoing
Lebanon 2020 Ongoing
Ecuador 2020 Ongoing
Source: Moody’s, J.P. Morgan
For EM corporates, in addition to lower default rates, we have also seen higher
recoveries than for DM counterparts. EM corporate 2020YTD average recovery
rate (based on prices 30-day after default) is 43% or 36% ex. distressed exchanges.
Recovery rates for US HY bonds has recently reached a record low of 16.8% (LTM),
significantly below the 25-year average of 40.4% while for European HY, the
recovery rate is 37% (LTM). The low US HY recoveries have been driven by
commodity credits with energy and metals & mining recoveries at just $11 and $2,
respectively. EM corporates had a high commodity default cycle in 2015-16 when
recoveries were materially lower (bottoming at 27% in 2016). This time around, EM
corporates have a much cleaner bond stock (i.e. less independent/marginal players,
more quasi-sovereign HY credits) and no material contribution to defaults from the
commodity space (US HY energy sector has accounted for 46% of LTM default
rate). We also have a slightly different dynamic when it comes to distressed
exchanges – which tend to be favorable for recovery rates (i.e. resulting in >$50
recovery).
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Exhibit 148: EM corporate recovery rates are superior to DM market in the current default cycle
By Region US HY
Year Global EM Asia LatAm EM Europe ME & A Overall
2000 22% NA 22% NA NA 25%
2001 15% 15% 19% NA NA 22%
2002 30% NA 30% NA NA 30%
2003 47% NA 47% NA NA 40%
2004 NA NA NA NA NA 59%
2008 52% NA 53% NA NA 27%
2009 35% 50% 32% 33% NA 22%
2010 42% 39% 30% 49% NA 41%
2011 50% NA 26% NA NA 49%
2012 21% 27% 17% NA NA 53%
2013 34% 28% 29% 66% NA 53%
2014 45% 57% 36% 50% NA 48%
2015 49% 60% 22% 80% 13% 25%
2016 27% 36% 24% 38% 36% 31%
2017 46% 71% 43% 34% 85% 53%
2018 39% 46% 30% NA NA 40%
2019 50% 49% 53% 69% 43% 26%
2020YTD 43% 40% 46% 49% 28% 17%
LT Avg. 38% 43% 33% 52% 41% 40%
Source: J.P. Morgan
EMBIG and CEMBI ratings: Hovering around IG

Average ratings of the EMBI and CEMBI are hovering around the investment grade
line, while it would take a considerable amount of rating actions to move GBI-EM
below IG. The recent elevation of the EMBIGD to investment grade status was due to a
combination of composition changes – the addition of highly rated sovereign debt from
the GCC in 2019 – and technical factors resulting from the IG issuers outperforming HY
names significantly in 2020. After remaining a sub-investment grade index since
inception (July 1999), the EMBIGD first achieved IG status in 1Q2010, only to revert
back below IG in late 2015 following a spate of sovereign rating downgrades. Originally
designed as a sovereign benchmark, the EMBIG has evolved to include sovereign
contingent liabilities (quasi-sovereigns [2]) which now make up nearly a quarter of the
benchmark and are typically rated lower than the corresponding sovereigns. In addition,
the rising supply of lower credit quality debt from frontier markets continued to exert
downward pressure on the benchmark’s average credit rating.
The addition of approximately $150 billion in BBB and higher rated debt from
GCC countries in 2019 which boosted the EMBIGD benchmark’s average
rating close to IG (Figure 149). The unconstrained EMBIG has a comfortable
buffer to maintain the IG credit rating; it would require more than 75% of the
benchmark to be downgraded by 1-notch to move the benchmark rating below IG.
Whereas the EMBIGD has a smaller margin of safety and would require less than 5%
of the benchmark to be downgraded by 1-notch to lose its IG standing. In the EM
Corporates space, the average rating of the CEMBI Broad Diversified (CEMBI BD)
has remained investment grade over the entire history of the benchmark but has
receded from the BBB+ level in 2002 to BBB-/Baa3 as of 2020. A one notch
downgrade of approximately 10% of corporate bonds in the benchmark would
effectively to push the average ratings of both the CEMBI Broad and the CEMBI BD
below IG for the first time since inception of the EM corporate debt benchmarks.
2
Debt issued by 100% state-owned entities or 100% guaranteed by the national government
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Figure 149: EMBI ratings hovering around IG for the second time since inception
Baa1/BBB+ EMBIG EMBIGD
Baa2/BBB
Baa3/BBB- (IG)
Ba1/BB+
Ba2/BB
Source: J.P. Morgan
EM hard currency bond stock has expanded significantly

EM hard currency bonds are now $3.7trn in outstanding stock, with corporates
double the size of sovereigns. EM hard currency bonds are split fairly evenly among
sovereign, quasi-sovereign, and pure corporate issuers, as quasi-sovereigns are 44%
of the corporate bond stock. This is a shift from the pre-GFC period, when the size of
the sovereign bond stock was similar to or larger than corporates (including quasi-
sovereigns). Growth in the corporate debt stock has far outpaced that of sovereigns
since the GFC, more than quadrupling since 2008 (Exhibit 151) versus roughly
tripling for sovereigns (Exhibit 150). Much of the expansion in corporates has been
driven by Asia, where debt has grown by 717% since 2008 (versus an average of
322% across other regions), with Asia’s current debt stock of $1.4trn surpassing the
total 2012 corporate debt stock of $1.1trn and accounting for 55% of the current
$2.5trn total. Conversely, Asia has maintained the smallest regional debt stock in the
EM sovereign hard currency space. Middle East & Africa has constituted the greatest
proportion of sovereign hard currency debt since 2019, currently accounting for a
third of the total debt stock and expanding by nearly 789% since 2008, the fastest
regional pace by far over this period. This contrasts with 214% for Latin America,
237% for EM Europe, and 323% for EM Asia. LatAm and EM Europe also posted
modest growth in corporates, with EM Europe corporates recording a contraction
over the past three years.
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Exhibit 150: EM sovereign hard currency debt stock has more than Exhibit 151: EM corporate hard currency debt stock has more than
doubled over the past decade and tripled since the GFC quadrupled since the GFC
EM sovereign hard currency debt stock by region, $bn EM corporate hard currency debt stock by region, $bn
1,286 2,493
2,383
2,500 Middle East & Africa
1,169
1,200 MEA LATAM EUR ASIA 2,161
1,061 Latin America 2,076
980 2,000 Emerging Europe
1,000 1,814
840 Asia 1,6341,692
800 733 1,379
661 696 1,500
603
1,106
600 513 543
466 860
415 1,000
400 709
561 605
500
200
0 0
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
EM sovereign debt composition: More issuers, more IG

The EM sovereign bond universe has seen an increasing number of participants
and the emergence of “super issuers". The bond stock has gradually become more
IG over time, less due to improving creditworthiness, and more due to rising IG
issuers dominating new supply. The share of IG issuers in the EMBIGD stands at
53% currently, rising since 2018, despite a multi-year trend in ratings downgrades
(Exhibit 152). GCC inclusion in EM indices and their continued dominance in new
issuance has contributed to this trend. Jumbo issuances have been driven by GCC
issuers, which has collectively issued an average of $42bn per year since 2016, a
tenfold increase versus the prior 5 years. As such, the share of Middle East in the
EMBIGD has been rising, while Latin America has fallen (Exhibit 153).
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Exhibit 152: The EMBIGD’s IG component has gradually increased Exhibit 153: The share of Latin America within EM sovereign bonds
over the past two decades, peaking in 2014 has declined while Middle East has recently surged
Proportion of EMBIGD classified as IG versus HY, % Hard currency sovereign debt stock by region, % of total
100% IG Non-IG Africa Europe Latin America Middle-East Asia
100%
90%
90%
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: J.P. Morgan
Source: J.P. Morgan
The last decade saw an expansion of countries issuing in hard currency bonds
with over 30 debut issuers, which increased the share of frontier markets in the
EMBIGD. The changing composition of the EMBIGD has also been marked by a
notable rise in the presence of frontier markets, which now account for roughly one-
quarter of the market cap. Debut issuers have largely been frontier (Exhibit 154),
pushing the number of countries to 74 currently in the EMBIGD.
Exhibit 154: There have been many debut issuers in the past 10 years
Debut issuances and size by year, $bn
9
Tajikistan, 0.5
8 Maldives, 0.2
4 Kenya, 2.0 Kuwait, 8.0
3 Rwanda, 0.4
Zambia, 0.8 Paraguay, 0.5
Turks & Caicos, 0.2 Ethiopia, 1.0
2 Cameroon, 0.8
Namibia, 0.5 Honduras, 1.0
Mongolia, 1.5 Azerbaijan, 1.3 Benin, 0.6
1 Serbia, 1.0 Armenia, 0.7
Montenegro, 0.3 Angola, 1.5 Papua N. Guinea, 0.5
Belarus, 0.6 Bolivia, 0.5 Tanzania, 0.6 Sharjah, 0.8 Suriname, 0.6 Uzbekistan, 1.0
0 Nigeria, 0.5 Rep. of Srpska, 0.2
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
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EM corporate debt composition: More Asia, but less IG

The regional mix of EM corporate bonds has shifted substantially over the past
10 years, with Asia increasing due to China’s dominance in EM corporate new
issuance. The three regions were relatively balanced until 2013, but the trajectory
diverged thereafter. Issuers from China started to become bigger contributors,
starting with quasi-sovereigns and banks, then broadening to HY issuers (especially
property), non-bank financials, IT companies, and local government financing
vehicles (LGFVs). This trend accelerated after 2015, as demand by China onshore
investors for USD bonds from Chinese issuers rose significantly following the CNY
devaluation. The country segment now accounts for 40% of global EM corporate
issuance and one third of the bond stock. On the other hand, country specific
complexities including Operation Car Wash in Brazil, Russian tensions, and
elections in major Latin American countries led to more limited issuance from
Russia, Brazil and Mexico, which had material issuance in prior years. Lower GDP
growth/capex spending and commodity prices in recent years have also led to more
modest expansionary issuance outside of China. In terms of the rating split, the
weight of IG bonds has been coming down from about 70% to close to 60% in recent
years. As IG has continued to account for 60-70% of total issuance, the change in the
mix is more due to the migration from IG into HY. Many of such fallen angel credits
were the result of sovereign rating pressure, most notably Brazil (2015/2016), Turkey
(2016), and recently Mexico (2020).
Exhibit 155: EM corporate bond rating split has become slightly less Exhibit 156: … with Asia (i.e. China) increasing its regional share
IG over time since 2013
% IG % HY/NR Asia EM Europe Latin America Middle East & Africa
100% 100%
90% 90%
80% 80%
70% 70%
60% 60%
50% 50%
40% 40%
30% 30%
20% 20%
10% 10%
0% 0%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Homogeneity at the index level, despite more diverse composition. Despite a

more diverse profile of issuers over the years, both EMBIGD and CEMBI indices
have high correlations between their constituents. In a directional market, issuers’
price action often reflects their beta profiles, for example, high-beta outperforming
low-beta during a spread compression regime and conversely, low-beta
outperforming high-beta when spreads are widening. Correlations among
components tend to rise during episodes of spread widening, as evidenced by Exhibit
157 and Exhibit 158.
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Exhibit 157: Intra-EMBIGD spread correlations are highly sensitive to Exhibit 158: Intra-CEMBIBD segments spread return correlations
episodes of EMBIGD widening Trailing three-month correlations for CEMBIBD country-sector segments
Trailing nine-month correlations for EMBIGD subindices (RHS, %) versus (RHS, %) versus CEMBIBD STW (LHS, bp)
EMBIGD STW (LHS, bp)
650 CEMBIBD STW 100%
EMBIGD STW Intra-EMBIGD Spread Correlations (RHS)
600 Intra-CEMBIBD Spread Return Correlations (rhs)
1600 100% 90%
90% 550
1400 80%
80% 500
1200
70% 70%
1000
450
60%
800 50% 400 60%
600 40% 350
50%
30%
400 300
20%
40%
200 10% 250
0 0% 200 30%
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Source: J.P. Morgan. EMBI subindices used up to 2004, EMBIGD subindices used thereafter. Source: J.P. Morgan
Decomposing the EM corporate bond universe

