Emerging market finance gets creative as dollar bonds dry up

Emerging market finance gets creative as dollar bonds dry up

(Bloomberg) — At the BRICS summit in Johannesburg this week, one of the main items on the agenda was to reduce dependence on the dollar in emerging markets. In bond sales, this is already happening.

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Dollar bond sales from developing countries fell to their lowest levels since 2021 in August, as global yields rose to multi-year highs and 15 emerging countries traded at distressed levels. Only $1.4 billion in emerging market debt has been raised this month, compared to $4.5 billion in August 2022 and an average monthly sales of $15.4 billion this year.

The result of the crash is that alternative borrowing vehicles have become more prevalent in emerging and frontier markets, attracting more investors pursuing priorities such as environmental, social and governance goals. The lower supply of plain vanilla bonds also tends to support debt prices that investors are already holding.

“If demand is greater than supply then that tends to be good for the bond,” said Philip Fielding, co-head of emerging markets at Mackay Shields in the UK, who said it was buying emerging debt in the secondary markets for its $134bn bond as a new issue. ease up. “In many cases, it makes more sense to invest and then switch to a new, cheaper version rather than wait.”

Tighter global monetary conditions are prompting borrowers and investors to seek alternative financing methods such as syndicated loans, custody-linked securities, and local currency bonds. Such instruments can reduce borrowing costs for governments while reducing currency risk and uncertainty about refinancing.

For some, the move away from the dollar also has a geopolitical motive.

“The recent headlines of the BRICS group point more in the direction of new countries willing to form alternatives to the standard Western blocs,” said Sergey Goncharov, fund manager at Vontobel Asset Management in New York. “As emerging market countries issue less debt, they are instead turning to alternatives — regional lenders, supranational banks, and home markets.”

The stalled economic recovery in China and the rise in Treasury bond yields to the highest levels since before the global financial crisis helped fuel the search for alternative financing. Bahrain’s sale of $1 billion in dollar bonds in July is the only non-investment deal so far this quarter. Outside of the smaller sales from investment grade issuers, activity has all but come to a halt.

“For higher-rated issuers who can wait to issue bonds, they prefer issuing later to get a better chance of borrowing at a cheaper rate,” said Reda Karim, investment manager at Jupiter Asset Management in London. “For some high-yield issuers, the rate is too high and access to capital markets is also limited.”

Partly because of the dearth of new sales, the average yield on emerging market sovereign debt recently fell to 8.26% as of Friday, after hitting a nine-month high of 8.43% when China’s economic woes sparked a sell-off.

“A lower offer would be technically positive, especially if issuers are going into the loan market,” said Uday Patnaik, head of fixed income, emerging markets at London-based Legal & General Investment Management. “The problem will be if the issuer cannot find alternative financing sources.”

Conservation capital

One area where capital is most readily available is environmental protection. Gabon, where nine-tenths of the land is covered by trees, closed a $500 million debt deal for Nature this month to help refinance part of its debt and raise funds for marine conservation.

Although there were hurdles to complete the sale – the issuance was delayed and had to be priced at a higher-than-expected yield – it is the latest in a series of transactions that show sticking to environmental goals can help governments overcome borrowing challenges. Belize, Barbados and Ecuador have made similar deals, and Mozambique is in talks with Belgium about one.

Read more: Social bonds back as global sales hit a two-year high

“Sovereigns have to take it into consideration,” said Carlos de Souza, director of emerging markets money at Vontobel Asset Management AG in Zurich. “It provides money for the sovereign, deploys money for nature conservation, increases the supply of green and blue bonds, and boosts the prices of the respective sovereign bonds. Basically everyone wins.”

But related transactions are complex in nature and require lengthy preparation by issuers. Borrowers who need money more quickly are turning to syndicated loans, where multiple lenders contribute. In Africa alone, there were 225 such loans worth $32 billion provided to governments and companies over the past year.

“Market conditions will remain challenging, especially for the most vulnerable frontier economies,” said Bartosz Szawicki, market analyst at Polish financial technology firm Konotoxia. “Hence, syndicated loans, which spread the risk of default between the parties, are likely to prevail.”

local bonds

But if reducing dependence on dollar bond sales is the goal, nothing better than developing a vibrant domestic market. Countries around the world are now looking to attract more foreign investors to their domestic bonds.

And in Latin America, where real yields are higher than the emerging market average, investors bought $8.5 billion in local bonds this year through early July, the most since 2019. Peru, Chile and the Dominican Republic were the top exporters. Some of the proceeds are earmarked for environmental projects, making them more attractive to ESG investors.

Read more: Wall Street sees scheme to swap oil-related debt in Suriname

The New Development Bank, the multilateral lender set up by the BRICS countries, said it aims to increase the share of its local currency borrowing to 30% from less than 20%, and issued its first rand-denominated bonds last week. It says bonds denominated in Indian rupees are next.

what do you want to watch

  • Türkiye and India will release GDP data for the second quarter. Bloomberg Intelligence expects Turkey data to show economic activity slowing slightly, even as it is supported by election-related spending.

  • Poland will release inflation data for August. The consensus is that the CPI indicates that prices continued to fall for the second month in a row. Food prices in Sri Lanka are also expected to decline amid lower food prices

  • China’s Caixin Manufacturing PMI is likely to point to a sharp downgrade in August, as continued weakness in demand at home and abroad takes its toll.

  • The Hungarian Central Bank will decide on interest rates

  • Ghana and Hungary will be subject to sovereign rating review by Moody’s

–With assistance from Carolina Wilson.

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