Newsroom: Article

Emerging Market De(bt)velopments

In May 2007, the financial credit crisis erupted as a local problem in the US mortgage market that, it was assumed, would go away soon enough. But it has since grown to become the most serious financial crisis since the 1930s – the era of the Great Depression. The crisis has spread from an infection of the US mortgage banks to banks and insurers globally, encompassing not just securitised US sub-prime mortgages, but also the credit default swaps (CDSs) and associated financial instruments used to insure lending. The economies of the US and Europe are now under pressure, with ominous signs emerging elsewhere.

As the crisis seems to be lasting longer, spreading further and going more deeply than first imagined, it is starting to affect even the strongest markets and the fears of a global recession are rising. Emerging markets will not be spared. On the contrary, some emerging markets could be hit much harder than the developed markets. In this article, we will discuss the main factors triggered by the global credit crisis, increasing the risk of sovereign defaults in emerging markets.

The potential impact of the financial credit crisis on the economies of the emerging markets will mainly be in the following fields:

(1) Refinancing of maturing debt;
(2) Cost of financing;
(3) Obtaining financing; and,
(4) Reduced income from commodities.

Re-financing of maturing debt 
Dutch bank ING has calculated that $111bn of emerging market bonds must be refinanced during the next year. The bulk of the emerging debt due – about $60bn – is from banks and financial groups. To re-finance these bonds, fresh capital is required, but the credit crisis has lowered the availability of capital substantially. Emerging markets’ banks and companies are generally rated as higher-risk lenders, limiting their access to capital even further. Banks in Russia and Kazakhstan in particular, which accumulated a lot of credit prior to the credit crisis, are expected to default by a large amount.

Generally, it is expected that defaults in emerging markets will be limited to banks and companies. However, we do expect certain sovereign entities in emerging markets to encounter problems with re-financing of their debts, potentially defaulting on their payment obligations. These sovereign entities entail those countries that have large current account (trade) deficits and which rely on international investment to balance the books. South Africa, the Balkans, the Baltics, Central and Eastern Europe and Turkey are among those countries with a high current-account deficit.

Cost of financing
Until the eruption of the credit crisis, investment banking and other financing activities experienced dramatic growth. In 2005, investment-banking revenue from emerging markets accounted for almost $40bn, which is about 16% of the global investment-banking revenue. In 2007, this increased to about $80bn, at that moment a share of about 21% of total revenue. During the credit bubble, the emerging markets were benefiting from a reduced risk perception, which increased the availability of capital and significantly reduced the cost of capital.

Since the start of the credit crisis, however, the emerging markets have been hard hit, with the yields on the Emerging Markets Bond Index Plus (EMBI+) sovereign bond index up 20% against US Treasury securities during the month of September 2008. The EMBI+ index measures both Brady bonds and other sovereign debt. The ‘flight from risk’ across all markets has hit emerging markets – perceived as higher risk again – by increasing the cost of financing for both the sovereign and the non-sovereign lenders in emerging markets. The yield requirements have moved up significantly, which is reflected in the much lower prices of bonds, promissory notes, loans and other trade debt instruments as shown in Omni Bridgeway’s Emerging Market Debt Pricing figures.

Obtaining financing 
Emerging market bond issuance has fallen steadily this year. Only $330m in bonds has been issued in September, compared with $10bn as recently as July. In August last year, issuance averaged about $20bn a month, according to ING. In the first two weeks of October, emerging market equity and bond funds suffered around $6.5bn in outflows, which is close to a record sum, according to EPFR Global. This has continued a trend since 1 June 2008, when inflation fears put pressure on emerging markets. Outflows since then have risen to $35bn, a record for a 16-week period.

Several countries have decided to postpone the planned issuance of sovereign bonds due to the expected lack of interest. South Korea has decided to postpone the issuance of a sovereign bond of around $1bn - its first sovereign debt sale in two years - and the Republic of Ghana (rated B+/B+) pulled its planned $300m issue. Meanwhile, Nigeria still plans to issue a $500m, 10-year sovereign bond, but the final issue date has not yet been confirmed.

These postponements of bond issues seem to directly result from a market that has become highly averse to risk. The amount of available capital globally has decreased significantly, the effect of which is magnified for emerging markets.

Reduced income from commodities
Commodity prices have fallen in recent months amid expectations that a wider downturn in the global economy will dent demand. If the downturn in the economy lasts much longer, then commodity prices will move down even further. This will increase the reliance on external financing of some emerging markets, which are heavily dependent on income from the export of commodities.

We can conclude that we have entered a difficult era again for most emerging markets. The most vulnerable countries are the emerging markets with a large amount of maturing debt, a high current-account deficit and a large dependency on export of commodities. Kazakhstan, Turkey, Ivory Coast and Ghana are chief among these countries, although it should be noted that Turkey is less dependent on the export of commodities.

Pakistan – sovereign debt downgraded to CCC+ by Standard & Poors
In the midst of the aforementioned financial crisis, many countries’ finances have become a cause for concern. But fears about Pakistan’s current-account deficit, in particular, are mounting. In mid-October, Standard & Poors downgraded Pakistan’s sovereign debt to CCC+, just above default level. Last week, Moody’s lowered the rating of four of Pakistan’s banks following substantial erosion in the country's external liquidity position. All four banks’ foreign currency deposit ratings remain constrained by this country ceiling.

The security issues and political tensions are also contributing to an overall rise of sovereign risk of Pakistan.

Holders of sovereign trade debt are invited to contact us for advice on any questions relating to (potential) defaults or the possibility of trading out of risk positions.

A.R. Thiescheffer on thiescheffer@omnibridgeway.com
H. Rijkens on rijkens@omnibridgeway.com

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