A few short weeks ago, emerging market assets were being written off once again as the inevitable – and most severe – casualties of financial contagion, doomed by their inherent volatility to replay their historical roles.
But with hopes that the world economy is finally bottoming out, and amid signs of improvement from Asia, investors are pouring back into the asset class, which has gained momentum by news that US banks will need less extra capital than feared. Decoupling may be getting a second wind.
Growing appetite for high-yield assets saw emerging markets bond funds post their third successive weekly inflow last week, according to EPFR Global data.
Emerging sovereign debt spreads have rallied in recent weeks to trade at around 530 basis points over US Treasuries (down from 880 peaks in October), providing a more encouraging environment for those emerging economies to venture back to international capital markets after months of being shut out.
The more favourable credit conditions are particularly crucial for eastern and central Europe. According to the IMF, the region faces some $701 billion euros in debt rollover this year – three times more relative to its size than Asia and Latin America.
And emerging European sovereign borrowers are returning to world markets as global sentiment begins to pick up. Investors’ concerns over the region’s economic stability have been eased by increased IMF and EU funding in recent months.
But the region most exposed to the global credit crisis will have to pay up for new debt to keep luring lenders. Yields on emerging European debt remain high as massive state borrowing programmes of rich countries test investors’ ability to absorb lower-rated new debt.
Moreover, emerging markets in eastern and central Europe face tough competition from other sovereigns in both the emerging and developed market universe in 2009, given sharply increased borrowing by governments across the world. “It is a fact that the borrowing requirements for almost all sovereigns have increased substantially as a result of expansionary fiscal policies, low fiscal revenues and government guarantees for banking sectors,” says Memduh Aslan Akcay, director-general at the department of the Treasury in Ankara.
“The expected increase in investment grade sovereign supply will inevitably affect debt markets globally, and there will be a substantial increase in the competition for funds among all issuers.”
Nevertheless, Turkey became the latest from the region to launch a global bond, following the Czech Republic’s sale of a 1.5 billion-Eurobond earlier this week.
Slovakia has picked its arrangers for a euro-denominated benchmark bond while Poland is gearing up for an early June roadshow to sell a dollar issue. And Croatia too is looking for capital markets funding.
Russian return
Meanwhile Russia has said it plans to return to international capital markets next year, after nearly a decade, for a Eurobond of up to $5 billion. In recent months Russia has seen a flurry of new issue activity in a troika of different market segments suddenly resumed, after a long pause in issuance.
Gas export monopoly Gazprom reopened the international bond markets for Russian issuers when it launched a $2.25 billion offering via Credit Suisse. Not only was the issue the first by a Russian borrower in the public Eurobond markets since July 2008, it was also the biggest ever corporate debt offering from Russia.
The EBRD meanwhile issued a Rb5 billion floating rate note – its first domestic issuance in the Russian currency since 2006 – underscoring the bank’s commitment to helping to nurture the domestic capital market in Russia.
Finally, Gazprom’s oil subsidiary Gazprom Neft launched a Rb10 billion issue, which co-lead managers Renaissance Capital and Gazprombank claim was the first true market placement by a corporate issuer in the Russian primary debt market since 2008.
All three issues attracted larger-than-expected demand, illustrating the fact that despite widespread pessimism about the economic prospects for central and eastern Europe, there is still significant investor appetite for both credit and currency risk from the region.
Alexander Sklemin, corporate bond analyst at RZB in Vienna, says that Gazprom’s shows that the market attitude towards Russian issuers has “improved to some extent” as it shows “‘family silver’quasi-sovereign names can attract cross-border financing even in times of closed – or very tough – limits on Russian risk.”
He adds: “If market sentiment remains positive for some time, we will probably see some Eurobond issues coming from companies such as Rosneft, Russian Railways or Transneft.”
Meanwhile, the EBRD’s rouble bond illustrates the importance of international financial institutions (IFIs) in promoting the development of local currency markets throughout central and eastern Europe amid the global credit crunch.
In May 2005 the EBRD became the first IFI to issue rouble bonds in the domestic capital market and was also instrumental in helping to develop MosPrime, the Russian money market reference rate to which the issue was linked.
Domestic currency lending is a key priority of the EBRD, especially to borrowers whose revenues are in roubles. “The importance of being able to borrow in local currency and avoid foreign currency risk has become self-evident at a time when many currencies in the EBRD region have depreciated during the financial crisis,” says EBRD vice-president Manfred Schepers.
Under a managed devaluation the rouble weakened by more than 25% against the dollar over the course of the first quarter, increasing the borrowing costs for many Russian borrowers.
Gazprom Neft’s ability to raise double its targeted amount of Rb5 billion with its domestic bond issue was also greeted as proof that well-connected borrowers are able to tap local investors for much-needed cash. As Neil Smith, managing director at Florin Capital Management says: “Right now there’s a bifurcated credit market in Russia – split between those companies that enjoy government support and those that don’t.”
