A handful of frontier market governments have issued Eurobonds over the past few months, but these could create vulnerabilities further down the line, particularly in Egypt, Ukraine and Bahrain. Moreover, many frontiers remain locked out of global capital markets and/or in the midst of crises.
- A handful of frontier market governments have issued Eurobonds over the past few months, but these could create vulnerabilities further down the line, particularly in Egypt, Ukraine and Bahrain. Moreover, many frontiers remain locked out of global capital markets and/or in the midst of crises.
- A number of frontier governments have issued Eurobonds during the coronavirus crisis. Egypt, Belarus, Honduras, Bahrain, Paraguay and Guatemala issued dollar bonds on global markets between April and June. Governments of Ukraine and Jordan are the latest to tap global bond markets, having issued earlier this month. And El Salvador is expected to issue a global dollar bond in the coming days.
- This is, in some ways, an encouraging development. After all, no emerging market (let alone frontier) government issued Eurobonds during the height of the market panic in March (although some did issue dollar bonds in domestic markets). But there are three reasons for caution.
- First, interest rates on the recently issued bonds are pretty high. (See Chart 1.) Coupons on issuances in Egypt, Bahrain and Ukraine were around 7.5%, and El Salvador’s is expected to be 9.5%. These figures are not eye wateringly high, but they are on the upper end of historic EM issuance rates. (See Chart 2.)
- Second, the fact that the new issuances are denominated in dollars increases governments’ exposure to exchange rate falls. Foreign currency debts have been at the heart of almost all EM debt crises (with the notable exception of Russia’s in 1998) since the 1980s. Bahrain’s dollar peg looks vulnerable, we think that the Egyptian pound has further to fall, and the Ukrainian hryvnia could come under further pressure if the recent departure of the central bank governor is followed up by broader reform backsliding.
- Governments of Ukraine and Egypt look particularly exposed. They do not have any major source of dollar revenues (like oil exports), which would mitigate the risk of FX mismatches on balance sheets. And FX debts held externally by these sovereigns are sizeable at around 20% of GDP.
- Third, despite improving external conditions, many frontiers remain locked out of global capital markets. Sovereign dollar bond yields are still higher than 10% – the level at which only a few EMs have issued debt over the past decade – in Angola and Sri Lanka, as well as those frontiers already in the midst of crises (Argentina, Ecuador, Venezuela in Latin America as well as Lebanon and Zambia.
- One encouraging point to end on, however, is that narrowing current account deficits and lower external financing needs seem to be allowing several large frontiers to focus on domestic debt issuance. Kuwait, Vietnam, Nigeria, Kenya and Morocco – the five largest constituents of the MSCI Frontier Markets Index – have issued debt solely domestically and in their own currencies since the crisis began.
- As it happens, the fact that Vietnam and Kuwait have shunned external debt markets is not surprising given that they historically run current account surpluses (failure to pass a new public debt law has also prevented international issuance by the latter). But Nigeria and Kenya are more notable. Issuing less external debt, and more domestic debt, could cause problems over the long term by crowding out private sector lending. Over the next few years, though, it would improve debt dynamics and reduce balance of payments risks.
Chart 1: Coupons on Eurobond Issues Since Mid Feb. (%)
Chart 2: Coupons on EM Eurobond Issuance Since 2010
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Edward Glossop, Senior Emerging Markets Economist, +44 (0)7896064878, firstname.lastname@example.org