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During the 1990s as emerging market sovereigns shifted increasingly from bank debt to bonds for their capital needs, the pessimists painted a desolate picture in the case of a future default. They foresaw sovereigns locked out of the market for years as bondholders argued about restructuring and fought for compensation through the courts. The bad publicity would ensure that a defaulting sovereign was unable to sell its bonds to private investors for decades. How both investors and issuers would long to return to the bank debt era, reasoned these analysts, when only a few parties were involved in the negotiations and, with patience, all the problems could be solved.
But after all the gloom-mongering things have not turned out so badly for emerging-market sovereigns raising money via bonds. Over the past two years there have been a number of spectacular defaults, the most high profile of which was Russia's in August 1998. Although Russia defaulted on domestic bonds and Soviet-era debt, not Eurobonds, investors still charged that the sovereign would never again be trusted with their money. There was much wringing of hands, cussing and heated argument. As one investment banker puts it: "Suddenly the world as we knew it came to an end."
Yet only two years on, and even before this month's completion of the London Club debt exchange, Russia's return to the international bond markets is being contemplated. More than that, analysts are prepared to put a return in a timeframe of between one and two years. Investment banking interest in Russia has suddenly passed back from the debt negotiators to the originators. Once again Moscow's mandate hunters are writing out cheques at the city's best restaurants and prospectus writers are sharpening their pencils and consulting their thesauruses to find the most alluring adjectives to describe the Russian strategy.
If Russia, which is noted for its cavalier attitude to investors, can come back to the markets so quickly, who else could also be in line? To find out Euromoney asked rating agency Standard & Poor's to put together tables showing which emerging market sovereigns, on the evidence available, could soon be out roadshowing for investors. The agency came up with seven tables showing the prospects for defaulted sovereigns and for countries that have not accessed the bond markets in the recent past. S&P's managing director for sovereign ratings, David Beers, used a combination of statistical information such as the ratio of external debt to GDP, total bank lending, fiscal criteria, GDP growth rates and GDP per capita, as well as his own knowledge of the countries to produce the results.
What is interesting is that countries associated with very recent and contentious defaults - Russia, Pakistan, Ukraine and Ecuador - are all tipped as possibly returning within one to two years. Pakistan's and Ukraine's return are conditional on an improving political situation. Ecuador will need to restructure existing defaulted debt. All three, though, could be back in the international markets before 2002. For them there is no question of experiencing "a lost decade of development" as happened to Latin America while that continent struggled out of the bank debt crisis of the 1980s. If such countries care to take the message to heart that their policies must be changed and can demonstrate this to investors, their paper can soon be back in international portfolios.
Other analysts who were shown the S&P tables agree broadly with the conclusions. Although they might argue that a particular sovereign needs a longer or shorter time to access the markets, they all accept that the era of the bond is one of fast recovery from defaults and speedy rehabilitation into the market. This may well encourage other sovereigns that have never issued bonds to consider doing so and would lead to the maturing of the international bond market. For although the number of emerging-market sovereigns issuing is on the increase it is still far less than the number of governments which enjoyed cross-border finance in the run-up to the 1980s debt crisis. Many potential candidates have yet to take the plunge.
In the one-year to two-year timeframe, sovereigns not in default that could come to the market include a mixture of countries (table V) some of which are recovering from difficult economic circumstances, such as Bulgaria and Romania; others that are relatively comfortable and do not desperately need the money such as Egypt, Morocco and Algeria; and others where the political situation is acting as a constraint, such as Iran and Sri Lanka. In the case of Bulgaria the introduction of a currency board so reversed the flow of money that it went from being desperate to comfortable in a short space of time and could now come to the market this year.
In Iran, accessing the capital markets has found its way onto the political agenda since reformers see it as a way of bolstering the liberalization process. Conservatives oppose it for the same reason. Everything depends on which faction triumphs. Sri Lanka's debut depends on a settlement of the civil war.
Several emerging-market countries are in the fortunate situation of being able to access the market but not needing to do so for financial reasons. Their minds could be changed, however, if sovereign issuance was considered a prudent move for setting a benchmark for corporate issuers. Egypt is a good example of a country in this position, although a Fitch IBCA report on it is cautious about the prospects. "The government is likely to continue to make net repayments of external debt. The authorities have for several years considered issuing a Eurobond to establish a benchmark for private-sector borrowers, but this would require both the president's permission (which may not be forthcoming) and optimal pricing conditions," says the report.
