The Evolution of China’s Lending to Emerging Markets

Why we expect a more selective approach in the future.

    PREVIEW

    The increasing prominence of China as a financier of developing nations has garnered considerable attention in recent years and has changed the landscape of sovereign debt investing. This paper discusses the evolution of Chinese lending practices, anecdotal observations regarding the Chinese approach to sovereign debt distress and our views on how Chinese lending to emerging markets (EMs) will evolve going forward. Case studies to date suggest China is inclined to take a relatively benign approach to sovereign debt distress, although the recent experience in Zambia reminds us that the approach is certainly not “ one-size-fits-all.”

    In the future, we expect China to take a far more selective approach to overseas lending, with higher thresholds in relation to the economics and/or strategic geopolitical merit of outward investments. Such a dynamic could contribute to divergent performance between weaker EMs, with a handful of commodity-rich and strategically important high yielders continuing to benefit from a “Chinese put.” China’s lending abroad will continue to be so varied in terms of size, type and motivation that we stop short of generalizing regarding the impact on EMs in aggregate. We will continue to assess China’s economic and strategic rationale for lending on a country-by-country basis, with such analysis providing valuable insight into the sustainability of China’s support.


    WHAT ARE THE RISKS?

    All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. 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. 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.

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    Contributors

    • Senior Vice President, Portfolio ManagerFranklin Templeton Fixed Income
    • Senior Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Portfolio Manager, Research AnalystFranklin Templeton Fixed Income
    • Vice President, Research AnalystFranklin Templeton Fixed Income