All emerging market bonds are not the same

11 Jan, 2017 by Dwarka Lakhan

Emerging market debt is relatively safe and offer potentially greater yields

As emerging market (EM) bonds become an increasing larger component of the global bond universe, it is not unusual for investors to classify all EM bonds as the same. But the truth is: there are different types of EM bonds – sovereign, corporate, and local and hard currency.

While EM bonds are considered risky, the asset class has grown by an average of over 20% per year between 2004 and 2015 to reach over US$16 trillion or almost 12% of all bonds issued globally[i] – largely due to the higher yields they offer and the decreasing risk of default.

This growth rate is faster than that of developed market (DM) debt, highlighting the increasing importance of emerging market debt which has become a fully integrated component of the global bond market.

Currently, over 65 geographically diverse EM countries and more than 500 EM corporations issue debt in either hard or local currencies.

Basically EM debt can be classified into two broad categories:

Sovereign debt, and
Corporate debt

These two categories can be further subdivided into two additional categories:

Hard currency sovereign and corporate debt, and
Local currency sovereign debt

Sovereign Debt

Sovereign debt is issued by governments of EMs in either hard currencies like the US$ and Euros or in the local currency of the issuing country.

Corporate Debt

Corporate debt is issued by domestic and multinational companies domiciled in emerging markets in either hard currencies like the US$ and Euros or in the local currency of the issuing country.

The shift to local currency debt

Traditionally, the greater portion of emerging market debt was denominated in either US$, or Euros. However, that has changed in recent years with the greater portion of EM debt now issued in the currency of the issuing country.

EM Debt Breakdown[ii] (by type)

(as of December 31, 2015)

EM Sovereign Local Currency Debt US$7.6 trillion

EM Corporate Local Currency Debt US$5.6 trillion

EM Sovereign Hard Currency Debt US$744 billion

EM Corporate Hard Currency Debt US$1.7 trillion

Why the shift to local currency debt?

The shift to issuing debt in local currencies has resulted from improved credit ratings of EM; significantly higher economic growth; substantially lower debt levels; and much higher foreign reserves – resulting in EM countries becoming less dependent on external borrowing. Incidentally, bonds issued in local currency are not susceptible to swings in hard currencies like the US$ or Euros, reducing currency risk for investors and making issuing countries less vulnerable to defaults on hard-currency denominated debt.

[i]BAML Research as of April 18, 2015

[ii] Barings Viewpoints, June 2016

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.