As liquidity support fades, fiscal deficits will have to narrow
EM governments will be under pressure to cut fiscal deficits next year
Tighter external financing conditions and domestic fiscal rules are likely to push many EMs toward austerity next year. Some may offset this with loose monetary policy, but many could be forced to follow Turkey’s lead and hike rates.
Default risk is still under-priced in EM hard-currency bonds
We may have underestimated the role that IMF lending played in re-opening international bond markets to lower-rated EMs. But IMF lending criteria will push EMs toward austerity next year, which will prolong their economic downturn.
Currency and policy risks will weigh on EM local-currency bonds
EMs with stronger economic fundamentals may be able to maintain low rates, but others are subject to similar vulnerabilities as Turkey. They may have to choose between lower interest rates or lower exchange rates.