The EM corporate bond universe consists of several large components, however,
our CEMBI index tracks less than half of the universe while the rest is either
part of other EM indices or considered off-index. Our tracking of EM corporate
bond universe includes hard currency bonds (in USD, EUR, GBP, and CHF) and
while USD bonds account for a lion’s share of that, the rest (~12%) are not CEMBI
eligible. In addition, index eligibility criteria splits EM corporate bonds into those
that are in the CEMBI family (pure corporates and majority, but not fully sovereign
owned entities) and EMBIG (which only includes corporates that are fully
government owned). Lastly, the universe includes various off index bonds such as
short duration bonds, bonds that do not meet minimum size/liquidity requirement,
credit enhancements, as well as EMBIG non-eligible 100% quasi-sovereigns (Exhibit
159 and Exhibit 160).
Exhibit 159: EM corporate hard currency bonds breakdown into different components
Source: J.P. Morgan
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Exhibit 160: EM corporate hard currency bonds breakdown by market capitalization
Off-index quasis CEMBI Broad quasis

12% 13%
Off-index 100%
quasis
9%
EMBIG 100%
quasis CEMBI Broad corps
12% 32%
Off-index corps
22%
Total EM corp = $2.4tn

Source: J.P. Morgan
The changing composition of the EM sovereign and corporate universe has seen
EM corporates change from under- to out-performing sovereigns in times of
stress. The main contributor to this from the corporate side has been a larger weight
of Asia which tends to be the more stable region. Indeed, issuance from the region
has risen from 39% of total in the first half of the past decade to 63% in the second
half and as high as 66% in recent years. China became the largest issuing country in
2013 and has been providing over 40% of issuance in recent years. On the other
hand, the contribution from Latin America and EM Europe declined from 31% and
18% in the first half of the past decade to 17% and 8%, respectively in the second
half. Ownership dynamics (more below) have also led to better stability of EM
corporate bonds. Meanwhile, the share of the more volatile NEXGEM segment of
EMBIG Div has grown from 10% about a decade ago to a peak of 26% in 2018 and
18% today, leading to the asset class’ underperformance in times of stress.
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Exhibit 161: CEMBI Broad vs EMBIG Div composition changes since year-end 2014
EMBIG Diversified CEMBI Broad
% weight Aug-20 Dec-14 Chg Aug-20 Dec-14 Chg
Composite 100.0% 100.0% 100.0% 100.0%
IG 55.1% 64.7% -9.6% 61.7% 70.7% -9.0%
HY 44.9% 35.3% 9.6% 38.3% 29.3% 9.0%
Asia 18.6% 20.2% -1.7% 50.1% 41.1% 8.9%

EM Europe 18.8% 30.8% -12.0% 8.9% 13.7% -4.8%
Latin America 32.4% 35.6% -3.3% 27.3% 34.3% -7.0%
Middle East 18.3% 3.8% 14.5% 10.9% 8.5% 2.4%
Africa 11.9% 9.5% 2.5% 2.8% 2.4% 0.5%
Argentina 1.3% 2.0% -0.7% 1.0% 0.4% 0.5%

Brazil 3.0% 4.5% -1.5% 11.4% 16.9% -5.5%
China 4.2% 4.1% 0.1% 25.3% 16.0% 9.3%
Colombia 2.9% 3.9% -0.9% 2.6% 3.0% -0.4%
Hong Kong NA NA NA 7.4% 7.8% -0.4%
India 0.9% 0.6% 0.2% 4.7% 5.5% -0.7%
Indonesia 4.7% 4.5% 0.1% 1.3% 0.8% 0.5%
Korea NA NA NA 3.6% 4.4% -0.8%
Mexico 4.6% 4.6% 0.0% 7.0% 7.5% -0.4%
Peru 3.0% 3.0% 0.0% 1.6% 2.2% -0.6%
Qatar 3.6% NA NA 1.5% 2.1% -0.7%
Philippines 3.1% 4.8% -1.7% 1.4% 1.0% 0.4%
Russia 3.5% 3.9% -0.4% 5.3% 9.5% -4.2%
Saudi Arabia 3.9% NA NA 2.6% 0.2% 2.4%
South Africa 2.4% 3.4% -1.0% 1.1% 1.3% -0.2%
Thailand NA NA NA 1.4% 1.9% -0.5%
Turkey 3.2% 4.9% -1.7% 2.5% 3.0% -0.5%
UAE 3.7% NA NA 3.5% 3.6% -0.1%
Ukraine 2.4% 1.8% 0.5% 0.4% 0.2% 0.2%
Venezuela 0.0% 2.0% -2.0% NA NA NA
Source: J.P. Morgan. As of August 31 2020 and December 31 2014.
One other driver of differences between EMBIGD versus CEMBI Broad

performance is duration. The CEMBI Broad has been a significantly lower
duration product than the EMBIGD, which has consistently led to its lower total
return volatility. At 4.8 today, CEMBI Broad duration-to-worst is 3.3 years lower
than 8.1 for the EMBIGD. This is the highest differential over the past decade and
compares to -1.8 back in 2010. The change reflects both a decline in duration of the
CEMBI Broad and rise in duration of the EMBIG Div.
Exhibit 162: Gap between EMBI and CEMBI duration has widened and is at an all-time high
9.0 4.0
EMBIG - CEMBI EMBIG Duration CEMBI Duration
8.0 3.5
7.0 3.0
2.5
6.0
2.0
5.0
1.5
4.0
1.0
3.0
0.5
2.0 0.0
1.0 -0.5
0.0 -1.0
Source: J.P. Morgan; Note: duration differential on rhs.
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These compositional changes have also led to CEMBI Broad spread pick-up
versus EMBIG Div submerging into negative territory, however country and
duration adjusted, the differential remains around 80-90bp today. The CEMBI
minus EMBIGD spread difference has been in the negative territory since early 2017
due to compositional factors. During the sell-off earlier this year, this negative basis
breached a 130bp level, however, the difference normalized since, with CEMBI
Broad spreads around 90bp tighter than EMBIGD. Our EM corporate versus
sovereign framework (link) adjusts for compositional mismatches and shows the
relative out-/under-performance of corporates against their respective sovereigns on a
comparable basis. According to this framework, EM corporate bonds still trade at a
pick-up to sovereign. While a common perception could be that EM corporates
underperform their sovereign at times of stress, we have seen exceptions. These
include the likes of Argentine corporates, which have traded significantly through
sovereign spreads throughout the current crisis/Argentina sovereign restructuring.
Exhibit 163: CEMBI’s STW has fallen below that of EMBIGD in recent Exhibit 164: EM corporate spread over sovereign
years, in contrast with its historical average EM corporate minus their own country spread maturity-matched (bp)
STW of EMBIGD versus CEMBI broad, bp
400 All Corporates (rating restricted)
1200 EMBIGD STW 400
CEMBI Br STW 350 EMBIG Quasis
1000 CEMBI Br STW minus EMBIGD STW 300 CEMBI
300
800
200 250
600
100 200
400
150
0
200
100
0 -100
50
-200 -200
0
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jul-17
Jul-18
Jul-19
Jul-20
Source: J.P. Morgan

Source: J.P. Morgan
Who owns the outstanding EM sovereign bonds?

EM sovereigns remain well supported by a large dedicated investor base. We
estimate that around $500-550bn of the bond stock is held by offshore dedicated EM
mandates, of which half are in the hands of EMBIG-benchmarked portfolios (Exhibit
165). Crossover investors, such as global bond funds, are estimated to hold another
$250-300bn, and the rise of GCC issuance has increased the presence of EM in IG-
only global bond funds. Local investors hold up to $200bn of sovereign bonds,
including participation from pension funds, asset managers, banks and sovereign
wealth funds.
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Exhibit 165: EM sovereigns have a heavy EM-dedicated concentration

Rough split of EM hard sovereign bond ownership
1Calculated as the sum of: the estimated allocation to EM sovereigns among active funds benchmarked to Bloomberg Barclays Global
Agg multiplied by the combined assets benchmarked to Global Agg and USD Agg, The estimated allocation among WGBI
benchmarked funds times total benchmarked assets
2Source: J.P. Morgan’s EM Client Survey and J.P. Morgan estimates
3Source: J.P. Morgan estimates
4Includes self-reported allocations from our EM Client Survey, publicly available ownership data, J.P. Morgan estimates
5 EM Client survey multiplied by self-reported percentage allocations to EM hard currency sovereign debt
6Pure sovereigns (non-quasi) only. Source: J.P. Morgan Index Research
7Source; EPFR Global, J.P. Morgan estimates
The evolution of EM debtors: the increasing role of China

and official creditors
The nature of the lenders to EM countries has been evolving with China's
bilateral lending an increasingly important part of EM debt. Looking at the
universe of DSSI-eligible countries (72 IDA countries plus Angola) in order to
approximate the trend observed in EM Frontier countries, bonded and Chinese debt
have increased the most over the last few years (Exhibit 166). DSSI countries had
$489bn of government external debt in 2018, up 47% from $333bn in 2014. Against
this backdrop, bonded debt has more than doubled and Chinese debt has around
doubled over the same period of time. While bonded debt has had the highest growth
rate over the past few years, its $60bn stock remains lower than the stock of
multilateral debt ($220bn) and Chinese debt ($102bn).
The composition of EM public external debt has implications for bondholders.

Within frontier markets, countries with large bonded debt also tend to have a
significant amount of official debt (Exhibit 167). In particular, standing at around
15% of DSSI countries' government external debt as of 2018, bilateral debt is a
meaningful part of countries’ debt service and a pause of bilateral official debt
service is significant. For instance, the 13 SSA issuers eligible under this scheme had
US$7.9bn in official bilateral payments due in 2018 (42.8% of their total payments).
In SSA, we have estimated that postponing bilateral debt due in 2020 could free up
around US$11.3bn in resources (see Every little bit helps, 17 April 2020). Smaller
Frontier bond issuers also tend to display a larger proportion of Chinese debt,
although Angola is an exception.
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Exhibit 166: Bonded and Chinese debt have increased the most Exhibit 167: Frontier countries with large bonded debt also tend to
across frontier markets exhibit a significant part of official debt
Frontier market government external debt, $bn % of Chinese debt (x-axis), % of official debt (y-axis), size of bonded debt
(bubbles), 2018
Official multilateral Official bilateral Non-official
China Bondholders 100%
489.1 St. Vincent
446.3
90% Rwanda and The
60.4 Grenadines
Guyana
44.1 80% Dominica Mozambique
384.8 Grenada
356.0 101.7 Papua New Guinea
333.2 32.0 91.2 Honduras
70%
% of official debt
30.1
23.6 78.6 31.3 Ghana Pakistan Ethiopia
53.7 61.5 30.7 Kenya Cameroon
60%
26.7 76.0 Nigeria Senegal
26.6 27.2 72.7
63.9 66.1 50% Congo, Rep.
62.9 Fiji Tajikistan
St. Lucia Mongolia Maldives
40% Zambia
207.6 219.6 Angola
166.4 173.3 181.4
30% Cote d'Ivoire Lao PDR
20%
2014 2015 2016 2017 2018 0% 10% 20% 30% 40% 50% 60%
Source: World Bank, J.P. Morgan
% of Chinese debt
Note: DSSI countries. Source: World Bank, J.P. Morgan
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Who owns the outstanding EM corporate bonds?

