Recent developments in Argentina and Turkey and the Sept. 11 attacks on the US have put emerging bond markets under pressure. Several Eurobond issues in the pipeline are being postponed and capital flows to the emerging markets are forecast to drop. Emerging countries in Asia and Latin America who have strong linkages with the US through trade and capital flows will be affected most by the slowdown of the American economy. The emerging European bond markets have also been adversely affected by the negative developments in Turkey, while those of Brazil and other Latin American countries could be in serious trouble if Argentina collapses. European banks have an exposure of over $40 billion to Argentina and American banks have around $10 billion.
Countries which are expected to weather the storm with relatively little damage are those with less developed financial markets and with limited exposure to the US. The credit worthy sovereign Arab Eurobonds are likely to see stronger demand next year, as investors become more keen to differentiate between more and less credit worthy borrowers. Investors in these bonds could be rewarded with capital gains on top of the higher coupon that these bonds pay.
The possibility that Argentina will soon default on its $132 billion sovereign debt will greatly affect confidence in the emerging debt market and could further widen the spread between yields on outstanding Eurobonds issued by developing countries and those of the US treasuries. While Standard & Poor’s downgraded Argentina’s debt from CC to selective default, Fitch has already declared Argentina to be in default. The proposed debt swap whereby newly issued bonds with substantially lower interest rates of 7 percent will replace existing bonds with rates ranging between 11 percent and 24 percent is seen in the market place as a default dressed up as a restructuring.
Spreads on Arab sovereign bonds widened markedly in the wake of the attack in the US on Sept. 11. For example spreads on Egyptian bonds rose by almost 1.5 percent to trade at about 500 b.p. over treasuries. Higher spreads were also seen for Qatar, Oman and Morocco’s sovereign bonds. Yields have edged lower since then, but rates on virtually all emerging market debt are still higher today (prices are lower) than they were in June this year.
Bond issuance by emerging market borrowers amounted to $42.5 billion in the first nine months this year, somewhat lower than the $54 billion issued in the corresponding period of last year. However, bond issuance recovered from the exceptionally weak levels seen at the end of last year, when there was only $6 billion of issuance in the fourth quarter. Debt exchanges, undertaken as part of Mexico and Argentina’s liability management programs, have boosted issuance this year. Excluding these swaps, bond issuance in the first nine months of this year would have been $36.2 billion, compared with a similarly adjusted $46.1 billion in the corresponding period last year, a decline of 21 percent.
Only six Arab governments have so far resorted to borrowing in the international bond market and the total amount of issues outstanding is close to $11 billion, with Lebanon accounting for around half of that. Besides Lebanon, Tunisia has been a regular issuer in the international bond market and has been the only Arab country to issue bonds denominated in yen in the Samurai bond market. So far this year, only Lebanon and Egypt tapped the Eurobond market with issues exceeding $4.3 billion, and Morocco is expected to come to the market early next year.
The Lebanese government has issued $2.17 billion worth of international sovereign Arab Eurobonds this year, including a $1,150 million bond in April and a $750 million bond in August largely taken up by domestic banks, who also participated in a 300 million euros reopening in October. These bonds were issued at the relatively low spread over US Treasuries, despite growing concerns about the sustainability of the country’s fiscal position. Egypt made its first Eurobond issue in the international market on June 29 this year. The issue raised a total $1,500 million, in two tranches, and was three times higher than was initially planned.
The larger portion was a $1,000 million facility with a maturity of 10 years, priced at 335 basis points over US treasuries. The coupon is 8 percent. The other tranche was for $500 million over five years, priced at 275 bp and carrying a coupon of 7 5/8 percent.
The currency composition of bond issuance this year has been similar to that of last year. About 51 percent of issuance (excluding exchanges) has been denominated in dollars compared with 56 percent in 2000.
Correspondingly, there has been a modest increase in bond issuance denominated in euros (to 14 percent, up slightly from 12 percent in 2000). This reflects in part slightly greater appetite for bonds issued in the European.
Market conditions, have become extremely difficult in the past few months and there have been episodes of intense concern, particularly related to prospects for Argentina. The recent events, which have significantly increased risk aversion, have resulted in a period where there have been little or no bond issuance. At least two bond issues from the Arab region that had been queuing up to come to market were put on hold for the time being, Morocco’s 400 million-500 million euros ($367 million-$458 million) sovereign issue and the debut corporate Eurobond to be issued out of the GCC by the National Bank of Kuwait of $300 million.
Bond issuance from the Arab region will undoubtedly resume next year. With interest rates falling in the US and Europe, managers of bond portfolios and mutual funds will be looking for higher yields, mainly in the emerging bond markets. Bonds issued by credit worthy sovereign Arab borrowers, such as Egypt, Qatar, Tunisia, Oman, and Morocco will be in demand. Investors in these bonds will be rewarded with higher prices (capital gain), on top of the high interest coupon that these bonds pay. Existing Eurobonds issues from the Arab region (with the exception of Lebanon) are considered to be an asset class that merits an added exposure next year.