Richard Luddington, managing director of emerging market origination at JP Morgan in London, says: "Egypt could access the bond market. It has no real need for the money given its high level of foreign reserves, but it would be beneficial as setting a benchmark for other entities from the country and for promoting Cairo as a regional financial centre. A successful debut bond would put Egypt firmly in the regional peer group of Tunisia, Oman and Qatar which have proven access to the international bond markets."
Similarly, Morocco has talked about issuing for years and Algeria's fiscal situation has been helped considerably by the oil price rises. For all that, Algeria is very much in play. Debt traders actively trade Algerian paper and Chase is starting to take investors on visits to the country satisfied that the security situation has improved.
Nigeria is the example par excellence of the new bond environment. Nigeria is behind in its official Paris Club debt but current with its Brady bonds. There is an argument about how much Nigeria owes and the $1.5 billion in the current budget for servicing it is probably insufficient. Nigeria is a prime candidate for the IMF's burden-sharing approach to indebtedness whereby private investors are forced to take their share of the pain. "The next candidate for burden-sharing is Nigeria," says David Boren, global strategist at Montpelier Asset Management, which invests in emerging market debt. "The budget allocation is insufficient to meet the demands of the Paris Club, the multilaterals and private investors."
Given this background, Nigeria is hardly a country that can be expected to get a rapturous reception in the bond market. Yet it can be included in the list of sovereigns likely to access the market within one or two years because of the likelihood of some kind of restructuring. Debt exchanges illustrate the flexibility of the markets in accommodating the different needs of borrowers.
Says Chase's director of research for international fixed income, Robin Hubbard: "There are two types of exchange offer. One type is where collateralized debt is swapped for uncollateralized such as Brazil and Mexico exchanging Bradys for new Eurobonds. There is some imbedded value in the collateral which the market cannot use in the same way that the sovereign can. This drives the issuer to the market. The second type is where a debt exchange is used as an alternative to default as was the case with Pakistan and Ukraine. Nigeria is likely to fall into the second category, whereas Bulgaria could come into the first."
Moving out to a horizon of two to five years, many more sovereigns are brought into the issuance frame including both defaulters and countries that have discussed issuance for years but never gone ahead (tables III and VI).
The oil price is a key factor for many of them. The Gulf oil states have relied on oil revenues to finance all of government expenditure with little or no need to impose taxes. When the oil price was low these countries were starting to undergo reforms and diversify their sources of raising money which could eventually have included the capital markets. But with the oil price bouncing back they have temporarily been let off the hook. Some African countries could use oil revenues to put together some form of structured financing, probably the only option available to them.
Moody's has given Saudi Arabia an unsolicited rating but the country has not sought a rating as it has no wish to open up the books to outsiders. That desire for secrecy may have to change if the oil market does not stay buoyant. It would need to get rated to issue in the bond market. With Bahrain, which does not have sovereign oil resources, giving the country a rating is complicated by the offshore banking sector, which adds to the country's liabilities.
An exciting name in the two- to five-year list is that of India. With its great economic power and standing there is no doubt that India could issue if it wanted. Indeed India also belongs to a group of countries that could arguably issue at any time because of the buying power of Indian banks and expatriates. Lebanon is a sovereign that can issue in the worst kind of political environment for exactly these reasons. But some analysts argue that with India the debate over price could be particularly intense, with the sovereign eschewing the kind of coupon that would attract investors. The pessimists foresee Russia delaying its return to the market for exactly the same reason.
The external situation will clearly have as much bearing on issuance timetables as a sovereign's internal circumstances. Some analysts feel that in the current environment of increasing US interest rates and high volatility the prospects for a rush of issuers are poor.
"I am pretty pessimistic for a lot of the issuers on the list unless the situation changes dramatically. US interest rates need to be trending downwards for investors to look to new issuance by emerging-market sovereigns for extra yield," says Montpelier's Boren.