The EM corporate external bond market size has grown to $2.4tn, but the fairly
modest dedicated AUM benchmarked to the CEMBI ($127bn) has raised
questions on who holds the vast majority of the bonds. EM corporate bonds have
a very broad and diverse investor base, spanning dedicated EM investors, DM
investors both in the US and globally, as well as local investors across the EM
regions. We estimate that dedicated EM investors (across CEMBI, EMBIG, and
other EM funds) hold 19% of the outstanding bonds. Local investors are the biggest
holders at 56%, especially out of Asia (48%); US and European crossover investors
hold a meaningful 14%. The other 11% is not explicitly accounted for, and we think
this could be explained by holdings which are in non-benchmarked and/or blended
EM funds, multi-asset strategies, and short-term fund.
Exhibit 168: Who owns EM corporate bonds?
Other EM, 10%
EMBIG, 4%
European Strategic,
0.7% CEMBI, 5%
European HY, 0.8%
European insur & pension, 1.4%

Asia local linvestors,
European IG,… 48%
US insur & pension,
US HY, 0.6% 5%
US HG, 5%
EM Europe locals,
1%
Latam locals, 2%
Middle East locals,

5%
Source: J.P. Morgan, BondRadar, Bloomberg. Note: Based on the $2.1tn out of the $2.4tn asset class that we identified – adds up to
89%.
Local institutions within EM have increasingly become a core part of EM

corporate investor base, in the form of commercial banks and insurance/pension
funds which purchase external bonds from their respective countries or within the
same region. These investors are not typically considered as dedicated investors, but
we find that they are in fact the most sticky investors, even more so than EM
corporate dedicated funds. Indeed, during times of overall market volatility, the most
resilient regions have been Asia and the Middle East, which have a high portion of
bonds held by local investors.
We think the crossover investors have a larger influence on EM corporate

secondary flows relative to their actual holdings, especially compared to local
investors which tend to be hold-to-maturity. For US investors, there is a strong
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regional bias towards Latin America, which accounts for the majority of holdings.
We attribute this to the stronger familiarity of US investors to the region and higher
percentage of SEC-registered bonds. In addition, secondary liquidity of Latin
American bonds is also better in US hours given the trading is mostly conducted in
the same time zone. We found that European investors have a much more balanced
holding profile across the regions.
The typical perception is that crossover investors are opportunistic and would
only be involved in EM corporate bonds when there is an attractive pick-up
over their DM benchmarks. Moreover, it is assumed that the lack of dedicated
resources and expertise on EM raises the risk of a quick exit at the first sign of
trouble, thereby exacerbating the volatility. Although we acknowledge that crossover
investors are likely to have less holding power compared to dedicated EM and local
investors, we think the reality is more nuanced. While they are not strictly dedicated
to EM, there are still major bond indices which include EM bonds and therefore
attract benchmarked money. In addition, total return and income funds may have
more flexibility in buying EM corporate bonds which are not part of a specific
benchmark. We also find there has been a build-up in internal expertise on EM
corporates within some of the crossover investors which is likely to provide more
stability to their holdings.
Growing asset class, but declining liquidity

Trading volumes in EM hard currency sovereign bonds have not increased
commensurately with the growth in the debt stock. EMTA data shows that while
quarterly trading volumes have been trending up over the past 13 years, turnover has
declined, when volumes are normalized for the size of the debt stock (Exhibit 169).
There is some observed seasonality in liquidity, with volumes generally higher in
1Q, and declining throughout the year (Exhibit 170).
Exhibit 169: Trading volumes in EM hard currency sovereign debt Exhibit 170: Liquidity has historically peaked in Q1 and declined
have not increased commensurately with debt stock sequentially in each quarter thereafter
Quarterly trading volumes (RHS, $bn) and volumes as a proportion of total Average of quarterly trading volumes since 2007, $bn
debt stock (LHS, %)
300
Volume as a %of total debt stock Volume
1.0 400 290
0.9 350 280
0.8
300 270
0.7
250 260
0.6
0.5 200 250
0.4 150 240

0.3
100 230
0.2
50 220
0.1
0.0 0 210
Dec-07
Sep-08
Dec-10
Sep-11
Dec-13
Sep-14
Dec-16
Sep-17
Dec-19
Jun-09
Mar-10
Jun-12
Mar-13
Jun-15
Mar-16
Jun-18
Mar-19
200
Q1 Q2 Q3 Q4
Source: EMTA Quarterly Debt Trade Volume Survey , J.P. Morgan Source: EMTA Quarterly Debt Trade Volume Survey , J.P. Morgan
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EM corporate trading volumes tend to be lower than those for sovereigns due to
the smaller issuer sizes and less developed curves, but relative to DM, the
comparison is more mixed. It is not straightforward to analyze the secondary
liquidity of EM corporate bonds globally as the trading occurs across three different
regions, with Asia mostly traded out of Hong Kong/Singapore, CEEMEA in
London/Europe, and Latin America in the US/Americas. Out of these, the only
regular data available is the TRACE volume which tracks the trading activity among
entities based in the US. Focusing on Latin America only, we found that the daily
turnover for Latin America corporate bonds was slightly higher than for US HG and
lower than US HY in recent years. The daily turnover for Latin America IG bonds
was 0.31% in 2018 and 0.43% in 2019, which was above US HG (0.26% in 2018 and
0.28% in 2019). However, on HY side, Latin America turnover was 0.24% across
both years, or half the level of US HY (0.53% in 2018 and 0.57% in 2019). We think
this was due to the high level of trading in some of the IG quasi-sovereigns within
the region, while Latin America HY turnover has been depressed due to the
exclusion of bonds which underwent liability management.
EM corporate trading volumes picked up materially in the first few months of

the year (+10%) but started to moderate in March as the sell-off accelerated.
The drop in market liquidity was also evident in the bid-offer price spread for the
CEMBI, which spiked from a fairly stable level of $0.6 to $0.7 until February to over
$2 in late March, which was the highest levels since October 2011. While in DM
credit, the management of risk positions was conducted via an increased use of
derivative products, in EM corporates, the use of such products is quite limited.
Exhibit 171: CEMBI Broad Average Daily Volume Traded vs Bid-offer spread
US$ mn Estimated average daily volumes (lhs) (points)
3500 5.0
Average weekly bid-offer price (spread)
4.5
3000
4.0
2500 3.5
3.0
2000
2.5
1500
2.0
1000 1.5
1.0
500
0.5
0 0.0
Source: TRACE; CEMBI Broad bid-offer price spread, points
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Luis Oganes Katherine Marney Global Emerging Markets Research
luis.oganes@jpmorgan.com katherine.v.marney@jpmorgan.com 11 September 2020
Jessica Murray Nur Raisah Rasid
(44-20) 7742 6325 (65) 6882 7375
jessica.x.murray@jpmorgan.com raisah.rasid@jpmorgan.com
ESG investing and development finance

increasingly overlap in EM space
 ESG investing has entered the mainstream of global financial and asset
managers, including EM-dedicated funds, are increasingly integrating ESG
factors and impact considerations into investment decisions
 ESG investing is shifting from purpose neutral to purposeful, which brings
it closer to the concept of sustainable development and could help EM
issuers that pursue sustainable activities to raise market financing
 UN Sustainable Development Goals (SDGs) are not on track to be met by
2030, in part due to an annual $2.5tn financing gap; the mobilization of
private capital will be critical as multilateral development banks (MDBs)
cannot cover this gap alone
 MDBs were the pioneers in issuing SDG bonds to fund lending, but bond
issuance linked to SDGs by DM and EM corporates and sovereigns has
risen significantly in recent years
 There is increasing investor acknowledgement that the only way to mitigate
ESG risks in EM in the long run is by enhancing sustainable growth
outcomes; as a result, there is growing overlap between the frameworks for
ESG investing and development finance in EM
 As a result, EM investors are increasingly seeking out frameworks and
methodologies to qualify and quantify impact so as to avoid impact-washing
 This overlap, which captures elements of ESG investing more skewed
towards development outcomes, but which retains the broader market
appeal of traditional ESG, will help to attract new sources of capital for EM
issuers in the years ahead
 Cooperation between MDBs and private institutions will likely grow to help
EM issuers access capital markets; further public-private cooperation
provides fertile ground for innovation when it comes to financing
instruments, use-of-proceeds tracking and impact measurement
 Low-income EM countries tend to have the largest SDG financing gaps, but
also the lowest ESG scores, which can be a problem to attract capital and
may require a more forward-looking ESG scoring framework
 While the growing interest in ESG investing is leading to a global
regulatory push for investors to consistently consider these factors in their
investment decisions, particularly in Europe, so far there is no global
standardization of sustainable investment regulations
ESG and SDG worlds collide in EM

There is increasing overlap in EM space between ESG investing and
development finance as investors are acknowledging that ESG in EM cannot
just be about risk mitigation, but has to include actively generating and
enhancing sustainable growth. Traditionally, ESG investing and development
finance have operated in two separate spheres and adhered to different taxonomies
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and frameworks. ESG investing, which incorporates environmental (E), social (S)
and governance (G) factors into investment decisions, is now part of the mainstream
of global finance and has a framework that is more mature and that is being extended
from the DM to EM spaces. Meanwhile, development finance has been applied
almost exclusively in EM economies, where development gaps are the greatest, even
though several of the United Nations Sustainable Development Goals (SDGs) also
apply to DM countries. However, as illustrated in Exhibit 172, this overlap—which
captures elements of ESG investing more skewed towards developmental outcomes,
yet retains the broader market appeal of traditional ESG—is becoming clearer in EM
as the sector evolves and is likely to increase further when it comes to the capital
raising strategies of EM issuers and the investment strategies of dedicated and non-
dedicated EM investors in the post-COVID world.
Exhibit 172: Intersection between ESG and development finance in EM space
Investments targeting
Sustainable Development Goals
ESG investing Sustainable Development finance

investment
in EM
Source: J.P. Morgan
ESG is shifting focus from responsibility to sustainability, which emphasizes

impact quantification and sustainable development. Some strategies within ESG
investing focus distinctly on advancing some of the SDGs, such as the sustainability
themed and impact investing funds where ESG and development finance can meet
under the same roof, but capital invested in these types of strategies is relatively
small as they have until recently been typically associated with niche philanthropic
investors. In turn, while development finance does not strictly require projects to
adhere to all three E, S and G filters, projects ought to be sustainable by design, have
use of proceeds that target certain objectives and adhere to a principle of “do no
harm.” This section elaborates on the concepts of ESG investing and development
finance in EM to make the case that the increasing overlap between the two
frameworks could actually help EM corporate and sovereign issuers attract new
sources of capital, particularly in the post-COVID world in which a lot of the
resources that were expected to finance projects to narrow the development gaps of
EM countries are being diverted to alleviate the more pressing needs derived from
the pandemic.
ESG momentum reaches EM amid a shift from purpose

neutral to purposeful
Following a dramatic rise in interest after the global financial crisis, ESG
investing has entered the mainstream of finance. Values-based or socially
conscious investing have long existed as part of a niche market with origins often
linked to socio-political objectives. More recently, the launch of the United Nations
Global Compact in 2000 propelled environmental (E), social (S) and governance (G)
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principles into capital markets for the first time. The concept of “ESG investing” was
subsequently endorsed by a spectrum of global financial institutions including banks
and asset managers in a landmark 2004 report from the UN Global Compact titled
“Who Cares Wins: Connecting Financial Markets to a Changing World.” Estimates
of the current size of the ESG market vary widely. At the broadest level, taking all
assets where the manager considers any environmental, social and governance issues
in their decision-making, estimates published by the Global Sustainable Investment
Alliance (GSIA) in 2018 and the ESG & Sustainability team in J.P. Morgan’s Equity
Research more recently suggest that the ESG market may rise to around $45tn of
AUM in 2020 (see “What happened to ESG? Deciphering the complexity of a
booming market,” J-X. Hecker & H. Dubourg, 6 March 2020). The broadly defined
ESG market has been expanding beyond Europe and the US, most recently in Japan.
Indeed, ESG assets under management in Asia Pacific are expected to grow in this
broad definition from $2.9tn in 2018 to $11.1tn this year, implying a significant
growth in the region’s share of the global ESG market (Exhibit 173). However, at the
other extreme of estimates, considering only assets where the manager actively and
systematically incorporates ESG factors fully into their decision-making, J.P.
Morgan global cross-asset strategists estimate that ESG AUM consist only of
approximately $3tn. This narrower estimate starts with the assessment of the universe
of retail funds focused on ESG, which is around $700bn, and applies the 3x ratio of
institutional versus retail ESG assets to reach an estimate of institutional ESG-
dedicated funds of $2.1tn (see N. Panigirtzoglu et al in “J.P. Morgan Perspectives:
ESG and COVID-19: Friends or Foes?”, J. Chang et al, 18 May 2020).
Exhibit 173: Broadly defined ESG assets under management by region

