Emerging-Market Funding Gets Creative as Dollar Bonds Dry Up

At the BRICS summit in Johannesburg this week, a key item on the agenda was reducing dollar dependence across emerging markets. In bond sales, it’s already happening.

(Bloomberg) — At the BRICS summit in Johannesburg this week, a key item on the agenda was reducing dollar dependence across emerging markets. In bond sales, it’s already happening.

The sale of dollar bonds from developing countries sunk to the lowest since 2021 in August as global yields spiked to multi-year highs and 15 emerging nations traded at distressed levels. Only $1.4 billion has been raised in emerging debt this month, compared with $4.5 billion in August 2022 and average monthly sales of $15.4 billion this year.

The upshot of the collapse is that alternative borrowing instruments are becoming more mainstream in emerging and frontier markets, attracting more investors pursuing priorities such as environmental, social and governance targets. The lower supply of plain-vanilla bonds also tends to support prices for the debt that investors already hold.

“If demand is greater than supply that tends to be good for bonds,” said Philip Fielding, co-head of emerging markets at Mackay Shields UK, who said he’s buying emerging debt in the secondary markets for his $134 billion bond house as new issuance abates. “In many cases it makes sense to be invested and then switch into a cheap new issue rather than wait.”

Tighter global monetary conditions are pushing both borrowers and investors to seek alternative funding routes such as loan syndication, conservation-linked securities and local-currency bonds. Such instruments can ease governments’ costs of borrowing while minimizing currency risk and uncertainty over refinancing. 

For some, shifting away from the dollar also has a geopolitical motivation.

“The latest BRICS headlines point even more in the direction of new countries willing to form alternatives from the standard Western blocs,” said Sergey Goncharov, a money manager at Vontobel Asset Management in New York. “As EM countries issue less debt, they instead pivot towards alternatives — regional lenders, supranational banks, local markets.”

The stalling of China’s economic recovery and a spike in Treasury yields to the highest levels since before the global financial crisis have also helped fuel the search for alternative funding. Bahrain’s $1 billion sale of dollar bonds in July is the only non-investment grade deal so far in the quarter. Beyond smaller sales by investment-grade issuers, activity has almost ground to a halt.

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

Partly due to the dearth of new sales, the average yield on emerging-market sovereign debt has eased recently to 8.26% as of Friday, after hitting a nine-month high of 8.43% when China’s economic troubles sparked a selloff.

“Less supply would be positive from a technical standpoint, especially if the issuers are going to the loan market,” said Uday Patnaik, London-based head of emerging-market fixed income at Legal & General Investment Management. “The problem would be if the issuer could not find alternative funding sources.”

Conservation Capital

One area for which capital is more readily available is environmental protection. Gabon, where nine-tenths of the landmass is covered by trees, completed a $500 million debt-for-nature deal this month to help refinance a portion of its debt and raise funds for marine conservation. 

Though there were hiccups to complete the sale — the issue got delayed and had to be priced at a higher-than-anticipated yield — it’s the latest in a string of transactions showing that committing to conservation goals can help governments overcome borrowing challenges. Belize, Barbados and Ecuador have struck similar deals, and Mozambique is in talks with Belgium for one.

Read More: Social Bonds Make a Comeback with Global Sales at Two-Year High

“Sovereigns should consider them,” said Carlos De Sousa, an emerging-markets money manager at Vontobel Asset Management AG in Zurich. “It saves money to the sovereign, deploys money for nature conservancy, increases the supply of green and blue bonds, and boosts bond prices of the sovereign in question. Everyone wins, basically.”

But nature-linked deals are complex and require lengthy preparation by issuers. Borrowers who need funds more quickly are going for loan syndications, where multiple lenders contribute. In Africa alone, there were 225 such loans worth $32 billion extended to governments and businesses over the past year.

“Market conditions will remain challenging, especially for the most vulnerable frontier economies,” said Bartosz Sawicki, a market analyst at Polish financial technology company Conotoxia. “Consequently, the rise in popularity of syndicated loans, which spread the risk of default between parties, will probably prevail.”

Local Bonds

But if reducing reliance on dollar-bond sales is the goal, nothing beats developing an active local market. Countries around the world are now looking to attract more foreign investors to their local bonds. 

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

Read more: Wall Street Sees Blueprint in Suriname’s Oil-Linked Debt Swap

New Development Bank, the multilateral lender founded by the BRICS nations, 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 to Watch

  • China reduced a levy on stock trades to 0.1% to 0.05%, alongside other measures, triggering a brief surge in mainland shares that quickly fizzled
  • Turkey and India will release 2Q GDP data. Bloomberg Intelligence expect Turkey’s data to show that economic activity slowed down slightly, even as it was supported by elections-related spending
  • Poland will report its inflation data for August. Consensus is for CPI to show that prices continued to decline for a second consecutive month. Sri Lanka’s is also expected to fall amid declining food prices
  • China’s Caixin manufacturing PMI will likely signal a steeper retrenchment in August, as persistent weakness in demand at home and from abroad takes a toll
  • Hungary’s central bank will make a decision on interest rates
  • Both Ghana and Hungary will be up for sovereign rating reviews by Moody’s

–With assistance from Carolina Wilson.

(Adds China measures in What to Watch section.)

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