Emu will have major repercussions for the emerging economies of
central and eastern Europe - in terms of economic management
policies, and in the way that issuers fund themselves.
Already five states from the region have been nominated for fast
track EU membership as part of the EU's enlargement drive, with
others likely to follow.
And the creation of a vast single currency funding market, and pool
of investment capital, to their immediate west is causing issuers
from the region increasingly to focus their attention on raising
capital in Europe.
Public sector issuers should become increasingly regular issuers in
euros; the development of a more sophisticated credit market in
Europe should bring better funding opportunities for private sector
issuers; and Eurobond issuance in eastern European currencies
should continue to rise.
Although the advent of European economic and monetary union (Emu) in January 1999 has had the most direct impact on those 11 European Union (EU) member states forming the first wave of entrants into Emu, their central and eastern European peers will be affected almost as much by the introduction of the euro.
While governments in Denmark, Sweden and the UK continue to wrestle with the politically thorny issue of Emu membership, the authorities in central and eastern Europe are keen to participate as soon as possible.
In particular the five states from the region nominated for fast track membership of the European Union - the Czech Republic, Estonia, Hungary, Poland and Slovenia - are all feverishly working towards achieving the macroeconomic ratios which will enable their entry into Emu as well.
The desire to be part of the euro bloc is demonstrated by those countries' economic management policies - all of which are oriented towards achieving Maastricht-type criteria. But it is also demonstrated by the growing trend of Eurobond issuance from the region, which reflects the creation of the future single European currency and the consolidated European bond market it will entail.
This trend involves not simply the launch of euro denominated bond transactions, but also issuance in euro and non-euro bloc currencies designed to target specific investor groups which will play an important role in the post-Emu marketplace.
As regards funding activity in the future single European currency itself, the seriousness with which governments in central and eastern Europe have long regarded the entire Emu project can be gauged by the fact that as early as August 1989, Hungary - one of the region's most politically and economically progressive countries - opted to raise funds in the euro's predecessor currency, the Ecu.
Showing EU credentials
The National Bank of Hungary's Kredietbank-led Ecu50m seven year issue may have been modestly sized at the equivalent of just $79.5m but it nevertheless signalled the country's intent to re-establish itself at the heart of Europe's bond markets.
A Ecu200m five year issue via Credit Suisse First Boston in September 1991 helped to reinforce this desire and to cement Hungary's reputation as one of central and eastern Europe's leading transition economies.
Following Hungary's accession to OECD membership in 1996 and its future membership of Nato and both the European Union and Emu, the country's Baa2/BBB-/BBB- rated credit story is likely to be well received by investors when it opts to tap the euro.
In the recent past, however, the country has sought to consolidate its investment profile in the world's current leading funding currencies - the Deutschmark, the Japanese yen and the US dollar - to ensure a well balanced debt burden among a diversified group of investors around the world.
While the Hungarian authorities intend to set a sovereign benchmark in euros, they have cautioned that they will only do so if they are able to raise funds at a level that accurately reflects Hungary's improving creditworthiness. In May Moody's raised its sovereign rating for Hungary to Baa2 from Baa3.
The advantages of an investment grade credit story when tapping the euro sector were amply demonstrated in mid-May when A3/A/A- rated Slovenia - central and eastern Europe's top rated sovereign - was able to raise Eu500m of seven year money via JP Morgan and Paribas at just 57bp over Ecu OATs.
That compared favourably with the country's outstanding Eurobonds - comprising a $325m 7% August 2001 issue from July 1996, which was trading at a spread of 67bp over US Treasuries, and a DM400m 5.75% June 2004 offering from May 1997 quoted at 65bp over Bunds.
Overwhelming investor demand from across Europe for scarce Slovenian risk enabled the borrower to enjoy a blowout success on its first outing in the currency and resulted in the issue being upped to Eu500m from Eu400m at launch.
By issuing at a time of a flight to quality in the emerging market debt sector and shortly after the EU summit which fixed the entry levels for the 11 first wave member currencies going into Emu, the Slovenian authorities were able to leverage off the country's single-A ratings and the increased investor focus on the euro.
Beyond the economic rationale of the debut transaction, Slovenia was also able to make a political statement about its commitment to achieving EU membership and eventual entry to Emu.
While EU and Emu membership as well as investment grade ratings status may still be distant ambitions for Ukraine, they did not prevent the B2 rated sovereign from becoming the first central and eastern European issuer to raise funds in euros. Furthermore, at an issue size of Eu500m, the landmark two year offering emerged in March for far more than the Eu200m-Eu400m envisaged by the cash-strapped Ukrainians.
Led by SBC Warburg Dillon Read, the deal benefited from the growing investor demand for name and credit diversification as well as high yield returns in euros.
Featuring a 14.75% coupon the transaction was priced to yield 15.06% or a margin of 1,084bp over Ecu OATs on a issue/fixed re-offer price of 99.50.
That represented the highest ever coupon and launch spread in the fast growing single European currency bond sector and was well above the levels at which other emerging market sovereigns had previously launched euro issues - Ba3/BB/BB rated Argentina (Eu400m 8.75% five years, 359bp launch spread), B1/BB-/B+ rated Brazil (Eu500m 8.625% five years, 390bp launch spread) and Ba2/BB/BB rated Mexico (Ecu400m 7.625% seven years, 230bp launch spread).
Ukraine's DM750m (since upped to DM1bn) three year issue from February had provided something of a pricing precedent however, featuring a headline-grabbing 16% coupon to yield 16.2% - 1,200bp over Bunds.
That issue proved a runaway success with European investors and had traded up by almost five points by the time the euro issue was launched.