US$ tn
48
42
Asia Pacific
36 North America
30 Europe
24
18
12
0
2016 2018 2020e
Source: GSIA, J.P. Morgan estimates
ESG has matured against a backdrop of increased public awareness over

environmental issues, most obviously climate change, but COVID-19 may
increase the focus on the social and governance pillars. ESG investing was
galvanized by the macroeconomic and political shift focused on fighting climate
change. The Paris Agreement in 2015, which saw policymakers from both DM and
EM countries commit to limit the global temperature rise this century to below 2°C
above pre-industrial levels, marked a turning point. The transition required to meet
the Paris Agreement touches all major sectors of the economy—energy, agriculture,
industry, transport and infrastructure—such that it has essentially blown open the
ESG market globally. While equity dominates the ESG market with around half of
total AUM, ESG-focused fixed income is gaining momentum—particularly green
bonds issued by corporates and sovereigns in both DM and EM countries. The
macroeconomic shift associated with transition towards a low-carbon economic
model is therefore driving a greater supply of ESG-oriented issuance. This supply is
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being met with demand from asset owners who increasingly demand more from their
investments than just positive returns. Indeed, issuances of green bonds are
frequently oversubscribed. While it remains to be seen how COVID-19 will affect
the ESG agenda, so far it appears to be broadening the focus beyond the ‘E’
environmental factor and towards pandemic resiliency, represented by the ‘S’ and
‘G’ factors.
The window of ESG discourse within the financial community has shifted such
that it is not difficult to imagine a world in which all investors, including EM-
dedicated funds, apply some form of ESG lens to their investments. Some large
asset managers in Europe and the US have announced plans to integrate ESG criteria
into all of their funds by as early as 2021. As explained in the next section of this
report that discusses indices, while ESG investment strategies (and the taxonomy
used) vary by firm, they broadly fit into seven strategies that define their
methodologies for incorporating ESG into the investment vetting process. Similarly,
equity and fixed income index providers—like MSCI and J.P. Morgan—apply a set
of methodologies for ESG index inclusion that are seeing growing demand. In fact,
assets benchmarked to J.P. Morgan’s ESG indices (JESG) have grown to over $15bn
since their launch in 2018 and are expected to surpass $20bn by the end of 2020,
with the EM-dedicated indices accounting for most of this figure. There is now
longer-dated evidence that EM investors need not sacrifice returns for the sake of
sustainability, with research by MSCI and J.P. Morgan on the performance of ESG
equity and fixed income indices suggesting that their returns outperform their
benchmarks (see “JESG indices: Seven years of data bust the myth of ESG
underperformance”).
The shift of ESG investing from purpose neutral to purposeful brings it closer to
the concept of “sustainable development,” which could help EM issuers that
pursue sustainable activities to raise market financing. The initial wave of
mainstream ESG investing focused on the theme of responsibility, in which investors
consider ESG factors that impact the financial value of the asset and is more about
managing the risks for the investor while taking a neutral view on the actual recipient
of the investment. This type of assessment typically focuses on governance issues,
more so than environmental or social concerns. In doing so, the first wave of ESG
investment was somewhat narrow, exclusion-based (i.e. no tobacco, oil, coal,
armaments, etc.), and purpose neutral. The second wave of ESG marks a broadening
from a focus on responsibility towards a focus on sustainability, in which investors
consider ESG factors that impact not just the financial value of the asset but also the
wider environmental and social systems. Sustainable investment employs a long-
term multi-stakeholder approach to value creation, which is closely linked to
sustainable development where there is greater focus on real world outcomes and on
quantifying impact. This shift in the focus of ESG investing can provide an
opportunity to EM issuers―both corporates and sovereigns―to raise market
financing more easily when their projects and policies are deemed as sustainable and
aligned with the objective to reduce their countries' economic development gaps.
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Private capital needed to help finance the Sustainable

Development Goals
A common framework of understanding “sustainable development” was
introduced by the adoption of 17 Sustainable Development Goals (SDGs) by
members of the United Nations in 2015. The UN has played a critical role in
identifying economic development gaps and creating agendas to guide development
finance to where it is needed most. In 2000, the UN country members committed to
pursue 8 Millennium Development Goals (MDGs) as part of a global effort to reduce
poverty by 2015, mainly through increased donor assistance to developing countries.
Although the MDGs did help lift more than one billion people out of extreme
poverty, the achievements were uneven and development gaps persisted. In 2015, the
UN launched the 17 SDGs that aimed to curtail poverty but also tackle wider issues
(Exhibit 174). The achievement of these goals is meant to rely not only on the
sustainable development policies of individual DM and EM countries, but also on the
engagement of other stakeholders including the private sector and civil society. The
SDGs convey an agenda for a more sustainable and equitable future for the global
population that, beyond ending poverty, seeks to promote growth while addressing a
range of social needs, mitigating climate change and promoting environmental
protection. The goals themselves are supposed to be achieved by 2030; however,
with less than a decade to go, many SDGs are still not on track, as documented by
the UN SDG 2019 progress report.
Figure 174: United Nations Sustainable Development Goals (SDGs)

1. No poverty End poverty in all its forms everywhere
End hunger, achieve food security and improved nutrition and promote
2. Zero hunger
sustainable agriculture
3. Good health and well-being Ensure healthy lives and promote well-being for all at all ages
Ensure inclusive and equitable quality education and promote lifelong
4. Quality education
learning opportunities for all
5. Gender equality Achieve gender equality and empower all women and girls
Ensure availability and sustainable management of water and sanitation for
6. Clean water and sanitation
all
7. Affordable and clean energy Ensure access to affordable, reliable, sustainable and modern energy for all
Promote sustained, inclusive and sustainable economic growth, full and
8. Decent work and economic growth
productive employment and decent work for all
Industry, innovation and Build resilient infrastructure, promote inclusive and sustainable
9.
infrastructure industrialization and foster innovation
10. Reduced inequalities Reduce inequality within and among countries
11. Sustainable cities and communities Make cities and human settlements inclusive, safe, resilient and sustainable
12. Responsible consumption Ensure sustainable consumption and production patterns
13. Climate action Take urgent action to combat climate change and its impacts
Conserve and sustainably use the oceans, seas and marine resources for
14. Life below water
sustainable development
Protect, restore and promote sustainable use of terrestrial ecosystems,
15. Life on land sustainably manage forests, combat desertification, and halt and reverse
land degradation and halt biodiversity loss
Promote peaceful and inclusive societies for sustainable development,
Peace, justice and strong
16. provide access to justice for all and build effective, accountable and
institutions
inclusive institutions at all levels
Strengthen the means of implementation and revitalize the global
17. Partnership for the goals
partnership for sustainable development
Source: United Nations. https://sdgs.un.org/goals
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Financing the SDGs in EM economies has mostly been the focus of multilateral
development banks (MDBs)—until now. Development finance as a discipline
involves utilizing sources of finance and professional know-how to deliver solutions
that promote economic development and enhance quality of life in EM and other
developing economies. The origins of development finance date back to the
establishment of the Bretton Woods institutions in the 1940s. In the aftermath of
WWII, the International Monetary Fund (IMF) and World Bank were created to
support the world’s new economic and financial order: the IMF to oversee monetary
systems and promote exchange rate stability, and the World Bank to finance post-war
reconstruction in Europe. In this sense, the World Bank is the first major
development finance institution, although its focus has shifted from post-war
infrastructure recovery to alleviating global poverty. Since the establishment of the
Bretton Woods institutions, development finance as a discipline has matured, with
the term development finance institution (DFI) being a catch-all for any institution
that provides financing for economic development and improving quality of life.
Financing from these DFIs can come in many forms including grants, credits and
loans—often at concessional rates, longer maturities and denominated in US dollars.
Such lending by public sector-focused MDBs is typically done by raising funds from
government budgetary contributions or on international capital markets, and using
the proceeds to provide loans to developing countries. Over time, DFIs broadened
their focus to also finance the private sector as another way to spur growth in EM
economies—such as through the IFC, EBRD, DEG and FMO. As the needs of EM
borrowers have evolved, DFIs have expanded their product offerings in the form of
guarantees, trade finance, swaps, local currency loans and equity offerings, which
has led them to establish stronger partnerships with private sector financial entities.
An annual $2.5tn financing gap to meet the SDGs by 2030 means that MDBs
cannot cover this alone. In 2014, a year before the SDGs were formally unveiled,
the UN Conference on Trade and Development (UNCTAD) published a report which
estimated that developing countries face a $2.5tn annual investment gap in key
sustainable development sectors, with economic infrastructure having the greatest
shortfall (Exhibit 175). The report assessed that while public sector funding remains
critical, especially in areas like healthcare and education, it is limited and insufficient
to meet the SDGs. At the time of the UN analysis, the “business as usual” scenario
implied the private sector would cover only $900bn of the financing gap, leaving an
unrealistically high $1.6tn to be covered by the public sector. To that end, the UN
itself encouraged a scaling up of private sector investment through an effort labelled
Financing for Development to cover a greater portion of the gap. It is realistic to
assume that the financing needs to meet the SDGs left to be covered by the private
sector has increased further since then, particularly because significant public
resources of EM countries are being reallocated to alleviate the impact of COVID-
19, while there is little political appetite among DM governments to increase aid
budgets or capital contributions to institutions like the World Bank as they battle
their own economic crises related to the pandemic. All that said, lack of financing is
not the only reason the SDGs are not on track to be met by the 2030 target. In many
EM countries, policy priorities are not aligned with the SDGs or public management,
social and distributional conditions prevent governments from making much progress
in meeting those objectives.
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Figure 175: SDG investment gaps and private sector involvement

Annual investment gap Average private sector involvement,%
(2015-2030),
EM DM
US$ bn
Economic infrastructure
Power 530 40-50 80-100
Transport 260 30-40 60-80
Telecommunications 155 40-80 60-100
Water and sanitation 260 0-20 20-80
Food security
Food security & agriculture 260 75 90
Environmental sustainability
Climate change mitigation 530 40 90
Climate change adaptation 80 0-20 0-20
Social infrastructure
Health 140 20 40
Education 250 15 0-20
Total 2,465
Source: UNCTAD 2014 World Investment Report, J.P. Morgan
MDBs were the pioneers in issuing SDG bonds to fund their lending, but bond
issuance linked to SDGs by corporates and sovereigns globally have risen
significantly in recent years. Corporates and sovereigns in both DM and EM
countries can issue bonds in primary markets with specific use of proceeds that fit
broadly into three categories: green bonds, social bonds and sustainability bonds
(Exhibit 176). As these instruments have gained greater prevalence in the market, the
International Capital Market Association (ICMA) has laid out guidelines on the use
of proceeds, project evaluation, management of proceeds, mapping programs or
projects to SDGs, and reporting for issuances of each type of bond, which issuers can
turn into a framework to be applied in their issuance programs. Aside from providing
a blueprint, ICMA’s guidelines support third-party assessments to certify SDG bonds
at issuance and minimize the risk of “greenwashing” or “social washing.” To that
end, the SDG bond framework for issuers will often include a set of exclusions that
the proceeds from SDG bonds will not invest in, such as exploration or production of
fossil fuels, production of illicit substances, or activities that involve deforestation or
child labor. The use of proceeds of so-called sustainability-linked bonds are less
strictly tied to specific projects and issuers can direct the money to general budgetary
purposes so long as they commit to furthering sustainability objectives by meeting
some performance targets.
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Figure 176: ICMA use of proceed categories for SDG bonds