But economic conditions could change dramatically over just a few months allowing new issuers to come to the market. Chase's Hubbard says his view is that the list should be divided not so much on time horizons as between those sovereigns that could issue if the conditions were right - such as Algeria, Bahrain, Botswana, Bulgaria, Egypt, India, Jordan, Morocco, Peru, Saudi Arabia - and those that are unlikely to issue whatever the conditions. In this last category, he puts Kenya and Bangladesh. Says another banker who focuses on Africa: "The only sub-Saharan African name that is likely to issue is Botswana. Botswana could issue if it needed the money but otherwise I can't see anyone else issuing clean bonds. Structures based on oil or projects are a possibility."
Structured financing would be the route back for African credits Gabon and Cameroon which the S&P defaulters' table has as possible returnees in a two- to five-year timeframe.
Côte d'Ivoire, in the same table, which earlier this year delayed an interest payment, falls into the category of countries that might do an exchange as a substitute for defaulting while Indonesia could arguably do a straight bond issue in time as its debt-restructuring process bears fruit.
"Indonesia is one of the most likely in a five-year horizon," says Boren. "External debt is approaching 100% of GNP now they have taken on the banking sector's debt and there is a big requirement for diverse sources of financing."
Pre-crisis Asia was considered to be an equity rather than a debt market. Post-crisis, several countries such as Indonesia, Thailand and South Korea have much larger debt burdens emanating from the public and private sectors. With official flows there may be a desire to raise private-sector money to pay off debts. The incentive to access the market will depend on the terms of the bail-out capital.
Mexico quickly returned to the market to refinance its bail-out package arising from the 1994 crisis. Morocco has fixed-interest Paris Club debts granted during the 1980s, when interest rates were higher, that could probably be refinanced more cheaply in the current bond market.
Jerome Booth, head of research at Ashmore Investment Management - which is launching an emerging markets equity fund to go alongside its debt funds - raised the question of whether countries that fall under the highly-indebted poor countries (HIPC) initiative, launched at the autumn meetings of the World Bank and IMF, should be included in the list. At the outset no HIPC countries appeared, in the revised version published here Bolivia was included. Booth's argument was that countries that struggled to meet the requirements of the HIPC programme would be sufficiently advanced in their reform programme to access the markets. It might be preferable, he argued, to use money raised from bonds to repay official debts rather than be tarnished with the ignominy of seeking debt forgiveness. Ghana and Benin are two countries that have been discouraged from seeking relief because of the Japanese policy of refusing new bilateral aid to countries that default.
"To qualify for HIPC you have to dutifully follow prescribed polices at the end of which a country could access the markets anyway," says Booth. "HIPC is not offering very much and there is no HIPC part two. But accepting it may cut a country off from the markets."
Booth also thinks that the HIPC programme tackles the problems of the stock of debt rather than the more critical question of flow of money. His argument is that if the conditions are right for investment to flow into a country the stock problem will eventually take care of itself.
But Chase's Hubbard thinks that accepting debt relief does not prejudice a country in the eyes of private bondholders. "The private sector doesn't care if the official sector takes a write-off," he says. "It's only the official sector that cares what happens in the private sector [in it's push for burden-sharing]."
Finally, the S&P tables IV and VII give examples of countries, in default or not, that are unlikely to come to the markets in either the short or medium term. These are mostly either sovereigns where politics is a barrier such as Cuba, Iraq, Myanmar, North Korea, Serbia and latterly Zimbabwe, or places that are cash-rich and don't need the money, such as Brunei, Hong Kong, Kuwait, Taiwan and the UAE. Paraguay could arguably be put in both lists since the involvement of the military in politics makes it something of a pariah state while its connections to Taiwan provide it with finance.
Investor perceptions are very important in deciding which countries can access the markets. Argentina is usually cited as the emerging-market sovereign that does best at tapping the markets frequently and cheaply because of its success in selling its story. Says JP Morgan's Luddington: "Ultimately it's not a question of price that determines when or whether a sovereign can access the market but the country's success in selling the story."
He highlights the achievements of the Slovakian finance minister Brigita Schmognerova in participating in roadshows and also delivering on her promises and of Argentina with its debt management team that is out promoting the credit all year round.
