Emerging Market Issuance: Giddy Times
Even though global demand for emerging market bond issues has been extremely positive in the first quarter of 2004, a number of recent adverse geopolitical events-the attempted assassination in Taiwan, presidential impeachment in South Korea, and renewed tension in the Middle East following the assassination of the Hamas leader-have already caused consternation. Looking ahead, emerging market issuers will continue to take advantage of an attractive funding environment which is facilitated by central banks in key regions maintaining an accommodative stance. However, the sharp run up in commodity prices-whose trend is generally positively correlated with emerging market issuance-to unprecedented highs since 1990 magnifies the risk that gains may be more circumspect in the coming months. Any hiccups in the global growth outlook-especially in Europe where weakness is already manifest-or an unexpected acceleration in interest rates in the U.S. could impede capital flows to the emerging markets and constrain financing prospects, particularly for weaker-rated borrowers.
In 2003, a combination of factors conspired to drive 2003 issuance to near record highs: continued liquidity in the global capital markets, an intensified search for yield among investors, a concomitant decline in risk aversion, and a substantial improvement in credit quality. Upgrades accounted for 53% of all emerging-market rating actions in 2003, the first time upgrades have exceeded downgrades in seven years. Furthermore, an impressive run up in global commodity prices-fueled in part by strengthening economic fundamentals in the U.S. and Japan as well as voracious appetite from China’s manufacturing sector-generated impressive export earnings and stimulated need for additional capital among issuers based in emerging markets.
Emerging market new bond issues posted their second largest levels ever in 2003 with volume of US$148.8 billion, just short of the previous high of US$151.4 billion recorded a year earlier (see chart 1). The past year marked a third strong year of bond issuance from emerging market entities, following the earlier bust generated by the Asian financial crisis. This year, the torrid pace has continued in the first quarter, with US$35 billion issued, which represents the second highest volume recorded historically in the first quarter.
The biggest gains by region in 2003 were seen in the Commonwealth of Independent States (CIS) region, where volumes more than doubled, albeit from relatively low levels (see chart 2). The AsiaPacific region-traditionally the largest borrower by volume-saw a decline of 16%, attributable in large part to a lower volume of issuance from South Korea. Issuers based in Eastern Europe, the Middle East and Africa (EEMEA) also failed to participate in the upside, issuing 30% fewer dollars than in 2002, due to weakness in Middle East and Africa. Meanwhile, Latin America expanded 63%, reflecting the region’s recovery from crisis. In the current year to date, Latin American and EEMEA-based issuers are continuing to actively approach the market.
Notwithstanding the decline on a year-over-year basis, South Korea continued to be the dominant issuer by country in 2003, responsible for US$44 billion in total proceeds. The country’s share in total emerging market issuance has however dropped from the record high of 55% in 2002. Korean banks have been especially active in overseas funding in the last few years, in order to finance aggressive growth in loan portfolios as well as to bolster regulatory capital adequacy ratios faced with a drop in profitability from exposure to selective corporates and soured credit-card loans. In addition to South Korea, other top borrowers by country in 2003 were Taiwan (US$17.9 billion), Hong Kong (US$14.8 billion), and Mexico (US$13.2 billion). These same four countries continued to lead the issuance calendar in the first quarter of 2004, with South Korea and Mexico leading the ranks at the end of the first quarter.
Looked at by sector, utilities and telecommunications were the only one that recorded annual increases in 2003 (see chart 3). New issues in utilities advanced 62.2% to US$13.8 billion in 2003 whereas the telecommunications sector grew 16.2% to US$11.5 billion. Meanwhile, the financial institution, banking, and industrial sectors all fell modestly from 2002 levels, although the banking sector recorded the biggest loss at 10.2%. Hong Kong-based conglomerate Hutchison Whampoa Ltd. was the most prolific emerging-market issuer, which along with its subsidiaries generated more than US$8.6 billion in proceeds in 2003 for refinancing and general corporate purposes. Within telecommunications, Russia-based Mobile TeleSystem Finance SA also raised a sizable US$1.1 billion in order to finance its acquisition plans over other wireless operators in the region.
So far in 2004, the relatively small utility sector has continued to show the fastest growth, gaining 44.6% year over year to US$1.7 billion. Meanwhile, banks, financial institutions and telecommunications were all still running below year-ago levels in the first quarter.