Green bonds
Renewable energy, energy efficiency, pollution prevention and control, management of resources, clean
transportation, and climate change adaptation.
Social bonds
Targeted at needy populations to access affordable basic water, sanitation, transport and energy infrastructure,
essential services, affordable housing, employment generation, food security and sustainable food systems and for
socioeconomic advancement.
Sustainability bonds
Combination of green and social projects.
Sustainability-linked bonds
General purpose but with the issuer committing to future improvements in sustainability objectives.
Source: ICMA, J.P. Morgan
Shifting investor attitudes towards sustainability and fear of “greenwashing”

are catalysts for greater overlap between the ESG and SDG frameworks in EM,
but there are limitations to such convergence. As mentioned in the introduction,
there is increasing overlap in EM space between ESG investing and development
finance as investors are acknowledging that ESG in EM cannot just be about risk
mitigation, but has to include actively generating and enhancing sustainable growth.
ESG investors are increasingly demanding proof of impact and use of proceeds from
their investments, stemming from a growing skepticism over “greenwashing” and
investor activism. Such a dynamic, which is already embedded in SDG lending,
could help catalyze the synergies between ESG and development finance by the
private sector in EM. At the same time, this evolution could also highlight the
limitations on convergence in practice between the two. An SDG-minded investor
may cast a wider net for the types of sustainable or development finance investments
they will consider compared to a strictly ESG-minded investor, who might exclude
an investment for not meeting their environmental, social or governance criteria. For
example, the SDG-minded investor might finance a water infrastructure project
through the lens of SDGs #7 and #9, while the ESG investor might screen out the
project on concerns of its environmental or social impacts on local communities.
Issuers and investors globally are increasingly adopting policies and strategies
linked to the SDGs, with green bonds dominating the labelled-bond issuance
landscape. MDBs have been issuing SDG bonds to fund their lending activities for
many years. For example, the World Bank issued its inaugural green bond in 2008,
and since the start of the COVID-19 crisis MDBs have been very active in issuing
social or sustainability bonds to bolster their response and lending programs.
However, green bond issuance by DM and EM corporates and sovereigns has also
been rising rapidly and until recently comprised the majority of new SDG issuance.
According to the Climate Bonds Initiative (CBI), global green bond and loan
issuance accounted for close to 75.2% of overall SDG issuance in 2019, reaching a
record $257.7bn last year (Exhibit 177). But the labelled bond market continues to
expand beyond green, with sustainability and social bonds increasingly prominent—
a trend that could be accelerated by the COVID-19 crisis (see the case studies of
SDG bond issuance in EM in Box 1). In fact, sustainability bonds increased to
$65.2bn last year from $21bn in 2018, while social bond issuance expanded to $20bn
compared to $14.2bn between the same years. Growth in green bond volumes is
occurring globally, though Europe saw the largest expansion in 2019 with issuance
up 74%. In turn, North American and Asia-Pacific markets saw year-on-year green
bond issuance growth of 46% and 29%, respectively, last year.
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Figure 177: Global SDG bond issuance by type

US$bn
400
350 Social bonds
300 Sustainability
Green bonds
250
200
150
100
50
0
2017 2018 2019
Source: Climate Bonds Initiative
In the specific case of green bond supply by EM sovereigns and corporates,

which has also been growing significantly in recent years, China remains by far
the largest EM green bond issuer. According to a recent report published by
Amundi/IFC, EM green bond issuance increased by 21% to $52bn in 2019 (of which
China accounted for $34.3bn), reaching a cumulative $168bn at the end of last year.
China’s relatively sizeable issuance is partly reflective of the recent regulatory push
from the Chinese government, though the development of a domestic green finance
initiative is another key factor explaining such large green bond origination. In EM
sovereign space, debut green issuance from Ukraine and repeat issuances from Chile,
Poland and Nigeria last year suggest greater participation in the green bond market
by EM countries (Exhibit 178). In terms of currency composition, hard currency
issuance accounted for about 52% of overall EM green bond issuance in 2019 and
the remainder was in local currency, of which Chinese yuan denominated issuance
accounted for 39% of total EM green bond issuance. Outside of China, local
currency green bond issuance in 2019 was mainly driven by new issues in Brazilian
real, Thai baht and South African rand, each accounting for approximately 1.8% of
overall EM green bond issuance last year.
Figure 178: EM green bond issuance in 2019

US$bn
15
34.3
12
0
MY
CN
IN
BR
ID
TH
UKR
PAN
ECD
CZ
PO
NIG
PHP
UAE
SA
PE
MEX
TRY
KNY
CHL
Source: IFC
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Evidence on SDG bonds performance is not well established yet, particularly in

EM. The evidence on the performance of SDG instruments is scarce given the lack
of directly comparable benchmarks. Although there are already some global green
bond indices in the marketplace, they exclude social and sustainability bonds, and
have different compositions in terms of average duration, credit ratings and sector
weights versus conventional indices, making performance comparisons difficult. In
the case of EM green bonds, their steady increase in supply means that they have also
been gaining prominence in JESG indices, although their index weight in EMBI
(0.87%) and CEMBI (3.06%) are still modest. When the returns of this handful of
index-eligible EM green bonds are compared to the non-green bonds from green
issuers or the overall benchmark during 2Q20—when COVID-19 hit markets—the
analysis suggest that green bonds from EM corporates outperformed but those from
EM sovereigns underperformed. Again, it is difficult to draw big conclusions about
performance given the relatively limited number of issues and the lack of a relevant
benchmark. The suite of indices of J.P. Morgan’s Index Group will soon include
global and EM green bond indices that should provide clearer evidence that investors
can be sustainability-conscious without having to sacrifice returns. That said, while
the lack of evidence of a significant premium for EM green bonds at this stage could
reflect the fact that ultimately the credit risk of the issuer is the same compared the
conventional bonds, eventually we may see some premium emerge as investors can
more directly influence the use of proceeds, the weight of green bonds in JESG
indices increases, and their use by EM investors get further traction.
Box 1: EM SDG bond issuance case studies
Poland was a one of the first EM sovereigns to develop a formal green bond
framework in 2016 and is among the most active in green bond issuance. Poland
adheres to the ICMA green bond guidelines where the Ministry of Finance, along
with other agencies, are in charge of identifying eligible green projects. Issuance
proceeds are held in a separate treasury account to finance new or refinance existing
projects, and the Ministry of Finance oversees management and reporting. Poland
has since issued three green bonds totaling EUR 3.75bn, whose proceeds have been
mainly targeted at clean transportation, renewable energy and sustainable agriculture.
Chile launched its green bond framework in 2019 to honor commitments made under
the 2015 Paris Climate Accord and fund projects guided by its own 2017-2022
Climate Change Framework. While its framework is similar to Poland’s, in Chile’s
case an inter-ministerial “green bond implementation group” selects eligible “green
expenditures” (e.g.; subsidies, taxes and capital investments) from the budget to be
directed at renewable energy, green transport, water management and green buildings.
Chile commits to allocate at least the amount of the green bond from funds in the
budget to these objectives. The ministries in charge of implementation also manage
reporting on allocation and on impact that are shared periodically with investors.
Chile’s first such issuance came in June 2019 and followed up in January 2020 for a
total portfolio of $6.2bn of EUR- and USD-denominated green bonds; the proceeds
were directed at financing extension to the Santiago Metro and other infrastructure
projects.
Mexico launched its social bond framework in late 2019 following a five-year
consultation process by the Agenda 2030 Council led by the President and
government ministries to suitably track and incorporate sustainable development
goals into the budgetary process. Starting in 2018, Mexico established a formal link
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between the budget, the 2030 agenda and the SDGs. Social bonds issued would be
used to fund eligible social and green projects from the federal budget such as
infrastructure, hospitals and energy efficiency. Eligible social projects will be based
off a “social gap index” (using data collected from national census) to target
vulnerable populations and geographies where needs are greatest in education, health
and access to basic services. Green projects, also eligible for financing, would not
adhere to this level of specificity. The Ministry of Finance and corresponding
ministries would be in charge of selecting, managing and reporting on eligible
projects. Mexico has not yet issued a bond under this framework, as the COVID-19
crisis began shortly after its launch.
Korea launched its sustainability bond framework in 2019 aimed at financing green
and social projects. The Korea Investment Corporation (KIC) manages the proceeds
for the Ministry of Finance, where use of proceeds can be invested directly in
projects, in funds or other vehicles that are thematically focused or in companies that
derive the bulk of their revenues from green or sustainable projects. The KIC
established working groups to review and select eligible projects, which can range
from green projects to healthcare, education and basic infrastructure. In June 2019,
Korea debuted with its first $1bn bond to finance social and green sustainable
projects.
Other EM countries are increasingly turning to social bonds to fund their COVID-19
response. Guatemala debuted this year a $500mn social bond whose proceeds would
be earmarked for COVID-19 prevention, containment and response. Uruguay,
Paraguay, El Salvador and Serbia also indicated in their recent issuances that part
of the proceeds would be directed at the COVID-19 response, though without
adopting ICMA’s social or sustainability bond guidelines.
Public-private cooperation to help EM issuers attract capital

Mobilizing private sector investment through more cooperation with the MDBs
will be critical to achieving the SDGs even if the 2030 target date is not met for
all of them. MDBs and other DFIs will need to establish more partnerships with
private sector players to crowd in private investment in the pursuit of SDGs. While
the EM world does offer positive risk-adjusted returns, the channels for global
investors to access these opportunities are often not robust enough, so broader
partnerships between MDBs and the private sector could provide an important link in
the chain. As discussed earlier, SDG-linked bonds are one example through which
private sector funds are being channelled to support SDGs. However, the work of
traditional development finance will need to be increasingly complemented with
financial instruments that go beyond fixed income—such as structured loans,
guarantees, hedging and swaps—in which private sector financial institutions can
bring to the table more experience, diverse capital structures and expanded investor
bases than MDBs. An example of private sector solutions to mobilize resources to
finance SDGs is provided by the J.P. Morgan Development Finance Institution
launched earlier this year, which aims to take development finance to the capital
markets and make it a traded asset class in its own right with a use-of-proceeds
framework to support SDGs in EM on a commercial basis.
Cooperation between MDBs and the private sector will also help EM issuers
that have limited or costly access to capital markets post COVID-19. Beyond
their usual business model as explained above, MDBs have also cooperated with the
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private sector over the years to help EM issuers gain more favorable access to capital
markets via partial guarantees for bond issuance. These guarantees provide a credit
enhancement to EM issuers that may otherwise have limited or prohibitively costly
access to commercial lending. Although there are few recent examples of this—
including the Ghana 2030 bonds that are backed by a World Bank partial guarantee,
and the Ecuador 2035 social bond that has an IADB partial guarantee—cooperation
between MDBs and market participants is admittedly in its infancy. However, such
cooperation is likely to gain more traction post COVID-19 as many EM issuers will
likely face challenging market conditions to roll over maturing bonds after the sharp
increase in debt ratios caused by the pandemic. Key to successful future cooperation
will be to ensure that all parties can appropriately and consistently assess the value of
credit enhancements provided by MDBs. Inclusion of credit-enhanced securities in
EM indices might help in this process by improving their liquidity, which in the past
has likely impaired the market’s ability to price such credit enhancements properly.
More generally, public-private cooperation is fertile ground for innovation in

channeling capital flows to EM. In one such example, responding to the need to
mobilize capital in EM for projects with environmental benefits, the IFC partnered
with Amundi, the European asset manager, to launch the Amundi Planet Emerging
Green One (EGO) fund in 2018. EGO is the largest EM green bond fund established
to date, and its unique purpose is to stimulate both supply and demand of green
bonds in EM. Rather than focus solely on sovereign issuance, the fund aims to
encourage green issuance by local EM financial institutions to subsequently support
domestic climate-smart projects and deepen the EM green debt capital market. The
pioneering structure of the EGO fund sees the IFC leverage its balance sheet to
reduce risk for investors. The fund includes several tranches, with the IFC and other
MDBs able to absorb losses associated with credit risk through first-loss junior and
mezzanine tranches. In 2018 the fund raised $1.4bn from institutional investors and
is intended to grow to $2bn as proceeds are reinvested over its seven-year lifetime.
Through the fund, the IFC also provides technical assistance to EM banks to help in
their green bond issuance and subsequent lending of proceeds. The objective of the
fund to stimulate supply and demand is somewhat self-fulfilling, and was deemed to
be ahead of schedule at its one year anniversary in May 2019. Another example of
innovation includes a proposal by market practitioners of a structure similar to the
successful Amundi/IFC fund to encourage investment in SDG-linked EM debt to
alleviate the potential post-pandemic credit crunch. A third example of innovation is
the J.P. Morgan Development Finance Institution, which is described in more detail
in Box 2.
Box 2: The J.P. Morgan Development Finance Institution
The Development Finance Institution (DFI) was launched within J.P. Morgan’s
Corporate and Investment Bank (CIB) to expand development financing
activity in EM. J.P. Morgan has a long track record in financing development-
oriented activities in EM countries. Even before the launch of JPM DFI in January
this year, J.P. Morgan has been a large player in development finance, serving clients
in 82 of the 144 World Bank-eligible borrowing countries. The DFI seeks to expand
upon these efforts by utilizing a robust framework for qualifying and originating
development finance business. The DFI will channel financing and financial
expertise to private and public sector clients in EM countries eligible for World Bank
loans.
J.P. Morgan’s DFI differs from traditional development banks in that it

