EM bonds: yield hunt reaches Honduras and aims for Papua New Guinea
By Pan Kwan Yuk. This article originally appeared on FT.com on March 18th, 2013.
It’s not gentrification, it’s desperation. What can be said of the current scramble for real estate in the poorer corners of Brooklyn, New York – can arguably also be applied to emerging markets bonds at the moment.
With yields from big, traditional EMs – like Mexico and Brazil – low, EM bond investors, much like the homeseekers priced out of the established bits of Brooklyn, are diving deeper into unfamiliar parts of the EM world in their quest for returns. Last week Honduras, a poor Central American country with the world’s highest murder rate, made its international bond debut, raising $500m.
And what a debut it was. Not only was the issue, sold at 7.5 per cent, 2.5 times oversubscribed, it was also pulled off despite Barclays, one of its would-be underwriters, withdrawing. Neither the country’s weak public finances, the moderate possibility of a coup, or the fact that Honduras – with a rating already deep in junk territory – has been put on on negative outlook by two rating agencies, appeared to have put off investors.
Standard & Poor’s, which has Honduras on B+ (or four notches below investment grade), placed the country on negative watch in February. The move was followed last week by Moody’s, which has Honduras on a B2 rating (or five notches below investment grade).
“It does seem an unusual saga and shows that risk appetite is still high, especially when you consider it is quite lowly rated, with twin deficit issues and elections coming up,” Stuart Culverhouse, chief economist at Exotix, told beyondbrics. “The pricing might also have been seen as attractive, in this low yield environment, and that may have been another factor for getting it away.”
Indeed, emerging market bonds seem to know no bounds these days thanks to the global glut of cheap money looking for a home and returns.
With big EMs such as Brazil and Mexico, once frequent issuers, issuing less and less overseas in favour of domestic debt, the market is basically chasing anything it can get its hands on. And frontier market issuers have been only too happy to fill the void.
The last nine months have seen unusual names such as Paraguay, Costa Rica, El Salvador, Mongolia, Guatemala, Bolivia, Sri Lanka, Zambia, Angola and Tanzania all successfully pulling off euro or dollar bond issues. (All are junk rated with the exception of Tanzania, which is not rated).
To this list, investors could soon add Papua New Guinea, Ecuador, Bangladesh, Panama, Rwanda, Uganda and Mozambique – all of which are reportedly looking to raise cash on the international bond market.
All this raises the question, is this a good or bad thing?
On one hand, desperation for yields are allowing countries – who wouldn’t have attracted investor interest five years ago – a chance to tap the market for cheap credit to fund much needed infrastructure and development projects. But on the other hand, investors may be setting themselves up for a bad fall by extending dollar/euro loans to some of the world’s most impoverished countries – many of which have a record of poor fiscal governance and political instability.
“It really depends on the country,” said Nicolas Jaquier, emerging market economist at Standard Life Investments.
“Bond investors need to be more discerning than ever these days,” he told beyondbrics. “You really need to do your credit risk analysis before jumping in.”
“For starters, what is the country going to use the proceed for? In the case of Honduras, we did not participate in the issue because the proceeds were just being used to cover the country’s fiscal deficit rather than finance productive infrastructure projects that could boost growth.”
Complicating the calculation of any risk-return analysis is the wildcard factor of political instability in some of these markets.
This was made painfully clear in Mongolia’s bumper $1.5bn two-tier issue last year. The bond, which had attracted $15bn in bids, sank within a week of its issue amid mounting signs of infighting within the coalition government. The bonds are currently trading at 94 cents to the dollar.
Not all recent issues have stumbled. Although its former president Fernando Lugo was tossed from office in a lightning-fast impeachment process that some have denounced as an institutional coup, Paraguay’s bonds are trading at par.
El Salvador, second only to Honduras in the UN’s global murder rankings and whose $800m issue in November also raised a number of eyebrows, has fared even better. Its bonds have gained more than 6 per cent since they were issued.
As for upcoming issuers, Exotix has this to say about the potential bond issue from Papua New Guinea, which it reckoned could yield around 7 per cent (tighter than Bosnia, Seychelles, Venezuela and Ecuador, and wider than Belarus and Egypt and Ukraine):
PNG is a resource-rich country with a fairly poor record on governance. The IMF is projecting a 20% increase in the level of GDP in 2015 as a liquid natural gas (LNG) plant comes on stream. Export volumes are projected to increase 55% when that happens. Fiscal revenues from the LNG project are projected to begin in 2018 and peak at around 10% of GDP by 2024…
…The main risk is medium term fiscal management. PNG performs badly on global governance rankings, 150th (out of 174) on Transparency International’s 2012 corruption index (just behind Syria, Ukraine and Eritrea, and just ahead of Paraguay, Guinea and Kyrgzstan). Local news portals feature numerous stories of corruption (link). It would be hard to blow revenues and cause a debt crisis starting at a 20% debt-to-GDP revenue over a shorter period, but over a decade it is easier.
We would therefore tend to take a more favourable view of a 2018 maturing bond, which would tide the country over until revenues come on stream, than a longer term bond, which could be risk being construed as intent to borrow beyond a period over which market trust has been earned.
So are frontier bonds a good bet? Only time will tell. While some seem to think that the mid-to-high single digit pricing on some of these issues compensates investors for the risks in investing in frontier markets, recent debt restructuring by Belize and Jamaica and a technical default by Grenada earlier this month are a reminder of the pitfalls in chasing yield in smaller, frontier markets.About New York Institute of Finance
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