Developing economies began a new era in public financial
management at the turn of the century. Battered by currency
mismatches and debt crises, sovereigns shunned external bond
issuance for domestic capital markets in an era of restrained
The global economic boom helped too. In Asia, thriving exports
endowed many governments with fiscal surpluses and domestic
capital markets provided any necessary government financing.
This left Indonesia and the Philippines as the only players in
global bond markets from the region.
In Latin America, Brazil and Mexico relied on commodity exports
and domestic banks to finance the budget. As a result, when
Latin sovereigns launched global bonds they did so to pay for
upcoming external debt maturities and to provide benchmarks for
domestic companies. Meanwhile, tight EU rules on public
spending capped external bond issuance by aspiring eurozone
So the global bull run was accompanied by a revolution in the
emerging market debt universe driven by waning external
sovereign bond supply and a jump in local currency debt.
Locally-issued sovereign debt outstanding across emerging
markets increased from $1.43tr in 2002 to $4.47tr in 2008,
according to Bank of America Merrill Lynch. This growth
contrasts with stagnation in the stock of external sovereign
bonds in a range of $400bn-$500bn over the same period.
Then came the storm. Over the past two years, emerging markets
have experienced the biggest upheaval since the Asia crisis in
the late 1990s. Collapsing trade, plunging domestic consumption
and vanishing revenues infected economies across the globe. But
then came the flood. Governments bolstered public coffers by
raising capital from multilateral development banks, the IMF,
aid donors and crucially the market.
According to BofA Merrill, sovereign bond issuance in global
markets in 2009 will be around $77bn double that of the
previous year. And this large-scale borrowing is on the cards
for the next two years at least. The bank forecasts new
external bond issuance in 2010 of $93bn, a 21% jump from
A big part of this year-on-year increase is down to an
anticipated $17.8bn of Russian sovereign bonds expected to be
issued in 2010. Some $62bn of new capital raising in
international markets is expected to come next year from
triple-B or lower-rated sovereigns while single-A and double-A
countries will issue $31bn of bonds.
"The sovereign landscape has changed tremendously," says
Jonathan Brown, head of emerging markets and European credit
syndicate at Barclays Capital in London. "For the two to three
years prior to the crisis, many sovereigns concentrated on
pre-financing their debt, redeeming bonds, cultivating the
local market and, in many cases, were net payers of debt
but now funding needs have jumped up."
Outside the triple-B bracket, sovereign issuance has been
dominated by high-grade but revenue-starved eastern European
economies. Poland, Slovenia, Slovakia, Czech Republic and
Lithuania all single-A rated or higher have
issued a total $18bn this year.
Turkey stays on track
As emerging market issuers seek to make a splash in global
markets, opportunism and flexibility are key.
Turkey, for example, has launched bonds this year with
well-timed and quickly executed deals. "Although there is a
significant improvement in the market conditions since the
beginning of the year, we still believe that the windows of
opportunities are likely to appear at short notice and are
likely to be short lived going forward," says Memduh Aslan
Akcay, director general of foreign economic relations at the
Turkish treasury. "We believe that flexibility and quick
decision making would be the key elements of success in this
Turkey in recent years has been one of the largest sovereign
issuers in EMEA. It issued $3.75bn of new paper in 2009 and in
the coming years will raise an annual $4bn-$5bn in
international markets. Turkey has grabbed cash quickly in the
face of the downturn thanks to its well-developed yield curve
that provides clear and liquid pricing points for
Domestic investors made up around 70% of the books for
Turkeys dollar bonds in 2008. Some observers criticised
those deals for failing to penetrate the foreign investor base
but the bonds outperformed the CEE region as well as
many Latin American sovereign peers in the grip of the crisis
during the fourth quarter of 2008. This was due to the
buy-and-hold nature of many of Turkeys domestic
That is in contrast with sovereigns with greater foreign
exposure which suffered price volatility in the
flight-to-quality sell-off after the collapse of Lehman
Brothers. This episode may have tempered the enthusiasm of
issuers to diversify their investor base, said analysts at the
But Akcay says Turkey is not in that position. "Although we
dont have a certain ratio for the distribution of bonds
to domestic and international investors, it is certain that we
are trying to maximize the non-resident allocation to the
Brown at BarCap says that the borrower is in good position. "If
they dont get the demand they want from foreign investors
then they can sell external bonds to locals."
Turkey recognises the merits of global distribution of debt,
says Akcay. "We dont see the domestic market completely
replacing the international market and we will continue
pursuing the goal of increasing the appetite of foreign
investors to Turkish assets."