operates on a commercial basis with a focus on capital markets transactions.
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The DFI provides structuring products with various risk-return profiles for
distribution to investors, without retaining most of these assets on the bank’s balance
sheet. By galvanizing the private sector to increase investment through blended
finance models, the DFI aims to bridge the development finance gaps in EM
economies. The DFI estimates that J.P. Morgan will be able to finance development
activities valued at more than $100bn annually from investment banking transactions
alone, with additional contributions from its markets businesses.
A rules-based DFI methodology will evaluate the eligibility of investment

opportunities. The methodology employs the IFC’s Anticipated Impact
Measurement & Monitoring (AIMM) framework and follows a 5-step process to
assess if transactions are DFI-eligible. All CIB-approved transactions undergo three
rounds of filters: exclusion, counterparty and product. First, the DFI exclude
transactions related to sectors or activities commonly excluded by other DFIs, such
as coal mining. Next, as the objective of the DFI is to channel financing and strategic
advisory to promote economic development in EM economies, the counterparty in
the transaction must be from a World-Bank eligible country. Finally, the DFI product
range can be considered narrower than the CIB’s to the extent that in-scope products
must facilitate new financing or assist clients in risk management that ultimately has
a positive developmental impact. Eligible DFI transactions will subsequently have
their underlying development intensity scored assessed as Low, Moderate, High or
Very High. These transactions will then be mapped to the UN’s SDGs, which are
either sector-specific or cross-cutting (for example, job creation and economic
growth).
J.P. Morgan’s DFI will publish regular reports to summarize its activities, but
the end investor will be responsible for ex-post impact evaluation. Given J.P.
Morgan’s role of an intermediary in banking and capital markets, the responsibility
for ex-post monitoring and evaluating of assets will fall with the ultimate lender or
investor. However, J.P. Morgan’s DFI will continue to monitor and evaluate assets
that it retains on its own balance sheet on a selective basis in order to refine the ex-
ante development assessment methodology and meet the industry’s best practices.
ESG scoring framework for EM sovereigns tied to

development gaps
The application of ESG scoring frameworks to EM sovereigns is inherently tied
to the concept of sustainable development and the assessment of development
gaps. There is a significant overlap between the ambitions of the ESG and SDG
scoring frameworks when it comes to EM sovereigns, which reinforces the notion of
growing overlap between them for EM investors. Governance and, to a lesser extent,
social factors have long been on the radar of EM investors, who are accustomed to
eruptions of volatility in EM asset prices due to these factors. ESG frameworks
already provide a formal way of monitoring and accounting for these alternative non-
financial risks, which overlap with assessments of development gaps. Governance
scores for EM sovereign issuers capture institutional strength and assess factors like
corruption perception, rule of law and regime stability. In turn, social scores of EM
sovereigns take into account basic human needs like health outcomes and food
security, as well as the stability of society, political freedom and youth
unemployment, among other factors. Finally, environmental scores of EM sovereigns
typically incorporate the economy’s energy and natural resource management and
usage, as well as exposure and vulnerability to climate risks.
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Low-income EM countries tend to have the largest SDG financing gaps. As

mentioned earlier, a key challenge associated with meeting the SDGs and closing
development gaps in EM countries is an annual $2.5tn financing gap, as estimated by
the UN in 2014. More recently, the IMF refined these projections for the five major
SDGs that represent an important share of national budgets (education, health, roads,
electricity, and water and sanitation) and estimated in 2019 that meeting them by
2030 will require additional public and private spending to the tune of $0.5tn for 49
low-income developing countries and $2.1tn for 72 EM economies. While the latter
figure represented a relatively manageable 4% of GDP of the EM countries in the
IMF sample, which could be raised by a tax reform, the former represented 15% of
the GDP of the low-income developing countries in its sample, making the delivery
of the SDG agenda much more challenging. The sector with the largest development
gap—defined as the difference between current funding and what is required to
achieve minimum needs—is infrastructure, especially in regions like Sub-Saharan
Africa.
Unfortunately, low-income EM countries also tend to have the lowest ESG

scores, which can be a problem to attract capital to finance the SDG financing
gaps. Using GDP per capita as a proxy for economic development, Exhibit 179
indicates a close relationship between level of development and ESG scores. Higher
income EM economies like Czech Republic and Korea enjoy higher ESG scores and
therefore are entitled to larger weights in ESG indices. With greater ESG inflows,
such economies can use this capital to advance their sustainable economic
development agendas and further improve their ESG scores further. Meanwhile,
economies burdened with lower levels of development tend to also have lower ESG
scores, which in some cases disqualifies them from ESG investment altogether. For
instance, Nigeria has such a low ESG score that it is excluded from J.P. Morgan’s
JESG EMBI index. Part of the issue is that ESG scores often rely on backward-
looking assessments that use low-frequency data, which implies that they struggle to
capture contemporaneous dynamics or to recognize when an underperformer is
taking steps in the right direction. Overall, ESG scores will need to evolve in order to
incorporate more forward-looking estimates of risks, development gaps and how
growth outcomes can be changed by SDG investing.
Exhibit 179: Relationship between development and ESG score

GDP per capita US
60000 ICE SWE
SAU AUS
TW BEL
50000 AUD
OMA FRA CAN
KOR ESP JAP UK FIN
40000
ITA CZE
MY EST LIT POR
SVN
HUN
30000 RUS ECU PER POL
TRY COLTHMEX PAN ROM
ALG ARG CHL URU LAT
20000 IRA CRO
CN BRA
EGY ZAR NAM
IDN BOT
10000 UZB UKR VIE PAR FIJ
GUA TUN
GHA
MAD PNG IND MWI PH GAM RWA COS
0
20 40 60 80 100
Source: World Bank, J.P. Morgan ESG JPM rank
The disparity between ESG scores of EM sovereigns and their development

gaps could serve to worsen the developmental inequalities between the EM
“haves” and “have-nots.” The inverse relationship between ESG scores and
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development gaps may prompt the reallocation of sustainability-focused investment

towards EM economies with relatively higher ESG scores. One way to address these
perverse dynamics is for low-ranked ESG issuers to actively issue green bonds,
which serve as the most accessible gateway to EM ESG indices, provided these EM
sovereigns are already included in the non-ESG benchmark indices. This is because
regardless of the ESG score of the EM sovereign issuer, under the CBI framework
green bonds enjoy a preferential score uplift in the JESG indices. Given that there is
also increased focus on the social pillar within ESG investing in the aftermath of
COVID-19, issuance of social bonds could also provide similar accessibility in the
future. In issuing and deploying funds from use-of-proceeds green or social bonds,
low-scoring and low-income economies should gradually see their ESG scores
improve and their development gaps narrow.
Connecting use of proceeds to outcomes is key for

sustainable investment
A consistent approach to outcome reporting is required to shore up confidence
and avoid “greenwashing.” In adhering to the ICMA guidelines for SDG bonds,
countries are required to commit to regular reporting for the use of proceeds, impact
assessments and monitor key performance indicators. Still, strategies for monitoring
the execution and impact of sustainable finance programs are quite diffuse, the
quality of data is mixed, and assessments (especially qualitative) can be quite
resource-intensive—particularly in the case of EM corporate and sovereign issuers.
As the sector evolves, investors are demanding more accountability from issuers and
confidence that investments are in fact “green.” Tracing improvements in social
development and climate indicators to their investments is a key differentiator of
SDG bonds from vanilla bonds, particularly if EM sovereigns hope to argue for
better relative pricing in the future.
According to ICMA guidance, governments may lay out in their bond

frameworks quantitative and qualitative metrics for monitoring projects or
programs, which can be reported on annually for the life of the SDG bond.
Green bond monitoring tends to be more straightforward as the sector is more mature
and with more high-frequency quantitative metrics available. For example, for a
green bond intended for clean transportation, an issuer might measure the number of
kilometers of electric bus or train lines created or the number of passengers who
switched to clean transport. In the case of renewable energy, the issuer might monitor
installed capacity, annual energy generation, number of beneficiaries, reduction in
greenhouse gas emissions, or percentage of energy saving. Social bond issuance is at
a more nascent stage and often do not carry a defined set of metrics as compared to
green bonds, although ICMA has also published guidance in recent years for
monitoring social bonds that issuers might consider, including health, education,
financial and environmental quantitative indicators, and for complementing the
analysis with qualitative assessments. For example, for programs aimed at
microfinance and female empowerment, an issuer might monitor number of loans for
female-owned enterprises or proportion of women in management positions, and
provide testimonials from beneficiaries of the program. As more DM and EM
countries enter the market with social bond frameworks, more models and metrics
for measuring impact are likely to be defined going forward.
Efforts are underway by many EM sovereigns to better monitor their own use
of proceeds, but the monitoring task for investors remains a challenge.
Monitoring often emphasizes ex-ante verification for use of proceeds and annual ex-
post reporting by governments. For example, sovereigns may contract a third-party
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opinion from private providers of ESG research and services like Sustainalytics or
Vigeo-Eiris to certify ex-ante that the country has adhered to ICMA principles in
designating the instrument. However, a growing emphasis on measuring impact of
proceeds could increase demand for verification by sovereigns and third-party
evaluation experts to certify that projects are on track. Indeed, sovereign issuers are
increasingly aware that the longevity of the sector will depend on connecting
proceeds to outcomes through effective and transparent reporting. An early template
for this approach in EM was Nigeria’s “Virtual Poverty Fund” established in 2007 to
manage the proceeds of its Paris Debt Club relief that was meant to be used on
projects targeting the MDGs. The fund established a framework to isolate, track and
assess impact of the proceeds within the budget to be used towards such MDG-linked
projects. As described in the case studies presented in Box 1 above, several EM
sovereign issuers have joined the efforts around SDG bonds by integrating line-by-
line budgeting, setting up inter-ministerial implementation groups, or ring-fencing
SDG bond flows into a separate funds in order to improve accountability. Higher-
rated EM sovereigns are increasingly implementing ICMA guidelines, and EM
investors could expect improved disclosure as SDG issuance migrates down the
rating scale—with the added advantage that SDG issuances come with more
transparency on use of proceeds and outcomes than general purpose bonds.
Ex-post impact monitoring by investors can be time- and resource-intensive,

and may spur more third-party evaluation in the future. When an investor buys a
bond issued by a MDB whose proceeds are on-lent for green or social projects, the
MDB typically manages its own monitoring and publishes the results in an annual
report. However, sell-side and buy-side firms often do not have boots on the ground
or the sector-specific expertise to closely monitor proceeds by EM sovereigns. In its
place, investors might hire third-party consultancies or sustainability experts to carry
out this laborious task after issuance and throughout the life of a project, an area that
could experience significant demand as the sector matures.
Global regulatory environment still evolving for sustainable

investment
While the growing interest in ESG investing is leading to a global regulatory
push for investors to consistently consider these factors in their investment
decisions, particularly in Europe, so far there is no global standardization of
sustainable investment regulations. ESG-related policies and regulations have
gained steam in the past two decades in response to greater interest (and need) by
investors. Systemic financial and environmental risks associated with climate change
and the need to protect a growing pool of ESG investors have spurred more policies
and regulations. With this growth has come more standardization, enabling ESG
policies to be worked more comprehensively into corporate and national sustainable
finance strategies and, at times, jumpstarting flows into the sector. To illustrate, the
Principles for Responsible Investment (PRI)—a United Nations’ supported network
of investors who regularly survey the sustainable regulatory environment—report
that 97% of policy revisions were developed after the year 2000. According to the
PRI, as regulations grow in number, their adoption is also becoming less sporadic,
and policies are being worked more comprehensively aligned to national sustainable
finance strategies. A movement away from sporadic and voluntary regulation is
helping to cement ESG and sustainable finance as an asset class in its own right.
However, there are significant regional differences: Europe is most advanced in
adopting a common ESG taxonomy and enhanced reporting on sustainability risks in
investments, while more standard policies are also taking shape fast across Asia. By
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contrast, the sustainable investing strategies in the United States so far has tended to
be more investor-led and market-driven, although this may also change if more
standard frameworks or regulations are adopted going forward.
The pace of growth in the regulatory environment is quickening, fueled by

