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Emerging market debt issuance has soared in the first six months of 2011, driven by heavy corporate bond volumes and flying in the face of debt problems in the developed world, but risk aversion may erode demand in the second half.
Emerging issuance hit record levels in 2010 close to $300 billion US, analysts estimate, and while bond sales have slowed recently, borrowing in the first half of this year is still up 33 percent on a year ago, at $175 billion, according to data from ING.
In the past a sovereign debt crisis in Europe would have frozen out all bond issuance from the developing world. But this year, even as euro zone states such as Greece teeter on the brink of default, countries such as Latvia and Iceland have returned to bond markets for the first time since high-profile IMF bailouts from the 2008 global financial crisis.
"The fact that $80 billion US was fairly easily raised in the face of the global market downturn over this quarter reveals the resilience of the market and appetite for emerging market debt exposure by bond buyers globally," said David Spegel, head of emerging markets strategy at ING in New York.
Much of the bumper issuance over the past six months has been down to higher yielding corporates, which came out of the global crisis relatively default-free.
Corporate debt sales are up more than 50 percent from the first half of 2010 at $124 billion, ING calculates -- successful issuers include Turkey's Akbank and Isbank, Nigerian Guaranty Trust Bank and Ukraine's Metinvest.
One factor behind surging high-yield issuance is the huge amount of cash sloshing around the global financial system -- a consequence of zero-interest rate policies in much of the developed world. These policies are now drawing to an end, and analysts are divided on whether there will be enough liquidity left to keep the new issue market aloft in coming months.
David Hauner, head of EEMEA economics and fixed income strategy at Bank of America Merrill Lynch Global Research sees the situation as a story of two forces.
"One, there is a lot of liquidity out there and second, issuance plans are higher than ever before," Hauner said.
That story of two forces is typified by a $350 million issue from South Africa's First Rand bank which garnered bids of $1.7 billion in early June, enabling it to place the bond at a lower yield than anticipated.
Western capital fleeing zero interest rates at home has been amply rewarded -- year-to-date returns on JP Morgan's emerging dollar bond index, the EMBI Global are at 4.6 percent while corporate bonds have earned 2.9 percent.
Local currency bond returns are even better at 5.5 percent -- contrast that with emerging stocks which are down 3.5 percent while returns on one- to 10-year U.S. Treasuries are around 3 percent, Bank of America/Merrill Lynch bond index data shows.
DAYS OF CHEAP FUNDING ALMOST OVER?
With developed interest rates still at rock bottom levels, it's no surprise that emerging issuers tried to lock in as much funding as possible. That picture may change in coming months.
Already, worries about peripheral euro zone economies and the looming end of the second round of the U.S. money printing, QE2, have soured markets, cutting issuance in the second quarter Of 2011 compared with the first.
The premium emerging bonds carry over U.S. Treasuries crept recently above the psychologically key 300 basis-point level, approaching the widest gap in a year.
Hauner noted that emerging sovereigns have raised half the $70 billion he forecasts for 2011, and risk appetite is likely to be less strong in the second half of the year.
"We could end up in a situation when not all issuance gets done," he added.
Technicals for sovereigns are positive, however, JP Morgan said, noting its latest client survey had revealed investor positioning in emerging sovereign dollar debt was at the lowest since November 2008, shortly after the Lehman Brothers collapse.
CORPORATE, FRONTIER RISKS?
The other worry is that riskier corporate and frontier market debt is starting to make up a bigger proportion of total issuance. About 42 percent of issuers in the second quarter of the year were rated below BBB-, a bigger proportion than in recent quarters, ING's Spegel estimates.
"The fact that speculative grade issuance is higher is of some concern," Spegel said, though he added: "History suggests that there is ample time before any bubble would burst, assuming that current excessive speculative issuance trends continue."
JPMorgan in a recent client note recommended staying underweight emerging corporates versus sovereigns, noting they "will likely underperform in a higher risk environment."
But investors see plenty of reasons still to buy emerging market debt because even the end of QE2 in the United States and higher euro zone interest rates will not substantially increase yields on offer in the developed world.
"We're seeing a record number of requests for proposals from pension funds, sovereign wealth funds and central banks eager to allocate to emerging debt," said Sergio Trigo Paz, who runs $5.5 billion in emerging debt at BNP Paribas Investment Partners.
Old hands in developing markets on the other hand will be unfazed by bailed-out or once-distressed borrowers, he said.
"Emerging market investors are attracted to countries that have gone through substantial deleveraging and restructuring and that are paying you a hefty spread to return to the market, rather than those that remain loaded with debt such as Greece, where moral hazard is the name of the game."