Governments and businesses in developing countries have borrowed in foreign markets at a record pace in early 2021, but investors say risks are increasing as some countries experience a resurgence of the coronavirus.
Borrowing through Eurobonds – debt issued abroad, mostly in dollars, euros and yen – hit a new quarterly high in the three months ending in March, with fundraising reaching 191 billion dollars, according to data from Dealogic and Moody’s Investors Service.
The increase in issuance in the first quarter was particularly strong among borrowers rated below the investment grade, the data showed, suggesting sustained demand for riskier assets.
“Both supply and demand are at stake,” said Atsi Sheth, global head of emerging markets at Moody’s. “On the supply side, there is an increased need for government and corporate level financing in emerging markets and on the demand side, global financial conditions are still quite liquid and there is still ‘money in search of returns.’
But with many developing countries struggling with a virus resurfacing and bond yields surging since the start of 2021, the number of potential pitfalls for emerging assets has increased, analysts and investors say.
The IMF this month raised its forecast for global growth this year and next, but warned of ‘divergent recoveries’, with large parts of the developing world faring worse than advanced economies and, in some cases, worse than expected.
Currency of India tumbled as a fierce new wave of coronavirus threatens his recovery. The country hit a grim milestone on Wednesday, reporting a world record of 315,000 new coronavirus infections, surpassing the U.S. peak earlier this year.
The Brazilian economy, which previously faced a surge in demand for its exports from China, is instead likely to derail again as its leaders push back lockdowns and the virus spreads unchecked. Death rates also jumped back in central and eastern Europe.
“Containment of the pandemic is definitely the key to the recovery and many of the major emerging markets are not here,” Sheth said.
Financial conditions are also changing. After a rapid and large-scale exit from emerging market assets at the start of the pandemic, investors have returned to a rising flood, with Joe Biden being elected President of the United States last November and the rollout of vaccines. in developed markets has contributed to large rally in risky assets this year.
At the start of 2021, said Phoenix Kalen, emerging markets strategist at Société Générale, “we were still in this space where things seemed rather benign”. Emerging currencies held up, inflation and US bond yields had yet to recover, and many emerging market finance ministers and treasurers were able to take advantage of attractive yields to withdraw older and more expensive debt.
Since then, however, US bond yields and inflation expectations have risen, and inflationary pressures have increased in developing countries – in part, for many countries, due to the weak currency.
“In the future things will get trickier,” Kalen said. With the return of volatility in currency markets, “finance ministers will be reluctant to issue in currencies and will leave themselves vulnerable to currency fluctuations.”
Pockets of more severe risk are emerging. The Brazilian government, in particular, has borrowed in its domestic market at maturities much shorter than before the pandemic, raising the possibility that it could struggle to refinance its debts if growth does not take off this year.
“Brazil really stands out,” said Tatiana Lysenko, senior emerging markets economist at S&P Global Ratings. “He certainly presents the greatest refinancing risk because of his short-term debt.”
Some analysts warn emerging markets may struggle to recover, even where the virus has been better contained.
UBS chief economist Arend Kapteyn said the “massive change effect” that will occur when households come out of foreclosure and start spending more on services and less on goods, will work against emerging markets.
“For MS, we say if anything, it will hurt them,” he said. “If anyone has benefited [from the pandemic-induced growth in goods trade] it’s in Asia, and since it’s defeated, they would likely lose. “
For bond investors in emerging markets, says Bhanu Baweja, strategist at UBS, it will be “a lot harder job from now on” as emerging market yields move even higher than those of advanced economies.
“Most of the things that lead [bond] higher prices – spread compression, high commodity prices, global trade recovery – it’s all done. From now on, credit spreads will no longer tighten but widen. “
Analysts say long-term threats are also growing. Many sovereign borrowers have entered the pandemic with serious imbalances that have only exacerbated. While previous crises have spurred reform in some cases, it seems unlikely this time around, Lysenko said.
“In this crisis, I don’t think we’ve seen that momentum,” she said. “On the contrary, we are more concerned that ongoing reforms will be delayed.”