major forces including the systemic financial risks associated with climate
change and the need for regulators to protect the growing pool of private ESG
investors. The PRI notes that the adoption of new rules, even if not mandatory,
serves to raise awareness of sustainability issues and can result in better
documentation and disclosure more generally. GIIN, the Global Impact Investment
Network, lays out a roadmap of actions to drive a long-term shift in the impact
investment sector, which includes enhancing regulation by clarifying the
interpretation of fiduciary duties with respect to environment and social
considerations, and crafting regulations that incentivize project development, impact
measurement and reporting. That said, regulators face a challenge of building out
more comprehensive frameworks covering increasingly complex SDG instruments,
while trying to avoid stifling a sector still in relative infancy—particularly in EM
space—in which innovations are necessary and indeed underway.
Europe is most advanced in building out a policy environment around

sustainable finance, including SDG investing that is important for EM, and
upcoming regulatory updates will likely focus more explicitly on sustainable
bonds. The EU’s Sustainable Finance Action Plan adopted in 2018 set out an
ambitious strategy to better connect Europe’s financial system with sustainable
outcomes. The Action Plan supports wider initiatives around sustainable finance,
including the Paris Agreement, the SDGs and, more recently, the European Green
Deal. Of the ten distinct “actions,” arguably the most urgent one was establishing a
clear classification system—or EU taxonomy—for sustainable activities and, to that
end, the European Parliament adopted the “Taxonomy Regulation” in June 2020.
Work on other actions, including an EU Green Bond Standard and EU Ecolabel for
Retail Financial Products remain in progress. Another important action, set to launch
in March 2021, is the requirement of financial market participants to disclose how
sustainability risks are embedded in their investment process and how such risks can
impact financial returns, as well as how their investment decisions affect
sustainability. In this way, the EU regulations go beyond recognizing systemic
financial risks, and also seek to ensure the European financial system contributes to
positive real world outcomes. Regulations like those described will increasingly put
sustainability at the forefront of EU investors’ minds and should help drive private
capital towards sustainable investments. Moreover, the regulatory focus on real
world outcomes complements the expansion of SDG bond investing in EM.
Sustainable investment in the United States tends to be investor-led and market-

driven, but this may change as US regulation is still evolving. Large US asset
managers and state pension funds have already adopted ESG factors into their
frameworks, with the US Forum for Sustainable and Responsible Investment
estimating in 2018 that investors that consider ESG factors had $12tn of managed
assets. Formal regulatory changes around ESG in the US have lagged other regions
around the world. While financial companies already report certain environmental
and social financial information that reaches investors, US policymakers have
eschewed regulation to strengthen ESG-specific non-financial disclosures. Notably,
in 2019 the US House of Representatives failed to advance a (European-inspired)
stewardship code bill that would have had the SEC require all public companies to
disclose ESG metrics. In its absence, disclosure has tended to be privately-led,
voluntary or as a result of investor pressure, particularly as momentum builds for the
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sector outside the US. Indeed, investor activism—such as shareholder proposals,

investor surveys and communication with management—has been an important
driver for changes in disclosure practices in the US.
The ebb and flow of ESG regulation in the US in part reflects shifting political
priorities of US administrations. There is an ongoing regulatory debate on the
fiduciary duty of managers of employee retirement plans (ERISA) towards ESG. For
example, in 2015 the Obama administration echoed prior guidance that ESG factors
could be used as a “tie-breaker” when financial factors are deemed as otherwise
equivalent in deciding between investments, while also considering that ESG factors
could be “proper components of the fiduciary’s analysis of the economic and
financial merits of competing investment choices.” A recent US Department of Labor
proposal seeks to retain this “tie-breaker” test while adding new reporting
requirements on the appropriateness of integrating collateral benefits into an
investment decision, while limiting the ability of ERISA fiduciaries to select ESG-
themed funds as the default investment option. On the contrary, the PRI and others
have argued that failing to consider long-term investment value drivers, like ESG, is
in fact a failure of fiduciary duty. Overall, the Trump administration has made
deregulation, including of environmental codes, a central tenet of its economic
agenda. For example, in 2017 President Trump announced that the US would
withdraw in 2020 from the Paris Climate Accord that was agreed by the Obama
administration, while the Democratic-presidential candidate Joe Biden has
committed to re-join the agreement. Biden has also proposed a $2tn green-energy
infrastructure program in his campaign platform. It is probably fair to say that the
outcome of the upcoming US election may broadly shape the future evolution of the
sustainable investment regulation in the US.
The policy environment for sustainable investment is broadening out in Asia

Pacific, particularly after the adoption of stewardship codes in Japan. Japan has
led the adoption of ESG policies in Asia Pacific, sparked by the structural reforms
promoting sustainable investment by the Abe administration. Reform efforts
culminated in the development of the Japanese Stewardship Code in 2014 and the
establishment of the Corporate Governance Code by the Tokyo Stock Exchange in
the following year. The policy environment of the wider region has since expanded,
with subsequent stewardship code launches that encourage investors to disclose
policies in Malaysia (2014), Taiwan (2016), Korea (2017) and Thailand (2017).
Although China has yet to publish a stewardship code, its inclusion into several
benchmark indices in recent years has been accompanied by the adoption of some
ESG policies, the latest being the mandatory disclosure of environmental factors for
the country’s listed corporations and primary bond market issuers beginning in early
2020. That said, there is arguably room to improve the ESG policy landscape in
China, which could involve the China Securities Regulatory Commission (CSRC)
and Asset Management Association of China (AMAC) publishing regulations and
guidelines for investors.
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jarrad.k.linzie@jpmorgan.com nikhil.bhat@jpmorgan.com 11 September 2020
Kumaran Ram Rupert Rink
(1-212) 834-4685
kumaran.m.ram@jpmorgan.com rupert.rink@jpmorgan.com
Credit enhancements and stripped yields

likely to make a comeback in EM indices
 Eligibility of credit-enhanced securities (if implemented) could be the most

material change in EM bond indices since the inclusion of Sukuk and Gulf
co-operation countries (GCC) debt
 After passing a milestone of US$ 1 trillion in notional value of sovereign
debt in 2019, the Emerging Markets Bond Index (EMBI ®) suite has come
full circle from its origin in the 1990s as a gauge for US Treasury
collateralized Brady bonds, to once again evaluate inclusion of credit
enhanced bonds from EM sovereign debt resolutions
 Stripped yields, used to calculate underlying risk after removing the high
quality asset (US Treasury) from Brady bonds, will likely be revived to
compare core risk within partially credit-enhanced issuance
 Multilaterals may require ESG and sustainability commitments in return
for future credit guarantees. Ecuador issued the first Sovereign Social bond
with Inter-American Development Bank offering a partial credit guarantee
 Pandemic-related market disruption has delayed inclusion timelines for
new markets in the GBI-EM; for example, Serbia is on track to achieving
index eligibility but the timeline has been extended due to the pandemic
 Egypt is on the right track towards benchmark inclusion with efforts
underway to link the onshore market with Euroclear, and supply of larger
benchmark sized issues
 India is the largest ‘off-index’ government bond market with the scale and
liquidity to reach a 10% allocation if included in the GBI-EM GD. Recent
measures to earmark bonds as fully accessible to international investors
could eventually pave way for benchmark eligibility
Déjà vu all over again: Credit-enhanced bonds in the EMBI

After passing a milestone of US$ 1 trillion in notional value of sovereign debt in
2019, the Emerging Markets Bond Index (EMBI ®) suite has come full circle
from its origin in the 1990s as a gauge for US Treasury collateralized Brady
bonds, to once again evaluate inclusion of credit enhanced bonds from EM
sovereign debt resolutions . The default rate of the EMBIG has already surged to
7% of notional in 2020 and expected to increase further (EM sovereign repayment
risks 2.0). There have been several calls for sovereign debt relief especially for the
vulnerable economies (e.g. countries eligible for IDA support2) which are likely to
face severe economic and social consequences from the coronavirus outbreak.
Notably, the joint communique released by the G-20 asked the International Institute
of Finance (IIF) to serve as a principal point of contact, to generate private sector
feedback and support for the G20/Paris Club Debt Service Suspension Initiative
(DSSI).
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Exhibit 180: EMBIG default rate has surged to 7% of notional

Default Date in Defaulted EMBIG Default Rate
Country Weight (%) in EMBIGD* Weight (%) in EMBIG*
EMBIGD Notional ($M) (As-of Year-End)
12/24/2001 Argentina 21,007 3.08 3.28 11.3%
12/15/2008 Ecuador 3,860 0.65 0.43 1.2%
2/1/2011 Ivory Coast 2,332 0.37 0.23 0.6%
8/21/2012 Belize 547 0.06 0.04 0.1%
7/31/2014 Argentina 12,180 1.99 1.36 1.9%
9/25/2015 Ukraine 11,350 1.91 1.34 2.1%
1/17/2017 Mozambique 727 0.09 0.05 0.1%
1/9/2018 Venezuela 29,042 0.44 0.74 -
2/12/2018** PDVSA 24,920 0.50 0.82 5.7`%
3/9/2020 Lebanon 15,264 0.50 0.30 -
4/20/2020 Ecuador 20,391 0.70 0.52 -
†
5/26/2020 Argentina 41,981 1.15 1.48 6.9%
Given that backdrop, our index research group has launched a consultation
(2020 J.P. Morgan Index Governance Consultation) as part of the annual index
governance to discuss the benchmark eligibility of credit-enhanced sovereign
debt with official sector support or high quality collateral. Traditionally, the
EMBIGD has excluded sovereign debt with any type of credit enhancement, such as
EM sovereign bonds partially guaranteed by an official creditor such as the World
Bank (e.g. Ghana 2030s issued in October 2015). In such cases, the resulting debt
instrument is not benchmark eligible due to relative lack of liquidity and price
transparency in the secondary markets.
However, given the unique nature of the current pandemic related market
shock and debt sustainability issues for a number of emerging markets, a case
can be made to consider newly created bond structures as part of any
coordinated debt relief solutions. From a benchmark eligibility standpoint, the key
pillars for new bond structures are accessibility, liquidity (regular pricing from the
third-party pricing providers and secondary market activity) and the ability to model
the cash flow structures (i.e. predictable and transparent) to calculate credit risk
premium and total returns. The structures being discussed include providing
multilateral guarantees on all or a portion of the cash flows or linking to high credit
quality sovereign collateral (such as US Treasury bonds). The latter scenario offers
many parallels to the circumstances dating back to the origin of the EM sovereign
debt through Brady loans and the launch of the EMBI® in the 1990s.
Incidentally, the methodology of the EMBI already includes provisions for

calculating the true credit risk of such a collateralized bond after ‘stripping’ out
the higher quality asset (i.e. US Treasury) and can be utilized to value such
instruments. Official creditor / multilateral guarantees are more complex to value
and discount depending on the legal framework and any first-loss or rolling
provisions in the guarantee, but still can be modelled provided the terms are clearly
laid out.
Another important consideration is that while the AAA-rated official sector

support is comingled with the sovereign credit risk, the guarantee does not
exceed majority of the obligations (i.e. less than 50% of cash flows at issuance).
This is key to ensure the bond structure remains a majority EM sovereign liability
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from a benchmarking perspective. It is also important to note that based on index

methodology, defaulted bonds remain included in the EMBI Global/Diversified,
provided they continue to satisfy all other inclusion criteria such as sufficient
liquidity and the minimum face amount outstanding. This is key since it is unclear
how the credit rating agencies (S&P, Moody’s and Fitch) will react to the provision
of credit-enhanced bond issuance both in terms of the credit default rating of existing
debt and provisional credit rating for new bonds.
Multilaterals may require ESG and sustainability commitments in

