Emerging-Market Debt

A run for your money

Developing countries in Latin America and Asia can borrow for longer

Aug 26th 2010

PERU is not an obvious investment darling. For much of its existence, the country has been in a state of default. As recently as 1990 the inflation rate was 7,500%. Yet in the past few years Peru has persuaded creditors to lend it money for ever-longer periods in its own currency. It issued its first 20-year local-currency bond in 2006; its debut 30-year bonds followed a year later. Earlier this year Peru was able to issue 300m soles ($105.2m) of 32-year local-currency bonds. Investors in these bonds are compensated for the risk of inflation by yields of just 6.9%, a once unthinkable prospect.

Peru is not alone. Anxious to wean themselves off flighty foreign funding after the crises of the 1990s, many emerging-market governments sought to build up local-currency bond issuance. Extending the maturity of bonds is the next step. In 2007 around 40% of Peru’s local-currency debt was short-term (ie, maturing in less than a year). That had fallen to 30% by 2009, according to the Bank for International Settlements. In Mexico average maturities have gone from 1.5 years in 2000 to seven years a decade later, says Gerardo Rodríguez, who heads the country’s debt office.

Asian countries are also trying to lock in yield-seeking investors. The Philippines is pursuing a number of debt swaps, offering to buy back shorter-dated debt in return for longer-dated issues. It hopes to stretch the country’s average debt maturity from ten years to 25 years. In Indonesia, bonds maturing in 2011-13 were exchanged in July for bonds maturing in 2031.

Improving growth prospects and lower public debt than many rich-world issuers have allowed Asian and Latin American countries to lengthen maturities. (Europe’s emerging markets have proved unable to do the same.) So too has a more professional approach to debt management. For instance, Uruguay created a debt agency in 2005. In the years that followed, it skewed its borrowing to the long end of the yield curve because it expected slower GDP growth, says Carlos Steneri, who heads the country’s public-debt agency.

Domestic savings pools have deepened over the past decade to absorb the supply of local debt issues. The number of retail investors is rising as people become richer. Pension reform has led to the creation of funds that are flush with cash and need assets to match their long-term, local-currency liabilities. Most of Peru’s 32-year bonds were reportedly picked up by local pension funds. Demand from such institutions explains why Latin America, with its more developed social-security net, is ahead of emerging Asia in extending its debt.

But a well-developed local market seems also to attract foreign investors. In Mexico a quarter of the long-dated local debt is held by foreigners. In the year to July, inflows to emerging-market debt funds have more than doubled to $21.6 billion from the previous year, according to EPFR Global, a financial-data firm. Whether investors are getting enough compensation for the risk of holding long-term emerging-market debt is questionable. But for issuers in a crowded sovereign-debt market, it means fewer trips to the well.

FROM THE ECONOMIST INTELLIGENCE UNIT

The IMF devises a new way to lend to vulnerable countries before they suffer from financial crises.

Already the world’s biggest lender to countries in crisis, the IMF is moving to extend its franchise in preventing such turmoil as well. The multilateral organisation on August 30th said it would bolster an existing credit line for nations with solid fundamentals and create a new one for countries with slightly shakier foundations.

The moves are designed to head off a basic problem of IMF assistance: asking for help sends a signal to market participants that conditions may be worse than they expected. The existing credit line, the Flexible Credit Line (FCL), has avoided this difficulty by heaping praise on its recipients. The new one, the Precautionary Credit Line (PCL), is less enthusiastic with its compliments, and so may still spark some of the panic it is designed to avert.

New type of credit lines

The big innovation in the new package is the PCL, which is designed to allow the IMF to commit to lend to a wider variety of countries. Promises of future assistance can help to deter crises since both governments and markets know that the IMF is prepared to step in with a certain level of aid in the event of market volatility.

Such commitments have worked well with the FCL credit lines, which made their debut in March 2009 at the depths of the global financial crisis. Mexico was the first qualifier, gaining a promise of SDR31.5bn (US$46.6bn at present) in case it required funds. Colombia later received a FCL, for a far smaller SDR2.3bn, while Poland contracted one worth SDR13.7bn. The IMF has only conceded these three financial lines, although it is thought to have wanted to grant them to more countries.

All three recipient countries were judged to have solid government finances and to have complied completely with IMF rules on such matters as data transparency. None of them actually drew on the credit lines, all of which were renewed for another 12 months earlier this year. Crucially, all three nations have successfully dodged any direct financial contagion from the global crisis, although economies slowed in Colombia and Poland and contracted in Mexico.

Tighter terms

The new PCL will permit the IMF to promise funding to countries with somewhat less exemplary records. In a statement issued on August 30th, the fund said that a recipient “may still have moderate vulnerabilities” in any of five key areas. These are the country’s external financing position, budget balance, monetary policy, financial sector stability and data provision.

A government signing up for such funding would have to accept some IMF conditions. It must, according to the agency, address “any economic vulnerabilities identified in the qualification process, with progress monitored through semi-annual program reviews.” In exchange, it would have access to up to five times its IMF quota, with an option to take 10 times its quota after 12 months.

These terms are substantially more relaxed than those for standby arrangements, the IMF’s main lending tool. Standby loans are typically released in stages with each parcel reliant on progress in meeting agreed criteria. In many cases, like that of Hungary at present, the government of a debtor country rankles against curbs on budget deficits or other conditions.

The IMF currently has 21 standby arrangements, the largest of which are to crisis-hit countries like Greece, Hungary, Romania and Ukraine. Despite the use of the word “standby” in the name of these loans, country recipients almost always draw down at least part of them.

Changing terms

The IMF also altered some of the terms for its FCL credits, but these are not likely to have a major impact. It said it would now approve two-year packages with an interim review after one year (previously the long offer was for one year with a six-month review). It will also remove an “implicit cap” on borrowing of 10 times a country’s IMF quota.

The FCL has worked well in the past year and a half, albeit only for three countries. The IMF is keen to extend this success to other potential borrowers with the aim of heading off crises, rather than just cleaning up after them.

However, it is unclear that the PCL will achieve this goal. The best borrowers will still sign on to FCLs while those that fall short will have to accept PCLs. This may taint them in the marketplace and with savers and investors. John Lipsky, the IMF’s first deputy managing director, emphasised in a conference call that there would be no standing list of qualifying countries and that negotiations for all credit packages would remain confidential.

Governments of countries that receive PCLs may also be reluctant to address any shortfalls the IMF identifies. This is especially true of newly elected governments that rejected the credit lines while they were in opposition. The biggest danger might come if the IMF moves to cut off a line of credit as a country rejects the conditions. That could truly set off a crisis.

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