A brave new world
As sovereign borrowing needs jump, issuers have
plunged into diverse markets with new benchmarks. Take the case
of Poland. In July, central and eastern Europes largest
economy (A2/A-/A) launched its first dollar benchmark in four
years with a $2bn 10 year bond at a spread of 290bp over US
Treasuries. As the public finances sank deeper into the red, it
subsequently re-tapped the dollar benchmark for another $1.5bn.
Benchmark issuance in a 10 year tenor is the sweet spot for
investors in the liquid US market, while euro denominated
credit is usually in five year format. This boosted the appeal
of issuing the dollar benchmark, says Anna Suszynska, deputy
head of the public debt department at the Polish ministry of
"The five year maturities in our yield curve were getting quite
crowded, and we wanted to issue in dollars for diversification
purposes," she says. "The pricing in US markets was not as good
as the euro markets in recent years but this has
Nevertheless, despite the competitive pricing for the Poland
dollar deal relative to euro issuance, all-in funding costs
have leapt up. In 2005, Poland issued its 10 year, $1bn
benchmark at a spread of 59.8bp.
Poland also returned to the Samurai market after an absence of
two years to price a ¥44.8bn ($495m) dual tranche
transaction in November. Suszynska says Poland is issuing in
diverse, global markets to ensure domestic borrowers were not
crowded out by the large supply of zloty government
Poland doesnt always swap foreign currency bonds into
zloty, so its reference level for new issues remains the 10
year government zloty paper that typically yields 6%-7%, says
In the years preceding the crisis, central and eastern European
issuers were much in demand from investors who expected
eurozone convergence to result in rapid price performance.
Partly for this reason, these countries were able to sell bonds
with low new issue premiums.
But the regional economic slump and the repricing of risk
globally transformed central and eastern European credit, in
many cases, into a mainstream emerging market product with
concomitant higher financing costs.
"We have found it quite a challenge to find euro investors for
quite a few sovereigns in the region," says Jonathan Brown,
head of emerging markets and European credit syndicate at
Amid the wreckage of euro convergence funds, Lithuania, for
instance, issued its first dollar benchmark in a decade in
October, a $1.5bn deal. "You have Greece and Italy that have
multi-billion euro funding needs, have access to deep liquidity
and benefit from narrow bid/offer spreads," says Brown. But
its a different story for central and eastern
Elsewhere in the region, countries have gone cap in hand to
bilateral and multilateral donors as well as raiding reserves
rather than relying on commercial financing. For example,
Estonia faces a 2.95% budget gap in 2010 but has deployed its
reserves accumulated before the downturn and cut spending
rather than launching bonds. These moves are aimed at ensuring
the Baltic nation does not breach the 3% deficit target to join
the eurozone. As a result, Estonia also has no plans to either
develop a local debt market or launch a Eurobond over the next
two years. "We have few market-makers and banks so there will
be no point in creating a domestic government debt market,"
says Ülle Mathiesen, head of the state treasury department
at the Estonian ministry of finance.
But this is the exception rather than the norm. The list of
emerging market sovereigns launching funding initiatives in new
currencies this year includes Indonesia, Colombia, Mexico and
the Philippines, all of which have issued in Japanese
"The global economic cycle has put tremendous pressure on
government budgets and so countries in emerging markets and the
developed world have been diversifying their funding sources,"
says Andrew Dell, head of emerging markets debt syndicate for
the CEEMEA region at HSBC.
Julian Trott, head of debt origination for CEEMEA at BofA
Merrill, predicts this trend is set to continue as global
credit markets thaw. "The premium for diversifying into other
currencies has gradually come down over the past six months,"
However, it is unclear whether diversified issuance will prove
to be a long-term phenomenon. Are borrowers broadening their
financing horizons to insure themselves in case their principal
funding market seizes up or are they just rushing to grab money
where they can? Michael Schoen, head of Latin America and
CEEMEA debt capital markets at Credit Suisse, says it is most
likely the latter. "Diversification is a cyclical phenomenon
and is a function of market conditions in any given point in
time." But Dell warns: "Diversification has to be a longer-term
process and is most appropriate for larger issuers."
The ranks of sovereign issuers is set to expand in 2010 with
the re-entrance of Russia. "The 800lb gorilla is the expected
Russian sovereign issuance for next year. They have not issued
since 1998 and their large multi-year funding needs going
forward shows just how much the market has changed with respect
to new supply," says Trott.