return for future credit guarantees
The UN Sustainable Development Goals (SDGs) provide the framework for
sustainable, low-carbon and resilient development under a changing climate.
The scale of the sustainable development investment challenge is well beyond the
capacity of the public sector, highlighting the need for international co-operation and
multilateral stimulus to help attract and, importantly, guide required investments. The
SDGs, termed as the “blueprint to achieve a better and more sustainable future for
people, planet and prosperity”, represent 17 of the greatest global environmental,
social, and economic challenges faced within the 21st century. Increasingly, its
agenda is used as a ‘national compass’ for countries to prioritize and disseminate
sustainable development financing and furthermore for multilaterals to effectively
address the funding shortfall.
Multilaterals are tailoring fiscal packages in response to the Covid-19 pandemic

and the profound challenges across the world it has given rise to. Many of these
challenges extend beyond a health crisis towards humanitarian disasters in low and
middle-income countries, which will require trillions of fiscal stimulus dollars to
restore the economic damage. In response, 2020 has witnessed multilaterals enter
capital markets uniquely, tailoring fiscal stimulus packages to specifically address
the social and economic crises caused by the pandemic. Between the IFC, EIB,
AfDB, CEB, and the Work Bank, more than $15 billion worth of debt has been
raised since March. Such labelled and intended use of proceeds from bonds are
commonly known as “Social Bonds” – bonds that raise funds for new and existing
projects with positive social outcomes.
Ecuador issues the first Sovereign Social Bond in the international market.
Similarly, for the first time multilaterals are supporting social relief by guiding
needed investments through credit guarantees. The Inter-American Development
Bank has offered a credit guarantee for the world’s first sovereign social bond, an
Ecuadorian bond issuance that seeks to support mortgage loans at a preferential
interest rate. Under this mechanism, approximately $1.35 billion will be offered to
benefit 24,000 middle- and low-income households. The credit guarantee from IADB
(which has an AAA credit rating) has allowed Ecuador to attract international
investors and importantly reduce the cost of financing. The social bond discloses
under its use of proceeds its compliance with four of the 17 SDGs: 1 No Poverty; 6
Clean Water and Sanitation; 10 Reduced Inequalities; and, 11 Sustainable Cities &
Communities.
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Pandemic-related market disruption has delayed inclusion

timelines for new markets in the GBI-EM
Serbia, which is on Index Watch for inclusion at the time of this publication, is
on track to achieving index eligibility although the timeline may have been
extended due to the pandemic-related market disruptions. In January, Serbia was
placed on Index Watch for potential inclusion into the J.P. Morgan Government
Bond Index-Emerging Markets (GBI-EM) series, in recognition of the improved
market access and liquidity for foreign investors. However, the pandemic related
market disruption has impacted overall liquidity and accessibility of the emerging
market bonds and currencies. As a result, most benchmarked investors have
advocated to extend the Index Watch period until the volatility and market liquidity
moderate.
Egypt, India and Ukraine are the other markets on the radar for potential GBI-
EM Global Diversified inclusion in the medium term. The GBI-EM Global
Diversified, which is designed to be the investable benchmark for with minimal
hurdles for replication, accounts for only 12% of the total stock of local currency
debt outstanding. Furthermore, the GBI-EM GD currently tracks only 19 local
currency bond markets (as of September 2020), compared to 73 countries (with USD
debt) in the EMBIGD. While that highlights the future potential for expanding
coverage of the benchmark, it also underscores the high bar for local currency
markets to demonstrate sufficient liquidity and accessibility before they can be
benchmark eligible. In addition to Serbia, the 2020 Index Governance Consultation
(link, pg #18) identified, Egypt, India and Ukraine as new countries that have
demonstrated sufficient progress towards easing market access for foreign investors
and thereby on radar for potential inclusion in the GBI-EM GD in the coming years.
Egypt is on the right track towards benchmark inclusion with efforts underway
to link the onshore market with Euroclear, and supply of larger benchmark
sized issues. Although Egypt has a sizable local currency debt stock, the local
sovereign curve is highly fragmented with several small bonds outstanding and only
a quarter of the debt meeting the minimum size for inclusion in the GBI-EM GD
(above US$ 1 billion for local bonds). The largest bond on the EGP government
bond curve is only US$ 1.1 billion in size which is barely above the benchmark's
minimum size criteria. Liability management of the local sovereign curve by tapping
existing benchmark bonds, will not only concentrate supply (and hence liquidity), but
also bring more bonds in scope for benchmark inclusion. Some of the measures have
already been implemented by the authorities and it is anticipated that the average size
of bonds to keep increasing over the coming years. First, some of the complexities
around tax assessment and rebate process have been simplified for international
investors and their global custodians In addition, Egypt has already signed a
Memorandum of Understanding (MoU) with Euroclear and expects to be link the
onshore bond market with the international settlement and clearing system by 2021.
Euroclear linkage in particular will likely be a game changer for government bond
liquidity as it is typically accompanied by increased accessibility to the local market
which could pave the way for benchmark inclusion.
India is the largest ‘off-index’ government bond market with the scale and
liquidity to reach a 10% allocation if included in the GBI-EM GD. Recent
measures to earmark bonds as fully accessible to international investors could
eventually pave way for benchmark eligibility. India is one of the largest debt
markets in EM local currency sovereign space with over $800 billion in debt stock of
Indian Government Bonds (IGBs). Since GBI-EM family’s inception in 2003, India
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has been part of the less GBI-EM Broad series, but never included in the more
widely followed GBI-EM Global Diversified which most EM local investors
benchmark to. In contrast to most new countries on the radar for inclusion into the
GBI-EM Global Diversified, liquidity in the bonds or FX has never been a hurdle for
IGBs for index eligibility. However, a stringent regime of capital controls has proved
to be major hurdle in the past for offshore investors. India has remained ineligible for
the flagship GBI-EM Global series, primarily due to limitations placed on the
purchase and sale of IGBs by foreign investors (for e.g. quota system to access IGBs,
limits on proportion of issue size that can be purchased by foreign investors, etc.). In
March 2020, the government of India introduced a scheme termed Fully Accessible
Route (FAR) under which designated bonds would be freely investible by foreign
investors without any quota requirements or holding limitations. Approximately
$115 billion in notional value of current and upcoming supply of IGBs have been
earmarked as FAR-eligible bonds. If deemed index eligible, these bonds would
account for approximately 8% weight in the GBI-EM Global Diversified with the
potential to grow the 10% (maximum weight) based on upcoming supply estimates.
From an index perspective, we will continue to monitor the development and track
record of the FAR regime. Apart from the capital controls, custody/settlement, legacy
trading and operational requirements have been cited by benchmarked investors as
hurdles for accessing the onshore bond. Euroclearability of the FAR-eligible bonds
would go a long way in making IGBs more accessible to offshore investors and
address some of the operational hurdles directly. All things considered, India is
making progress towards opening up its market to foreign investors and establishing
a track record for future inclusion in major bond indices, including the GBI-EM GD.
Ukraine is a relatively large economy with the potential to gain entry into GBI-
EM GD by continuing to increase accessibility and liquidity for onshore bonds.
The country has almost $15 billion in US$ denominated sovereign debt that is
represented in the EMBI family. However, on the local currency side, the country has
only one bond on its curve that meets the GBI-EM Global Diversified maturity and
size criteria. If included in the index, the Feb 2025s will only have approximately
13bps weight in the index. The concentration of foreign ownership on this bond is
high, but the security is rarely offered in the secondary market, hampering the
liquidity of the bond and affecting index eligibility. Accessibility to the market is
another concern for international investors with investors citing onerous process for
opening local accounts. Although, Ukraine onshore bond markets are linked to
Clearstream, it is not utilized by majority of the international investors benchmarked
to the GBI-EM. Improved secondary market trading, potentially increased supply of
local currency debt and improved accessibility are some of the measures that would
aid Ukraine’s benchmark eligibility.
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Disclosures
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Ratings System: J.P. Morgan uses the following issuer portfolio weightings for Emerging Markets sovereign credit strategy: Overweight
(over the next three months, the recommended risk position is expected to outperform the relevant index, sector, or benchmark credit
returns); Marketweight (over the next three months, the recommended risk position is expected to perform in line with the relevant index,
sector, or benchmark credit returns); and Underweight (over the next three months, the recommended risk position is expected to
underperform the relevant index, sector, or benchmark credit returns). NR is Not Rated. In this case, J.P. Morgan has removed the rating
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not a rating or a recommendation. Recommendations will be at the issuer level, and an issuer recommendation applies to all of the index-
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(Overweight, Marketweight or Underweight) based on our view of whether the combination of the issuer’s fundamentals, market
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EMBIGD index over the next three months. Our view of an issuer’s fundamentals includes our opinion of whether the issuer is becoming
more or less able to service its debt obligations when they become due and payable, as well as whether its willingness to service debt
obligations is increasing or decreasing.
J.P. Morgan Sovereign Research Ratings Distribution, as of July 4, 2020
Overweight Marketweight Underweight

Global Sovereign Research Universe 13% 78% 9%
IB clients* 71% 49% 80%
*Percentage of subject issuers within each of the "buy, "hold" and "sell" categories for which J.P. Morgan has provided investment banking services within the previous 12
months. Please note that the percentages might not add to 100% because of rounding.
The Sovereign Research Rating Distribution is at the issuer level. Issuers with an NR or an NC designation are not included in the table above. This information is current as of
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127

Jonny Goulden
(44-20) 7134-4470
128
Completed 11 Sep 2020 02:40 PM BST Disseminated 11 Sep 2020 03:03 PM BST

EM As An Asset Class in The Post-Pandemic World

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Global Emerging Markets

EM as an Asset Class in the

Emerging Markets Research

See page 125 for analyst certification and important disclosures.

This document is being provided for the exclusive use of dwessel@brookings.edu.

This document is being provided for the exclusive use of dwessel@brookings.edu.

This document is being provided for the exclusive use of dwessel@brookings.edu.

In this report, which is an update of our EM as an Asset Class series that we

EM growth will slow but diversification benefits linked to

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Outlook for EM fixed income returns is lower but Sharpe

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Source: J.P. Morgan

We expect the best risk-adjusted returns in EM fixed income to come from

This document is being provided for the exclusive use of dwessel@brookings.edu.

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ESG investing that is more skewed towards development outcomes will be

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Impact of slowing globalization and the

 EM trend growth has been declining since 2010

Was EM growth in the last two decades the norm or the

Near-term challenge to EM growth from the pandemic

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Exhibit 4: Post pandemic global GDP

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Near term risks to fiscal deficits, debt and financial stability

The pandemic-induced collapse in fiscal revenue has created a huge strain on

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Exhibit 6: Fiscal accounts have deteriorated significantly Exhibit 7: EM government debt

Government debt-to-GDP dynamics depend on three factors: the primary fiscal

Exhibit 8: EM primary deficit 2019-21

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Interest rate-growth differential has become less favorable

Exhibit 9: EMX interest-growth differential

Source: J.P. Morgan, IMF. EMX refers to EM ex. China.

Exhibit 10: Main determinants of EMX public debt

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Pandemic presents a different kind of EM debt crisis

In Exhibit 11, we illustrate this policy trade-off, under plausible assumptions. In

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Exhibit 13: Medium term interest-rate growth differentials*

From quantitative to regulatory to credit easing

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Exhibit 14: EM CB government bond purchases

Poland (103bn) 6.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

Markets may become concerned about this simultaneous shift to unconventional

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EM trend growth to grind down further

Exhibit 15: EM potential growth 2005-2019

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Exhibit 16: EM potential GDP growth (bottom-up)

Productivity decline is the key challenge for recovery

Exhibit 17: Contributions to EM GDP growth

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To correctly estimate the contribution of productivity and inputs in growth,

Exhibit 18: Results from 21-country panel GMM regressions, 2005-19

Exhibit 19: Decomposition of potential growth based on PF

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Exhibit 20: EMX total factor productivity

There are some divergences within EM regions. While EM Asia’s real

Exhibit 21: Real TFP

Unfavorable EM demographics isn’t helping