Sovereign paper
The bulk of Eurobond issuance from the region this year is likely to be restricted to sovereign issuance.
At the end of April the Czech Republic proved that there is still substantial appetite for strongly rated risk, when the single-A rated country raised €1.5 billion with a 2014 dated bond, which attracted over €2 billion-worth of orders, leading to an increase from the initially planned E1 billion issue size. “The success of this bond issue is a testimony to our country’s strong credit fundamentals, and we were encouraged that the international investor community recognized these achievements,” says Eduard Janota, Czech deputy finance minister.
Meanwhile, neighbouring Slovakia is looking to test investor sentiment with a €1 billion issue that will be its first international bond since it joined the eurozone this year. Also looking to come to market is EU hopeful Croatia, which is looking to raise at least €500 million. Among other sovereigns that have been regular issuers in the past, the likes of Hungary, Latvia, Romania and Ukraine are unlikely to tap international markets following emergency bailouts by the IMF.
But issuance prospects for corporates across the region are decidedly bleaker, especially in the hard-hit financial sector. In Kazakhstan, for example, where two of the leading banks – Alliance and BTA – recently announced debt restructurings, the ability to raise new money has been severely curtailed.
“I don’t see anyone except our shareholder and the IFIs lending us money right now,” admits Alexander Picker, chief executive of ATF Bank, owned by Italian banking giant UniCredit.
He adds that the bank is hoping to raise funds from both the International Finance Corporation and the EBRD. Backing from IFIs such as the EBRD is likely to prove a key factor in some institutions’ survival. In April, the EBRD took a 25% plus one share stake in Latvia’s Parex Bank, which had been rescued by the Latvian government in December after a run on its deposit base.
Meanwhile, the European Investment Bank (EIB) signalled its support for Croatia when it granted export agency HBOR a €250 million loan to support small and medium-sized enterprises hit by the global credit crunch. The loan was the largest ever provided by the EIB in Croatia.
“The EIB is one of the rare international financial institutions that provide favourable funding in these extremely difficult market conditions,” says Anton Kovacev, HBOR’s president.
Turkey
Turkey is the only other country in emerging Europe that is likely to be a major source of bond issuance in the near future, as authorities in Ankara are looking to exploit the fact that the country’s banking sector remains relatively well capitalized to achieve challenging funding targets in both the domestic and overseas markets.
On the international bond market front the Turkish Treasury’s Akcay says Turkey is looking to raise at least $3 billion – expected to be the biggest amount required by any sovereign in the emerging Europe region this year.
In 2008 Turkey had an indicated overseas funding target of $5.5 billion, but the market turmoil caused by the fallout from the global credit crunch and associated economic slowdown meant that it was only able to raise $4 billion. Akcay says that, as in the past, the bulk of overseas issuance will be sourced in the dollar and euro-denominated bond markets, but does not discount the possibility of tapping other currencies, market conditions permitting.
“The US dollar and the euro will remain as the core markets for us in the future,” says Akcay, but adds: “On the other hand, we are ready to tap new currencies if and when we believe the conditions are appropriate for a transaction.”
With regard to criticism from some market participants about the country’s reliance on the backstop bid from local banks and institutional investors for its recent Eurobond issuance, Akcay says that the strong level of domestic support enjoyed by the sovereign should be viewed as a positive rather than a negative factor.
“We believe this creates a positive momentum for our bonds in both the primary and secondary markets. Given the current market backdrop, it should be seen as strength rather than a weakness to have ongoing interest from local investors. Under current market conditions, almost all issuers are relying more and more on the local investor bid in their recent transactions.”
As well as a testing overseas funding target, the Treasury is also looking to raise a hefty TL105.1 billion domestically. A series of larger-than-expected rate cuts by the Central Bank of Turkey has encouraged Turkish banks and funds to lock in the relatively high yields available and have given strong momentum behind the country’s domestic issuance, which Akcay sees as another key positive.
Akcay says that although there is little short-term prospect of a ratings upgrade in 2009 the positive momentum behind Turkey’s credit story means it will not be squeezed out of the international bond markets by other sovereign borrowers. “We expect that rating agencies globally will maintain a negative bias on all credits for the rest of the year because of the criticism of their role in the current crisis. However, in the short term, we expect to see positive revisions to the rating outlook of Turkey.”
While the funding outlook for the sovereign looks relatively rosy, the prospects for Turkish corporates remain altogether more challenging. With companies’ access to international capital severely curtailed by the global credit crunch, Turkish regulators have eased issuance criteria in an attempt to breath some life into the country’s moribund corporate bond market.
Ozlem Meric Erten, head of fixed income trading at UBS, notes: “A Turkish corporate bond market would find it very hard to compete with the Turkish government bond market.”