Tracking the frontier markets debt bubble

23 July 2018/No Comments
By Nick Dunbar

There are good reasons for investing in so-called frontier markets, countries that belong outside the mainstream emerging markets category for reasons of development, market accessibility or size.

For example, in sub-Saharan Africa, there is the tantalising possibility that technology will help countries leapfrog the infrastructure hurdles that held them back until now. Or formerly closed-off Gulf nations need investment to help them wean themselves off oil dependence.

A couple of years ago, bond investors jumped on the bandwagon, enticed by double-digit returns on frontier bonds. Issuers got the message, and cranked up their borrowing in response. In 2018, investors grew wary and began exiting the market, pushing bond returns sharply negative for most emerging market issuers.

The Risky Finance sovereign debt tool can be used to investigate these trends. Using iBoxx data we see how dramatic it is, particularly when contrasted with more seasoned emerging markets. Our visualisation tool below ranks new borrowing versus total borrowing for each country, aggregating local currency and hard currency debt.

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Understanding the chart

This interactive chart tool shows borrowing patterns for emerging market countries in the Risky Finance iBoxx database. Use the controls at the top of the table to compare new borrowing to total or maturing debt, and to change the issuance year or to filter by external currency.

Change the chart type to 'table' to view issuance amounts, yields and maturities for each country.

For example, two thirds of Angola’s entire outstanding stock of sovereign debt was borrowed in the first six months of this year. For Ghana, the proportion is 40 per cent, followed closely by Qatar, Senegal, Oman and Kenya.

This flood of new debt has led to some debates. Should Qatar and other rich Gulf oil states be classified in the same way as far poorer African nations, or even as emerging market nations at all? JP Morgan, for example, is under pressure to include the Gulf nations, notably Saudi Arabia, in its widely-tracked EMBI emerging market bond index.

We can also use the chart tool to rank countries according to their ratio of new borrowing versus their maturing debt this year. In equilibrium, a country will refinance 100 per cent of maturing debt during the year, and at the end of June the ratio should be 50 per cent. That’s what we see for seasoned borrowers like Thailand or Singapore.

Countries with a ratio below 50 per cent are paying down debt faster than their new borrowing. That might happen because they don’t need to borrow any more, as a result of increased growth. Or it might be because investors are reluctant to roll over maturing debt at other than punitive costs and short maturities. We see this happening with some of the largest, mainstream emerging market borrowers.

Consider Brazil, whose total $1 trillion debt portfolio has an average yield of 7.6 per cent and maturity of ten years. Compare that to the yield on Brazil’s new borrowing this year, which is above 10.5 per cent, and has an average maturity of five years.

At least Brazil is doing all this new borrowing in its own currency, and can print money to pay the higher coupons. Mexico and Turkey have issued most of their bonds this year in dollars or euro, making them more vulnerable to currency declines.

By contrast, the frontier borrowers are those countries with a new-to-maturing debt ratio of 100 per cent or more (at the end of June), which indicates that they are ramping up their borrowing. In just six months, Sri Lanka borrowed 12 times the amount of debt it has maturing this year, followed by Qatar with a ratio of six. The next two countries, Kenya and Nigeria, are interesting because they buck the trend of negative investor returns (measured in dollars).

Screenshot of interactive visualisation available to subscribers.

Kenya may have borrowed 30 per cent of its total debt in the first six months of 2018, but that didn’t discourage investors, who swallowed the new issuance while keeping total annualised returns at ten per cent. Or consider Nigeria. The country has no shortage of problems, but a rebound in oil prices seems to have convinced investors to keep buying, ignoring the potential downsides of an election later this year.

Compare this with the other end of the scale, where Turkey, Argentina and Ukraine have returns below minus ten per cent. And this is excluding Venezuela, which is now in default. The handful of positive outcomes only emphasises the challenge that emerging market borrowers currently face.

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