THE APPEAL OF EMERGING-MARKET DOLLAR BONDS / THE ECONOMIST

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The appeal of emerging-market dollar bonds

For a start, the alternatives are hardly compelling

The hunt for bonds that pay more interest to retirees and others requiring a fixed income has taken institutional investors to some exotic places in recent years. 

Last month they alighted on Ghana, which issued $3bn-worth of Eurobonds, as dollar bonds issued outside America are known. 

Ghana may be exotic but it is also risky. 

Its government debt-to-gdp ratio was a hefty 78% in 2020. 

With such risks come rewards: the yields on Ghana’s new Eurobonds were roughly 8-9%.

The alternatives are hardly compelling. 

The spread, or additional yield, over Treasury bonds offered by American corporate bonds is close to its pre-pandemic low and not far from its all-time low. 

For a given credit rating, an investor can usually get a wider spread over Treasuries (and thus a higher expected return) by buying the dollar bonds issued by an emerging-market sovereign, says Yacov Arnopolin of pimco, a big bond-fund manager.

There are reasons for the discrepancy. 

Investors feel more comfortable owning corporate bonds, because the Federal Reserve has, in effect, provided a liquidity backstop for the market since last March. 

American companies stand to benefit from President Joe Biden’s $1.9trn fiscal-stimulus package. 

A rapid vaccine roll-out means America’s economy will get back to normal far sooner than most emerging markets. 

On top of this lies another factor. 

The risk of corporate default is something that can be calculated in a spreadsheet model. 

But working out the chances of a sovereign default is a more complex business.

Start with the things you can put in a spreadsheet, such as debt loads. 

The imf divides poorer countries into two categories, middle- and low-income. 

The first group saw public-debt burdens rise by around ten percentage points, to 64% of gdp in 2020. 

Those for the second, which includes Ghana, rose by around five percentage points, to 49.5%. 

Ghana’s debt burden is thus well above that of its peer group. 

Like some other poor countries, it had a lot of lumpy dollar debts coming due in 2022-24. 

That is why it used some of the proceeds of its recent sale to retire a Eurobond maturing in 2023.

The debt burden and maturity profile only get you so far. 

There are three other influences that investors might usefully bear in mind. 

The first is commodity prices. 

The collapse in crude prices last year left a few oil-producing countries short of hard-currency earnings. 

It played a part in the troubles of Ecuador, one of six countries to default on its bonds last year. 

For a while it seemed likely that Angola, a highly indebted oil exporter, would follow suit. 

Support from China and the imf saved it, along with a marked pickup in the oil price late last year. 

Rising metals prices are also helpful to many indebted countries. 

The copper price is important for Chile, Peru and Zambia; the price of gold to Ghana and South Africa.

The second factor is exposure to tourism. 

The hit to the industry from the pandemic played a part in the default of Belize and in stresses elsewhere, says Stuart Culverhouse of Tellimer, an emerging-market research firm. 

It might take years for tourism to recover fully. 

The imf recently sharply downgraded its forecasts for the Caribbean economies. 

Sri Lanka has been dogged by fears of default, in part because it has heavy debts, but also because of lost income from tourists. 

For Kenya, an energy-importer with a hefty debt burden, a hit to tourism and a higher oil price is an unfortunate combination.

A third influence is the imf. 

Understanding its ways is an essential part of investing in emerging-market bonds. 

The fund has lent a total of $110bn, supporting 86 countries, since the pandemic struck. 

Some of this has been in the form of debt relief; some in rapid-fire lending and credit lines; some of it is programme lending with strings attached. 

The imf is readying a $650bn issue of special drawing rights (sdrs)—essentially an overdraft facility at a negligible interest rate—for its members. 

The sdr gift will make a big difference to smaller countries, in some cases doubling their foreign-exchange reserves, says Yvette Babb of William Blair, an asset manager.

A frosty relationship with the fund is probably unwise. 

The kinder, gentler imf has kept sovereign defaults in check much as central-bank action and fiscal stimulus have kept corporate defaults in check in the rich world. 

There may well be further setbacks to some sovereign Eurobond issuers. 

But a lot more yield-starved investors may soon be dusting off their atlases.