Global Investing

As may be expected, the crisis has increased the risk of default by emerging market borrowers. According to estimates by ING Bank’s emerging bond guru David Spegel, the default rate on EM bonds is running at over $6 billion in the first four months of 2012, already surpassing the 2011 total of $4.3 billion. He  predicts another $1.3 billion of emerging defaults to come this year.

Spegel expects the default rate for speculative grade emerging corporates to rise to 3.25 percent by September, up from 3 percent at present.  That doesn’t look too bad, given defaults ran at 13 percent after the 2008 crisis and hit a record of over 30 percent in the 2001-2003 period. But ING data shows some $120 billion worth of corporate bonds trading at “distressed” or “stressed” levels, i.e. at spreads upwards of 700 basis points. The longer such wide spreads persist, the higher the probability of default. A worst case scenario  would see a 12.9 percent default rate by end-2012, Spegel says.

Many companies are having trouble rolling over maturing bonds (selling debt to pay off existing creditors). One reason might be the explosion in bond issuance this year. Data from Bank of America/Merrill Lynch shows bond sales by emerging borrowers, sovereign and corporate, totalled 14 billion in the first three months of the year, a quarter more than the same 2011 period.  Clearly everyone is rushing to raise cash before U.S. Treasury yields rise further. (see what we wrote on this a few months ago)

Now look at ING’s figures on syndicated bank lending. Syndicated loans are a key funding source for EM borrowers but they have dropped 51 percent in the first three months of 2012 from the previous quarter to $105 billion. Coinciding with the surge in bond issuance and European banks’ problems, this suggests many former bank borrowers have turned to bond markets intead.

What about potential loan defaults?  ING estimates $178 billion in syndicated loan repayments remain for 2012 and it is unclear how much of this will spill into bond market issuance. EM debt demand so far has been buoyant,  with EPFR data showing inflows of almost $18 billion year-to-date to EM bond funds. Even lower-rated EM companies and countries have easily raised cash. But Spegel warns:

Ukrainian officials were at pains to reassure investors last week that no debt default was in the offing. But people familiar with the numbers will find it hard to believe them.

The government must find over $5.3 billion this year to repay maturing external debt, including $3 billion to the IMF and $2 billion to Russian state bank VTB. Bad enough but there is worse:  Ukrainian companies and banks too have hefty debt maturities this year. Total external financing needs– corporate and sovereign – amount to $58 billion, analysts at Capital Economics calculate. That’s a third of Ukraine’s GDP and makes a default of some kind very likely. The following graphic is from Capital Economics.

In normal circumstances Ukraine — and Ukrainian companies — could have gone to market and borrowed the money. Quite a few developing countries such as Lithuania recently tapped markets, others including Jamaica plan to do so. Ukraine’s problem is its refusal to toe the IMF line.  Agreeing to the IMF’s main demand to lift crippling gas subsidies would unlock a $15 billion loan programme, giving  access to the loan cash as well as to global bond markets. But removing subsidies would be political suicide ahead of elections in October.  And with the sovereign frozen out of bond markets, Ukrainian companies too will find it hard to raise cash.