Funding for Emerging Markets Gets More Creative as Dollar Bonds Dwindle

During the BRICS summit held in Johannesburg this week, a central point of discussion revolved around the mitigation of dollar dependence within emerging markets. This issue has manifested in the domain of bond sales, where discernible shifts have already commenced.

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Notably, the issuance of dollar-denominated bonds from developing economies has witnessed a substantial decline, reaching its lowest point since 2021 during August. This decline can be attributed to the escalation of global yields to multi-year highs and the emergence of distress levels in the trading of bonds from 15 emerging nations. This month has seen a mere $1.4 billion raised in emerging market debt issuance, in stark contrast to the $4.5 billion recorded in August 2022 and the average monthly issuance of $15.4 billion throughout this year.

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The outcome of this downward trend in bond issuance is the increasing prominence of alternative borrowing instruments within both emerging and frontier markets. These instruments are garnering greater attention from investors who prioritize environmental, social, and governance objectives. Additionally, the decreased availability of conventional bonds has contributed to maintaining elevated prices for existing debt held by investors.

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Philip Fielding, co-head of emerging markets at Mackay Shields UK, noted that the dynamic of higher demand compared to supply is generally beneficial for bonds. As a response to dwindling new issuance, he disclosed that his $134 billion bond firm is acquiring emerging market debt in the secondary markets. This approach allows them to invest and subsequently transition to cost-efficient new issuances rather than adopting a wait-and-see stance.

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In the backdrop of tighter global monetary conditions, borrowers and investors alike are actively exploring alternative avenues for funding. These avenues encompass loan syndication, conservation-linked securities, and local-currency bonds. Such financial instruments serve to alleviate borrowing costs for governments, while also mitigating currency risks and uncertainties associated with refinancing.

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Beyond financial motivations, some stakeholders are prompted by geopolitical considerations to lessen reliance on the dollar. Sergey Goncharov, a money manager at Vontobel Asset Management in New York, inferred that recent developments within the BRICS consortium indicate an inclination among new countries to establish alternatives outside the established Western blocs. As emerging markets decrease their debt issuance, they are increasingly gravitating towards alternatives, including regional lenders, supranational banks, and local markets.

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The confluence of China's economic recovery deceleration and a surge in Treasury yields to levels not observed since the global financial crisis have amplified the quest for alternative funding sources. Notably, Bahrain's issuance of $1 billion in dollar-denominated bonds in July was the solitary non-investment grade deal within the quarter. Apart from modest issuances by investment-grade entities, the bond market's vibrancy has significantly receded.

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Reza Karim, an investment manager at Jupiter Asset Management in London, emphasized that higher-rated issuers are inclined to delay issuance to secure more favorable borrowing terms. Conversely, issuers with lower credit ratings are deterred by elevated interest rates and limited access to capital markets.

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Attributable to the scarcity of fresh bond offerings, the average yield on sovereign debt from emerging markets has somewhat moderated, reaching 8.26% as of the most recent data. This follows a peak of 8.43% amid a selloff spurred by China's economic uncertainties.

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Uday Patnaik, head of emerging-market fixed income at Legal & General Investment Management, remarked that diminishe

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d supply could be advantageous from a technical perspective, particularly if issuers turn to the loan market. However, the predicament arises if issuers are unable to identify alternative funding avenues.

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Environmental preservation is one sector where capital infusion is notably attainable. Gabon, predominantly covered by forests, recently concluded a $500 million debt-for-nature transaction. This initiative aimed to refinance a portion of its debt while raising funds for marine conservation. Although the issuance encountered delays and a higher-than-anticipated yield, it joins a series of similar transactions underscoring the potential of conservation commitments to address borrowing challenges. Other countries like Belize, Barbados, and Ecuador have embarked on analogous endeavors, with Mozambique exploring similar arrangements.

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Carlos De Sousa, an emerging-markets money manager at Vontobel Asset Management AG in Zurich, urged sovereigns to consider such ventures. He highlighted their cost-saving potential for governments, contribution to nature conservation, augmentation of green and blue bond supply, and the ensuing enhancement of sovereign bond prices.

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However, nature-linked transactions entail complexity and necessitate substantial preparatory efforts by issuers. Borrowers seeking expedited funding opt for loan syndications, where multiple lenders pool resources. Over the past year, Africa has witnessed 225 such loans worth $32 billion extended to governments and businesses, indicating the ascendancy of syndicated loans in the face of challenging market conditions, especially for vulnerable frontier economies.

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A pivotal strategy for alleviating dependence on dollar-denominated bond sales is the cultivation of an active local bond market. Globally, countries are actively striving to attract foreign investors to their domestic bonds. In Latin America, where real yields surpass the emerging-market average, investors have channeled $8.5 billion into local bonds through July, marking the highest influx since 2019. Countries like Peru, Chile, and the Dominican Republic have stood out in this regard. Notably, some of the proceeds are directed towards environmental projects, rendering these bonds more appealing to environmentally conscious investors.

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The New Development Bank, established by BRICS nations, has articulated plans to raise the proportion of local-currency borrowing from less than 20% to 30%. This objective was underscored by the issuance of rand-denominated bonds, with plans to introduce Indian rupee-denominated bonds in the future.

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