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Emerging markets monitor

December 2022

Marketing Material

Written by

Sabrina Jacobs

Sabrina Jacobs

Senior Client Portfolio Manager

Khanniche Sabrina

Sabrina Khanniche

Senior Economist

The more fossil fuel you burn, the richer you get. Higher carbon emissions and economic growth have gone hand in hand since the Industrial Revolution.

That’s been the case more recently for emerging market economies, whose carbon footprint is closely correlated with their populations’ standard of living.

Traditionally, developing countries have been heavy carbon emitters as their economic growth has in large part depended on natural resources and the industries which use them, such as manufacturing.

This means emerging market investors, too, have had a large carbon footprint.

But that now appears to be changing.

There is a growing body of evidence that shows emerging economies are managing to reduce their carbon emissions per capita – or carbon intensity – without sacrificing economic growth.

This is thanks to attempts by countries like China to embrace renewable energy, move up the manufacturing value chain, increase energy efficiency and introduce environmental regulation.

Innovations in finance could accelerate that shift. The growth of green and sustainability-linked bonds in emerging markets means capital is increasingly being channelled towards less carbon-intensive projects and investments.

All of which means investors in emerging market corporate bonds now have the opportunity to further diversify their portfolios while increasing their contribution to a sustainable transition and aligning their investments with net zero targets.

Plateauing emissions

Emerging economies are critical to global efforts to halt climate change as they account for nearly two thirds of current annual carbon emissions.¹

But this is to be expected. When a predominantly agricultural economy embarks on a path to industrialisation, its greenhouse gas emissions tend to rise as its GDP per capita increases.

However, this trend only holds up to a certain point in a country’s development.

This observation is referred to in policy circles as the Environmental Kuznets Curve – modified from American economist Simon Kuznets’ hypothesis, which originally stated that industrialising nations experience a rise and subsequent decline in income inequality.

While sometimes controversial, this environmental version of Kuznets’ curve appears more relevant today than it did when it was first observed in the 1990s.²

Kuznets curve — Source: Pictet Asset Management

Emerging markets’ advancement towards their emissions plateau is gathering pace.

Take China, the world’s second largest polluter. Its carbon intensity – a metric that measures the quantity of CO2 emitted per unit of GDP – has fallen by more than a fifth since 1990 to 0.57kg CO₂ per dollar of GDP.³In the same period, the country’s GDP per capita experienced a ten-fold expansion.

In other emerging economies – or lower to middle income countries – carbon intensity has declined at an even faster pace over the same period.

The improvement is due to a combination of factors. For China, the shift is primarily down to a change in its industrial structure.

Recent research shows carbon emissions from its exports, or emissions embedded in its international trade, have fallen in the five years to 2012 after peaking in 2007, thanks in part to changes in its export mix.⁴

The economy has transitioned from a reliance on emission-heavy steel and apparel manufacture to technology-oriented and more value-added sectors such as electronics.

This has come as Beijing has committed to reduce emissions and tackle air pollution as a response to growing public concerns over air quality.

China has also achieved improvements in energy efficiency. A separate recent study shows the country’s technologies in manufacturing production have improved three times faster than the world average between 2000 and 2014, helping slow the rise in global emissions within the export industry.⁵

Other emerging economies such as Taiwan, Bulgaria, Romania and Poland have improved even faster.

Greening EM corporate bonds

Our own research shows that if the decoupling of economic growth from carbon emissions continues, it could open up new possibilities for investors in emerging market corporate bonds.

The analysis examines the relationship between debt and carbon intensity. We find that the greater a country’s carbon emissions relative to GDP, the greater its level of corporate debt.

This reflects the fact that, by and large, highly polluting industries rely on debt to finance emission-heavy projects.

It also means that by holding emerging market corporate debt instead of the developed world equivalent, investors accept a higher carbon footprint as the price for securing higher yields.

This also implies that if the developing world continues to advance rapidly to peak emissions, its debt dynamics are expected to improve.

EM NFC and carbon intensity — Non-financial corporate debt. Source: Pictet Asset Management, CEIC, Refinitiv, Our World in Data, UNCTAD, data as of 15.11.2022

As these favourable trends pick up pace, investors have at their disposal other ways to control and reduce carbon risks on their portfolio.

Today, carbon intensity of top polluting decile of companies in JP Morgan CEMBI Broad Diversified index is 3.3 times that of the decile below and 30 times that of the fifth decile.