By contrast credits such as the Philippines that do not access the markets frequently have a tougher time selling their story. Papua New Guinea, which appears in table VI as a prospective bond issuer over the next two to five years, was actually roadshowed for a bond last year but in the end there was insufficient demand and the bond was never issued. Although Papua New Guinea has some pluses, such as being in the Commonwealth and enjoying support from Australia, there is probably too little known about the credit for it to issue a bond without more extensive marketing. An argument by analysts about the true state of the country's fiscal position at the time of the roadshow did not help in getting the credit's name established.
With sovereigns that have defaulted, some analysts make the distinction between those that were willing to pay and couldn't and those that had the capacity to pay but were not willing. Ashmore's Booth says that Ecuador had the capacity to repay but was persuaded not to under the influence of the IMF's burden-sharing stipulations. Venezuela is a country that has the capacity to pay but its bonds trade at very high spreads because the government is viewed as unpredictable.
S&P's Beers dismisses the idea that burden-sharing has forced countries such as Pakistan and Ecuador to default: "Pakistan is highly leveraged, that's the reason for the restructuring" he says. India and Pakistan were both subject to financial sanctions after the missile tests, says Beers, but India had the financial capacity to manage, unlike Pakistan. With Ecuador some people have blamed the IMF but if you look at the numbers Ecuador is one of the most highly leveraged sovereigns, much more so than Venezuela, he says.
But Beers agrees that a debt burden alone does not faithfully describe a credit. "The debt burden in Argentina is lower than the UK's," he says. "But that does not mean that Argentina is more creditworthy than the UK. You have to consider a country's credit history. After all, one way to lower your debt burden is not to pay and then get debt relief."
The speed at which defaulting countries are restructuring is lowering the amount of outstanding defaulted debt. This is just as well since more defaults are expected as lower-grade credits come to the market. As with corporate bankruptcies, where the stigma is lessening and those involved can quickly move on to new ventures, sovereign credits can come to the market, default and return much more quickly than in the past.
Says a S&P article dealing with the issue: "The dollar value of defaulted obligations now looks set to fall below last year's out-turn ... given the pace at which debt workouts are being completed. Thus far in the current default cycle, creditors and debtors are restructuring debt more quickly than was typical in earlier years. This represents an important milestone, one that will continue to be tested if sovereign defaults increase over the decade, as Standard & Poor's expects. Meanwhile, the market's evident capacity to manage debt workouts may have an ironic consequence by reducing the impetus to global financial architecture reform."
With debt workouts, the pessimistic view was always that thousands of bondholders with different interests would scupper the proceedings. In reality, bondholders realize that when a sovereign defaults they have little choice but to accept the terms of the restructuring. The choice is usually between getting paid a little or getting paid nothing. With Russia, creditors were in the weakest of positions since prior to the restructuring the obligor was Vnesheconombank, not the sovereign. The prospects for suing Vnesheconombank to recover Russian debts were highly remote. Even in the best of circumstances, suing a sovereign is unlikely to be a fruitful option.
Says Chase's Hubbard:"Investors generallydon't accelerate [demand early repayment from] a sovereign because there is no point in accelerating a sovereign. The sovereign can't be closed down when it doesn't pay. It's not like a corporate bankruptcy."
Hubbard cites the example of Côte d'Ivoire, where investors have not accelerated. He adds, however, that investors are not always so docile. In the case of Ecuador, the attempt to use interest collateral of the country's discount bonds to meet interest payments while cash would be used for non-collateralized bonds led discount bond holders to accelerate to prevent their being discriminated against. "In the event Ecuador defaulted on all bonds and no further acceleration took place supporting the general point," says Hubbard.
There is also a debate over what it means to be in default. According to Ashmore's Booth, creditors would have to vote a sovereign into default to meet a legal definition. That rarely happens because it is pointless. But S&P has a much stricter definition. For the rating agency, default is the failure to meet a principal or interest payment on the due date in accordance with the original terms. With bonds an exchange offer that is less favourable, even if agreed to by investors, counts as a default.
Certainly, bondholders are going to be on the wrong end of more unfavourable exchanges in future. They are going to declare, in pique, that particular sovereigns will never issue bonds again. But the reality is that times were never so good for governments to borrow money, screw up and start again. |