CONTRIBUTORS
Nicholas Hardingham, CFA
Portfolio Manager, Franklin Templeton Fixed Income
Stephanie Ouwendijk, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Robert Nelson, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Joanna Woods, CFA
Portfolio Manager, Research Analyst, Franklin Templeton Fixed Income
Carlos Ortiz
Research Analyst, Franklin Templeton Fixed Income
Jamie Altmann
Research Analyst, Franklin Templeton Fixed Income
Preview
Global financial markets have been subjected to multiple shocks over the past three years: the COVID pandemic; the end of quantitative easing, with the subsequent tightening of liquidity; the Russia-Ukraine war; and more recently, the unrest in the Middle East. For emerging markets, these developments have had implications for sovereign balance sheets, as well as fiscal policy, and, in many cases, have raised external vulnerabilities.
In this paper, we analyze the International Monetary Fund’s Debt Sustainability Framework, in terms of its inputs, outputs and shortcomings. We identify where the Framework can be valuable to bond investors and how they are constrained by it. Finally, we look at ways to deal with these constraints by considering the following:
- What does “debt sustainability” mean?
- The limitations of the Debt Sustainability Analysis (DSA).
- The role of the DSA in restructuring negotiations.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
Growth stock prices may fall dramatically if the company fails to meet projections of earnings or revenue; their prices may be more volatile than other securities, particularly over the short term.
Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt.
Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.