Meanwhile, the industrial sector has raked in US$15 billion in new issues in the first quarter, 19.5% more than in the corresponding period last year. This is in contrast to full year 2003, when issuance in the industrial sector fell 4.4% to US$48.4 billion. The most prominent borrowers within the industrial sector in 2003 were integrated oil and gas (US$11.9 billion), high technology (US$8.4 billion), consumer products (US$5.5 billion), and transportation (US$4.9 billion) (see chart 4). Gains were seen most visibly in the automotive subsector, which advanced 85%, albeit from a relatively low base. The more broadly defined transportation sector grew 30% amid a generally improving trend in revenues and earnings, even though the financial conditions vary widely within this sector. Cyclical sectors, such as the consumer products, retail/restaurants, forest products, and building materials displayed high growth in new issues commensurate with an increasingly positive economic backdrop.
Issuers from the integrated oil and gas sector, who feature prominently on the list of top emerging market borrowers by volume in recent history-topping the list in four of the last five years-are the leading industrial subsector so far in 2004. Borrowing by entities in this sector likely reflects increased investment spending in line with improving global economic prospects, receding fears of the impact of larger oil supplies from Iraq, and relatively tight inventory levels in the U.S. PEMEX led the charge in the first quarter of 2004, issuing US$2.4 billion, out of a total US$4.4 billion for the subsector.
Investment grade-rated entities (‘BBB-‘ and above) continued to have a relatively easier time raising funds in the bond market, although the rising tide of investor sentiment in 2003 led to increased volumes in both segments (see chart 5). Speculative grade rated entities (‘BB+’ and below) have been gradually inching up their profile in the bond market, accounting for 27% of total emerging-market issues with ratings in 2003, up from 25% in 2002 and 21% in 2001 though still lower than the 36% share in 2000. In 2003, a total of US$16.4 billion was raised in the speculativegrade segment, which represents the second highest volume raised in any given year, following US$24.8 billion in 1997.
Easy liquidity conditions in 2003 led to gains within all rating categories in 2003. Within the investment-grade segment, the ‘A’ rating category (including the ‘A+’, ‘A’ and ‘A-‘ rating designations) saw the biggest annual increase in issuance of 172% to US$18.8 billion (see chart 6). Meanwhile, the distribution of new issues by rating category suggests that issuance at the lower rungs of the ratings ladder (specifically at the ‘B’ rating category) also expanded in response of the favorable issuing environment. The ‘B’ rating category (including the ‘B+’, ‘B’ and ‘B-‘ rating designations) grew 105.9% to US$9.8 billion.
The increased appetite for risk among global investors set the stage for a near doubling of crossborder issuance to US$71.9 billion in 2003. In 2003, the proportion of cross-border issues relative to total issuance by emerging market-based issuers rose to a five-year high of 48%, sharply above the 34% average recorded in the four previous years (see Chart 7). Asia Pacific-based issuers maintained their traditional dominance in the cross-border market in terms of volume, but Latin America-based issuers displayed the fastest growth in 2003, their market share of total cross-border issues rising to 27% from 16% in 2002. In the same period, the proportion of cross-border issues raised by the Asia-Pacific region fell to 56% from 62%. In the first quarter of 2004, cross-border funding maintained a healthy clip; 63% of the total deal volume (US$22 billion) raised by emerging-market entities so far this year was sold to international investors.
The U.S. dollar retained its pre-eminent status as the currency of choice among emerging-market issuers in 2003 and in the first quarter of 2004. In 2003, within the cross-border market, it accounted for a mammoth 84% of all transactions on a volume basis. The volume of transactions denominated in euro showed a large increase, but still only accounted for 8.1% of cross-border transactions. The volume of cross-border deals that were dollar-based totaled US$60.4 billion in 2003 while euro denominated deals totaled US$5.9 billion; both levels represent a pickup from 2002.
Looking ahead, emerging-market issuers will continue to take advantage of an attractive funding environment as long as interest rates remain near record lows while central banks in key regions maintain an accommodative stance and investor demand for yield is high. The sharp increase in commodity prices-whose trend is generally positively correlated with emerging-market issuance- to unprecedented highs since 1990 however magnifies the risk that gains may be more circumspect in the coming months (see Chart 8). This surge is fueled by strengthening economic fundamentals in the U.S. and Japan as well as voracious appetite from China’s manufacturing sector, which has in turn generated impressive export earnings and stimulated need for additional capital among other issuers based in emerging markets. On a cautionary note, any hiccups in the global growth outlook-especially in Europe where weakness is already manifest-or an unexpected acceleration in interest rates in the U.S. could impede capital flows to the emerging markets and constrain financing prospects, particularly for weaker-rated borrowers.
Scott Holtzman contributed to this report.