While providing an encouraging backdrop for the euro issue, the stellar performance of the Deutschmark transaction built up expectations that the euro deal would perform equally well at launch; when it failed to do so, a number of investors quickly dumped their paper.
Nevertheless, with some 70% of the leads' primary market placement to institutional accounts - generally held to be a much higher proportion than the country's Deutschmark issue - Ukraine's foray into euros has established a following among fund managers which should stand the country in good stead for a planned Eurodollar offering later this year.
The issue also proved that even lowly rated credits from central and eastern Europe will be able to raise a substantial amount of funds in euros provided they are willing - and able - to pay up for such market access.
New borrowers line up
With the euro denominated issuance from central and European to date having spanned the two extremes of the ratings spectrum in the region, the scene is now set for a number of other sovereign issuers to follow in the wake of Ukraine and Slovenia.
Kazakhstan has chosen JP Morgan to run the books on the country's debut euro denominated bond offering, with the Ba3/BB-/BB rated sovereign looking for the equivalent of $300m-$500m over a five to seven year tenor. The country also considered dollar and Deutschmark issues before electing to launch a euro deal
Meanwhile, the Republic of Lithuania has mandated Credit Suisse First Boston and Dresdner Kleinwort Benson to lead manage the first euro issue from the Baltic states.
The Ba1/BBB-/BB+ rated issuer originally asked banks to bid on a DM300m five year to seven year offering, but has now opted for a Eu200m transaction instead - which is due to be launched in towards the end of June.
Ruta Skyriene, deputy director of the international department of the Lithuanian finance ministry, explains: "Last year we launched our first benchmark dollar issue, which reflected the fact that at present our currency [the litas] is pegged to the dollar. From the beginning of 1999 onwards the central bank proposes to peg the currency to the euro or a euro/dollar basket and so it makes sense for us to look at a benchmark euro issue."
Although Lithuania's decision to issue in euros provides further proof of the growing trend towards euro issuance generally, it is also viewed as a political statement by the Lithuanian authorities who are keen to press their claim to be part of the group of fast track central and eastern European EU entrants - which includes Lithuania's Baltic peer Estonia.
Given its substantial funding requirements, the Ba3/BB-/BB+ rated Russian Federation is also seen as natural candidate to bring a euro issue later this year to establish its profile in what is expected to become a major funding currency around the globe.
Already this year the Russian Federation has tapped the Eurolira market in a move widely seen as reflecting the ramifications of the approach of Emu.
With interest rates in Italy having fallen dramatically as the part of the country's preparations for Emu, Italian investors have been forced to diversify the name and credit composition of their portfolios to maintain income levels.
Russia's Lit750bn (increased from Lit500bn) five year issue via Credito Italiano and JP Morgan in April with its 9% coupon and 435bp launch spread offered the sort of returns that Italian investors have traditionally been able to enjoy in the domestic fixed income market.
From the Russians' perspective, the Eurolira issue offered them the chance to raise money at a lower cost of funds from an Italian investor base increasingly bullish on emerging market issuance at a time when dollar-based investors were becoming more and more bearish about emerging market credits - and demanding a higher price for their participation.
Furthermore, with Italian retail and institutional accounts among the keenest to buy euro denominated product, the Eurolira offering gave the Russian Federation the opportunity to establish name recognition with a specific group of investors likely to buy the name in euros.
The same rationale was the driving force behind Baa3/BBB-/ BBB- rated Republic of Croatia's decision to launch a Pta15bn 6.5% three year issue via Banco Santander - the first Matador bond by a central and eastern European issuer since December 1993.
And in April 1997 Croatian development bank HBOR was able to take advantage of the de facto lack of foreign exchange risk between the Deutschmark and the Austrian schilling resulting from Emu convergence to launch a Asch700m 5.625% five year issue via Creditanstalt, which was able to target investors across the DM bloc.
While the emergence of the euro will eclipse the Deutschmark and the Japanese yen as major global funding currencies, the dollar is nevertheless set to remain the funding currency of choice for Euromarket debutantes from central and eastern Europe.
Inaugural Eurobonds by Bulgaria, Kyrgyzstan and Uzbekistan are all set to be issued in dollars, reflecting both the continued importance of the US currency within most countries' external debt burdens and - for the time being at least - the larger pool of dollar-based investors willing to buy emerging market product.
Local market stimulus
US bankers maintain that it will be some time before the emerging market segment of the dollar denominated high yield bond sector in the US is eclipsed by its fledgling euro denominated counterpart in Europe.
Says one New York-based high yield specialist: "The more credit intensive and opportunistic nature of the US bond markets versus the more leverage and margin-driven Euromarkets makes for a more favourable issuance environment for specific industry sectors like energy and telecommunications."
At the height of the Asia-inspired emerging market sell-off in the fourth quarter of 1997, Kazakhstan-based oil and gas concern Hurricane Hydrocarbons and Polish telecom companies Netia Holdings and Poland Telecom Operators were able to raise funds in the US - at a time when it was impossible even for central and eastern European sovereigns to tap the Euromarkets.
Beyond the credit spread markets, Emu is also influencing the pattern of issuance in central and eastern European currencies.
The promise of economic convergence ahead of EU - and Emu membership for fast track candidates such as the Czech Republic and Poland - is one driving force behind rising issuance volume, and increased investor interest, in Eurobonds denominated in Czech koruna and Polish zloty.
Meanwhile the growing on-lending requirement for funds in the region's currencies has led the EIB to establish a domestic Hungarian forint MTN programme, with similar facilities in Czech koruna and Polish zlotys in preparation.
Growing trade links between East and West have also prompted Sweden's export credit agency SEK and Finland's Merita Bank and Postipankki to target international and Baltic investors with Estonian kroon, Latvian lats and Lithuanian litas issues.