At the BRICS (Brazil, Russia, India, China and South Africa) summit in Johannesburg last week, a key item on the agenda was reducing US dollar dependence across emerging markets (EM). In bond sales, it’s already happening.
The sale of US dollar bonds from developing countries sunk to the lowest since 2021 in August as global yields spiked to multi-year highs and 15 emerging nations traded at distressed levels. Only US$1.4 billion has been raised in emerging debt this month, compared with US$4.5 billion in August 2022 and average monthly sales of US$15.4 billion this year.
The upshot of the collapse is that alternative borrowing instruments are becoming more mainstream in emerging and frontier markets, attracting more investors pursuing priorities such as environmental, social and governance (ESG) targets. The lower supply of plain-vanilla bonds also tends to support prices for the debt that investors already hold.
“If demand is greater than supply that tends to be good for bonds,” said Philip Fielding, co-head of emerging markets at Mackay Shields UK, who said he’s buying emerging debt in the secondary markets for his US$134 billion bond house as new issuance abates. “In many cases, it makes sense to be invested and then switch into a cheap new issue rather than wait.”
Tighter global monetary conditions are pushing both borrowers and investors to seek alternative funding routes such as loan syndication, conservation-linked securities and local-currency bonds. Such instruments can ease governments’ costs of borrowing while minimising currency risk and uncertainty over refinancing.
For some, shifting away from the US dollar also has a geopolitical motivation.
“The latest Brics headlines point even more in the direction of new countries willing to form alternatives from the standard Western blocs,” said Sergey Goncharov, a money manager at Vontobel Asset Management in New York. “As EM countries issue less debt, they instead pivot towards alternatives – regional lenders, supranational banks, local markets.”
The stalling of China’s economic recovery and a spike in Treasury yields to the highest levels since before the global financial crisis have also helped fuel the search for alternative funding. Bahrain’s US$1 billion sale of US dollar bonds in July is the only non-investment grade deal so far in the quarter. Beyond smaller sales by investment-grade issuers, activity has almost ground to a halt.
“For higher-rated issuers who can wait to issue, they would rather issue later to have a better chance of borrowing cheaper,” said Reza Karim, an investment manager at Jupiter Asset Management in London. “For some of the high-yield issuers, the rate is too high and the access to capital markets is also limited.”
Partly due to the dearth of new sales, the average yield on EM sovereign debt has eased recently to 8.26 per cent as at Friday (Aug 25), after hitting a nine-month high of 8.43 per cent when China’s economic troubles sparked a selloff.
“Less supply would be positive from a technical standpoint, especially if the issuers are going to the loan market,” said Uday Patnaik, London-based head of emerging-market fixed income at Legal & General Investment Management. “The problem would be if the issuer could not find alternative funding sources.”
One area for which capital is more readily available is environmental protection. Gabon, where nine-tenths of the landmass is covered by trees, completed a US$500 million debt-for-nature deal this month to help refinance a portion of its debt and raise funds for marine conservation.
Though there were hiccups to complete the sale – the issue got delayed and had to be priced at a higher-than-anticipated yield – it’s the latest in a string of transactions showing that committing to conservation goals can help governments overcome borrowing challenges. Belize, Barbados and Ecuador have struck similar deals, and Mozambique is in talks with Belgium for one.
“Sovereigns should consider them,” said Carlos De Sousa, an emerging-markets money manager at Vontobel Asset Management in Zurich. “It saves money to the sovereign, deploys money for nature conservancy, increases the supply of green and blue bonds, and boosts bond prices of the sovereign in question. Everyone wins, basically.”
But nature-linked deals are complex and require lengthy preparation by issuers. Borrowers who need funds more quickly are going for loan syndications, where multiple lenders contribute. In Africa alone, there were 225 such loans worth US$32 billion extended to governments and businesses over the past year.
“Market conditions will remain challenging, especially for the most vulnerable frontier economies,” said Bartosz Sawicki, a market analyst at Polish financial technology company Conotoxia. “Consequently, the rise in popularity of syndicated loans, which spread the risk of default between parties, will probably prevail.”
But if reducing reliance on US dollar-bond sales is the goal, nothing beats developing an active local market. Countries around the world are now looking to attract more foreign investors to their local bonds.
In Latin America, where real yields are higher than the EM average, investors bought US$8.5 billion of local bonds this year through early July, the most since 2019. Peru, Chile and the Dominican Republic were the most prominent issuers. Some of the proceeds were earmarked for environmental projects, making them more attractive to ESG investors.
New Development Bank, the multilateral lender founded by the Brics nations, said it aims to increase the share of its local-currency borrowing to 30 per cent from less than 20 per cent, and issued its first rand-denominated bonds a week ago. It says bonds denominated in Indian rupees are next.