Russia might raise up to $17.8bn from the international markets
next year, based on an assumption of an oil price at $58 a
barrel, Alexei Kudrin, deputy prime minister and finance
minister, said recently. With this jumbo issuance, Russia would
become the largest sovereign issuer in all emerging
Such large, multi-year funding plans should set off a sea
change in debt management tactics, says Trott. "Historically
speaking in emerging markets, quite a few sovereigns have been
able to be pretty relaxed in the way they operate when compared
with SSA issuers or other sovereigns in the developed world."
And he says large sovereign issuers would benefit from having a
transparent funding strategy with clear issuance calendars,
preferred benchmarks and performance metrics for banks.
Sovereign issuers have plunged into global markets as
historically low rates and massive liquidity injections by
developed central banks have driven a rally for risk. And since
March external sovereign risk premiums have fallen to
pre-crisis levels. "Ten years ago, many emerging market
borrowers were paying double-digit coupons but now yields for
many are around 5%-7% so levels look extraordinarily
reasonable," says Dell. But will emerging market sovereigns
continue to price bonds at ever-aggressive spreads given the
large supply? Trott at BofA Merrill warns that large deal
volumes combined with front-loaded issuance in order to
pre-empt a rise in borrowing costs next year could spark
execution risks. "Sovereigns who are the third to issue, in say
a week, may get crowded out if markets are volatile."
Its the economy, stupid
Dell at HSBC says the market will comfortably absorb sovereign
paper because of the attractive risk-return metrics in many EM
economies. Changing risk perceptions have created a portfolio
shift in EMs favour, says Brown at BarCap. "Emerging
markets have largely performed well in this credit cycle and
have attracted new inflows of high-quality, real money capital.
As a result, we will see a balance between new inflows of
capital and new supply in the EM sovereign market next
But the fate of sovereign credit ultimately lies in the hands
of central bankers and finance ministers in the G7. Says Dell
at HSBC: "The volume of high-grade issuance from developed
sovereigns is going to be very significant in 2010 and that
will ultimately weigh on single-A and double-A spreads which,
logically speaking, will feed through into other assets."
However, in the longer term, debt capital markets bankers argue
the crisis has created a structural bull run for EM sovereign
credit. "You might like to say that the developed and emerging
world took one step back in the crisis but then the emerging
markets took two relative steps forward, which is one indicator
of a structural shift," says Paul Tregidgo, vice chairman of
debt capital markets at Credit Suisse.
And investors this year have bought into the hype. Markets
shrugged off Ecuadors sovereign default in 2008. Primary
markets across the globe welcomed Indonesia and Poland with
open arms despite surges in public indebtedness. Meanwhile,
some countries could snub foreign currency bonds while Brazil
is now even trying to choke off capital inflows.
Its all down to the economic fundamentals. In the late
1990s, unexpected runs on dollar liquidity spelt disaster for
southeast Asian and Latin American economies. This triggered
governments into action to reduce dollar-denominated debt and
run budget surpluses. So low public indebtedness in Asia and
Latin America, reduced currency mismatches among borrowers, and
counter-cyclical monetary and fiscal firepower has served to
barricade many emerging economies from the global
Despite the historically cheap cost of funding in international
markets, its worth putting EM sovereign issuance into
perspective. BofA Merrill predicts $93bn of EM government
global bonds in 2010. By contrast, the US treasury sold $123bn
of paper in the last week of October alone. "Im more
concerned about supply from the non-EM sovereigns than I am
from EM sovereigns," says Tregidgo at Credit Suisse.
Emerging market nations have generally avoided large-scale
international borrowing due to a fact of life: all countries
are not equal despite the growing sophistication of many
developing economies. For example, the flight-to-quality sell
off after the collapse of Lehman Brothers triggered portfolio
managers to repatriate capital and snap up G7 government paper.
This shift caused the widening of sovereign bond spreads of
emerging market countries. By contrast, the cost of public debt
servicing for developed countries was sharply lowered.
This served as a wake up call to emerging markets as they
incurred the wrath of foreign investors and reaffirms how
developed and developing countries, in many ways, are in a
league of their own. Thats because emerging economies
typically hope to keep borrowing to a minimum, mindful that
weak confidence in the sustainability of public finances has
historically conspired to create havoc in their economies. This
stands in stark contrast to the sky-high deficits and unbridled
government spending in the G7.
Emerging markets then are set to capitalise on an array of
funding sources in the coming years. But it will be a long
while before markets tolerate their fiscal deficits in the same
way as the so-called mature economies.