Submitted by Thomas Kirchner, founder of Camelot Portfolios
- Emerging market (EM) sovereign debt has been in demand by yield hungry investors.
- Calls for sovereign debt relief are mounting.
- Debt relief on intergovernmental loans could be favorable for EM government bonds.
The Corona epidemic is wreaking havoc on the economies of poor countries and calls are mounting for sovereign debt relief for the poorest nations. The unintended consequences may end up benefitting bondholders in emerging market debt if the overall debt level of debtor nations falls as a result of the debt relief.
Sovereign Debt Relief Proposals
With interest rates moving ever lower over the last decade, yield hungry investors have had to venture into areas previously considered exotic. Emerging market government debt is one such asset class that has attracted record asset flows.
As a result, financing conditions for many countries have reached levels once deemed impossible. Mexico, for example, issued $1 billion in 100-year bonds in 2010 for what was then a record low yield of 6.1%. Four years later, it issued £1 billion ($1.7 bn) in 100-year Sterling bonds with a 5.75% yield i. Many countries that previously were able to borrow only from other governments or international organizations, have been able to diversify their creditor basis by borrowing in bond markets. As a result, debt levels have risen to a point that some observers have considered odious.
Calls for a debt jubilee or debt forgiveness for poor countries have not only arisen after the epidemic began to impact the global economy but have been around for almost a decade, originating mostly from NGOs and various left-leaning political groups. The epidemic and its economic fallout have given these voices a new justification, and it has thus been well-received by many developed nation governments and international organizations.
So far, G-20 governments have provided approximately $20 billion in relief, in the form of a temporary suspension of debt service payments for the poorest countries through the end of the year[ii]. This applies to 76 countries of the International Development Association (IDA), some of which have also issued widely-held Eurobonds, such as Ghana, Honduras, Mongolia, Nigeria, Pakistan and Uzbekistan -- which have payments in the amount of nearly $20 billion scheduled in 2020. The IMF and World Bank are joining the effort with debt relief for six months for 25 low-income countries that are eligible under the Catastrophe Containment and Relief Trust. ii
What happens to bonds?
To the disappointment of debt relief advocates, the temporary measures agreed upon so far apply only to inter-governmental debt. Private bondholders cannot be forced to participate while there is not actually a default. Fiduciaries cannot simply give away their clients’ investments for a good cause. To get bondholders to accept a haircut, a default is necessary. However, defaults are what debt relief programs are designed to prevent.
The unintended consequence is that in preventing defaults, these debt relief programs may end up helping private bondholders because any reduction in overall debt levels make a default on private debt less likely. Should an actual reduction of official debt be decided, the value of private bonds could very well trade higher.
Among the candidates for debt relief are several oil producing countries whose economic challenges clearly are not related only to the epidemic, but more so to falling oil prices.
Ghana, rated B-, is a good example: it became an oil exporter after substantial discoveries only in the last decade, and has used its newfound oil revenues to justify accessing capital markets. Its dollar bonds trade a few points below par, yielding between 6% and 9.5%. These yields are high, but not near distressed levels that would be indicative of severe financial strain, as investors are seemingly confident that oil revenues will be sufficient to help cover some debt service payments. Nevertheless, Ghana is included among the candidates for public sector debt relief. This country alone is strong evidence that economic considerations rank second to the political desire for action of some sort.
The situation is similar for Nigeria. Rated B-, its bonds trade around par and yield 4% to 9%, depending on coupon and maturity.iii
Providing either of these two oil exporters with debt relief may not make sense at a time when oil prices are well off their lows. Mongolia does not produce oil, but it is a major exporter of coal and copper, also with a B- rating, with yields in the 5-6% range. Yet, it is also one of the IDA countries potentially eligible for debt relief.
These three countries are part of the IDA group of countries benefiting from the temporary suspension of debt service payments. Economically, it makes absolutely no sense to provide countries rated B- with relief from debt service. After all, countries rated B- are considered solvent, far from distress, and not at near-term risk of default.
Of course, the situation is different for most of the poorest countries in the world which may not have been investible enough to be able to access capital markets. The only debt these countries have is intergovernmental. It is clear that debt relief by the official sector would help these countries enormously. However, if governments end up being as undiscerning in their debt relief as it appears based on their statements to date, then bondholders will be the beneficiaries.
Therefore, increasing exposure to debt relief candidates in high yield emerging market portfolios might provide an attractive catalyst in the form of debt relief which goes beyond the typical catalyst, the commodities cycle.
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[i] Paul Kilby, Sudip Roy:” Mexico breaks new ground with 100-year sterling bond.” Reuters, March 14, 2014.
[ii] Jan Friederich, Duncan Innes-Ker: “Sovereign Debt Relief Momentum is Accelerating.” Fitch Wire , Fitch Ratings, March 31, 2020.
[iii] Bloomberg per 6/26/2020.