This means investors can reallocate between these segments to significantly reduce a portfolio’s carbon profile while staying within a given sector.⁶

What is more, the overall gap between the top and bottom deciles can begin to decline as more companies transition.

Another emerging trend we observe is that certain fossil fuel companies are using windfall profits instead of debt to finance transitions to cleaner energy.

Take Indonesia for example. The country’s coal miners – Indonesia is the world’s third largest producer – are enjoying historic windfall profits in the tunes of billions of dollars thanks to surging coal prices as a result of the energy crisis.⁷

This gives them unprecedented firepower to shift their business models, without borrowing more, to help the country’s goal of eliminating unabated coal power generation – or coal without carbon capture technology – by 2050. They can, for example, use these profits to build solar and hydropower plants or invest in a green industrial park to produce EV and batteries.

Accelerating the green trend

When it comes to an environmental impact, emerging economies have the potential to deliver the biggest bang for buck because of their large infrastructure and investment gap.

For these reasons, EM corporate bond markets provide a fertile ground for environmental, sustainability and governance (ESG)-labelled bonds.

Emerging companies issued over USD135 billion of ESG-labelled and sustainability-linked bonds in the first nine months of 2022, three times more than in the same period of 2020.

The share of emerging markets in ESG and sustainability-linked debt has risen to a fifth of the global total from 16 per cent in 2020.⁸

Issuance of these bonds has held up remarkably well, in contrast to what’s happening in the wider fixed income universe (see our previous article).

The outlook is also promising. Research from Pictet Asset Management and the Institute of International Finance suggests that annual ESG-labelled bond issuance in emerging markets could reach USD360 billion by 2023 and exceed USD700 billion in 2025.⁹

When it comes to an environmental impact, emerging economies have the potential to deliver the biggest bang for buck because of their large infrastructure and investment gap.

Peak intensity

Emerging markets, led by China, are reaching a peak carbon intensity in a shorter time frame than it took Western predecessors.

They can accelerate this sustainable transition by greening their corporate bond markets and shifting capital allocation to less carbon-intensive projects.

This should also allow fixed income investors to reduce the carbon footprint of their portfolios and align them with their sustainable or environmental objectives.

[1] Our World in Data
[2] https://www.jstor.org/stable/44379183
[3] Our World in Data; GDP is measured in constant 2011 international dollars.
[4] Pan, C., G. P., Peters, R. M., Andrew, J. I.,Korsbakken, S., Li, D., Zhou, and P., Zhou(2017), Emissions embodied in global trade have plateaued due to structural changes in China, Earth’s Future,5,934–946, doi:10.1002/2017EF000625
[5] Jiborn, Magnus, Viktoras Kulionis, and Astrid Kander. 2020. "Consumption versus Technology: Drivers of Global Carbon Emissions 2000–2014" Energies 13, no. 2: 339. https://doi.org/10.3390/en13020339
[6] Scope 1 and 2 emissions per dollar revenue, reweighted (coverage ratio of 78 per cent). Source: Trucost, Bloomberg, Pictet Asset Management, data as of 18.11.2022
[7] Net cash positions of top four Indonesian coal miners, source: JP Morgan, data as of 10.11.2022
[8] IIF, data as of 30.09.2022
[9] https://am.pictet/en/globalwebsite/global-articles/2022/expertise/esg/esg-bond-market-transformation/tab/Foreword

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About

Sabrina Jacobs

Sabrina Jacobs joined Pictet Asset Management in 2022. She is a Senior Client Portfolio Manager for the Emerging Market Fixed Income team based in London specialising in Emerging Market Corporate and Greater China Debt strategies.

Before joining Pictet, Sabrina was a client portfolio manager for Insight Investment’s Global Fixed Income and Specialist Equity teams. Prior to Insight, Sabrina worked at Barclays Capital in global distribution based in London and Singapore. Sabrina started her career in 2002 in Dresdner Kleinwort Wasserstein’s macro research team.

Sabrina graduated from Bonn University with a first class B.A. in Economics. She also holds an MSc in Economics from the London School of Economics and Political Science.

About

Sabrina Khanniche

Khanniche Sabrina

Sabrina Khanniche joined Pictet Asset Management in 2011. She is a Senior Economist, Lead on Eurozone and MEA.
Before joining Pictet, she was with Groupama Asset Management during four years as a Financial Engineer in charge of the analysis and modelling of hedge fund risks. In this regard, she published and presented her work in international academic conferences.
Sabrina holds a Master and a PhD in Economics from the University of Paris West Nanterre La Défense.

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