Emerging corporate debt tips the scales

August 13, 2012

Time was when investing in emerging markets meant buying dollar bonds issued by developing countries’ governments.

How old fashioned. These days it’s more about emerging corporate bonds, if the emerging market gurus at JP Morgan are to be believed. According to them, the stock of debt from emerging market companies now exceeds that of dollar bonds issued by emerging governments for the first time ever.

JP Morgan, which runs the most widely used emerging debt indices, says its main EM corporate bond benchmark, the CEMBI Broad, now lists $469 billion in corporate bonds.  That compares to $463 billion benchmarked to its main sovereign dollar bond index, the EMBI Global. In fact, the entire corporate debt market (if one also considers debt that is not eligible for the CEMBI) is now worth $974 billion, very close to the magic $1 trillion mark. Back in 2006, the figure was at$340 billion.  JPM says:

The international primary market for EM has transformed into a corporate debt market, with sovereign issuance now less than one-third of total EM external issuance.   

JP Morgan expects the $1 trillion milestone to be hit by year-end, when the total stock of sovereign dollar bonds will stand at $700 billion.

There are many reasons for this explosive growth. First, sovereigns are issuing less dollar debt, resorting instead to local bond markets where they can raise funds in their own currencies. Last year, governments raised $566 billion at home, compared to just $70 billion on dollar bond markets.  Their space has been filled by companies which have been emboldened by investors’ enthusiasm for emerging markets and the prospect of cheaper capital than at home. And most recently, the syndicated loan market, previously the main funding source for corporates, has dried up — JPM says loan volumes are down 90 percent from 2011.

The issuance bonanza has left many emerging companies with big hard currency debts on their books, which could be harder to service as economies slow. True, 70 percent of CEMBI-listed companies are now rated investment grade by credit agencies and that implies greater safety for investors. But debt defaults by Ukraine’s Naftogaz and Kazakhstan’s BTA proved that sovereign guarantees for state-run companies actually amount to very little.   Default rates by EM corporates surged to over 10 percent in the wake of the 2008 crisis.

Overall however, emerging corporate bonds have rewarded investors. The CEMBI Broad has returned 8 percent on an annualised basis since 2003, JPM says. And for now at least, default rates are low and should peak at less than four percent, analysts reckon.

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