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Opinion

Emerging markets tough out credit crisis

Emerging market debt has held up well in the face of a nascent credit crunch in developed markets.

A crisis in the US and European credit markets would usually prompt a big sell-off of emerging markets debt. But one of the most notable features of the financial markets over the past two months has been how well the asset class has held up.

Admittedly, bond issues from emerging markets borrowers have begun to be postponed because of worsening market conditions. And the JPMorgan Embi+ index widened to 209 basis points in late July from a record tight level of 149bp over in late May. High beta credits, such as Argentina and Venezuela, have been hit hardest.

To put that in some context, however, the iTraxx Crossover index for European credits widened by more than 100bp over the same period. The two indices have a similar average rating so their relative performances are a good indicator of how the emerging markets are coping given the credit market turmoil.

Just as interesting is what is happening in the primary markets. Over the past two months more than 30 leveraged loans and bonds in developed markets have been restructured or postponed because of the fallout from the collapse of the US sub-prime mortgage market. This list includes the $18 billion leveraged loan for the buyout of Alliance Boots, potentially the biggest-ever European LBO.

In the week beginning July 16, only one investment-grade bond was issued in the US as borrowers and investors were still coming to terms with the closure of two Bear Stearns hedge funds. Even the European ABS market, which has largely ignored the commotion experienced in other markets, took a big hit in the second half of July.

In contrast, several emerging markets borrowers have printed deals. Many of them are high-yield credits with little or no track record in the capital markets yet all of the transactions held up in the secondary markets in the initial days after pricing. Successful borrowers included Interpipe and Pivdennyi Bank from Ukraine. Locko Bank, a private medium-sized bank based in Moscow, and Bank St Petersburg, a Ba3/B-rated credit, also issued bonds. In Asia, True Move, a Thai mobile phone operator, successfully placed a seven-year note.

Ironically, the majority of those emerging markets borrowers that have delayed deals are blue-chip names such as Rosneft, Gazprom and Kazkommertsbank. As these firms are not too anxious about their funding plans they can wait for more benign market conditions to emerge. A few Argentine corporates also postponed their transactions, although that was as much related to the resignation of the country’s economy minister as to any imminent global credit crunch.

What does all this tell us about investor attitudes to emerging markets? Foremost, that they still see value in the asset class compared with other types of securities, even if they are not as bullish as they once were. Emerging markets bond funds, for example, enjoyed 12 consecutive weeks of net inflows from late April to late July, according to EPFR Global, a data provider that tracks fund flows. The run came to an end in the week ending July 20, after investors pulled $113 million. High-yield funds, in contrast, were hit with redemptions for six consecutive weeks.

Another conclusion that can be drawn is that the market is still open for responsible, pragmatic borrowers that are realistic in their pricing. Both Pivdennyi and Locko priced their deals with a generous new-issue premium. And although some investors, such as hedge funds, are turning away from new issues, long-only investors are committed.

Emerging markets remain attractive because their fundamentals have improved immeasurably over the past few years. Of course, the situation could change quickly if the US credit markets deteriorate further. A big spike in emerging markets debt prices cannot be ruled out. But generally the technical outlook for the asset class is positive. And that in itself is remarkable given the woes elsewhere.

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