In the search for investment yield, one asset class that is expected to grow significantly in the coming years is global local currency bonds, with recent macro conditions set to spur new demand.
Global Head, Capital Markets,
Global local currency bonds are bonds issued in local currencies and offered in offshore markets internationally. These bonds have been around for many years now and are steadily gaining traction from issuers and investors. They are attractive because issuers can settle and repay in the issuance currency or synthetically in a hard currency, like the US dollar.
For global investors, they stand to gain from the strong economic fundamentals of emerging markets and yet avoid potential challenges of local investment requirements. These requirements vary from market to market and could include prohibitive rules on forex hedging and conversion, high withholding taxes, or difficult custody processes. The complexities raise the cost of investment, and by extension, lower the return on investment. Global local currency bonds therefore fill a much-needed gap in the investment community: they provide an easy access to emerging markets and at the same time lower the cost needed in exchange for the higher yield. Local currency bonds tend to be less impacted by global events, offering portfolio diversification to the savvy investor.
For issuers, the associated credit risk may not necessarily be higher compared to hard currency bonds as well, with governments and state-owned enterprises among the common issuers of such bonds. Global local currency bonds expand the capital available to local issuers, especially if onshore liquidity is lacking relative to the size of the debt being issued.
To borrow in local currency often makes more sense. Whether it is a long-term infrastructure project or simply capital for general growth, the associated cash flows of these operations, more often than not, are in local currencies. Borrowing in local currencies therefore alleviates the need to hedge their liabilities as global local currency bonds would appear as a local currency liability on their balance sheet.
Issuing a local currency bond offshore is likely to cost less as well, especially if issued in tax-friendly jurisdictions. For instance, if an Indian company wishes to issue a rupee-denominated debt onshore, it is likely to carry an interest rate of approximately 7.5% - 9.0% at the time of writing. A Masala issuance (rupee bond by Indian issuers in offshore markets) settled in USD, however, is often below 7%. Besides the lower cost of borrowing, it also diversifies the issuer’s borrowing profile and expands the investor’s base.
A case in point: An Indonesian manufacturing firm may issue a rupiah-denominated bond to raise capital for a major expansion project where they require rupiahs to pay for the purchase of capital assets. The appetite for such a bond in the local Indonesian market alone may not provide for all the capital required by the firm. If the firm chooses to issue the bond offshore, international investors are then able to subscribe to it, hence effectively expanding the investor base and achieving the funding objective.
The time is now
We see the continued deepening of local currency bond markets driven by increased investor demand for exposure to local markets, especially in the emerging markets. Local currency denominated debt from the top eight emerging markets by size has grown steadily from 10% of global issuances in 2013 to 16% in 2016 (Bloomberg). The debt to GDP ratios of many emerging markets are also at levels significantly lower than those of the developed markets, which indicates room for expansion. China’s ratio, for example, is about 16%, while that of developed countries like the US and Germany hover around 70-75%.
Add to that, many Asian local currencies have been outperforming the US dollar in recent times, which provides further upside to investors that take a longer view of local currency bonds. The potential here is immense and should remain a market to watch.
About the Author
Henrik Raber is the Global Head of Capital Markets at Standard Chartered Bank. He joined the Bank in July 2009 as Regional Head of Capital Markets for Europe, Africa and Americas, and took on the role of Global Head of Debt Capital Markets in March 2010 before assuming his current role in mid-August 2014. Prior to Standard Chartered, Mr Raber was with UBS Investment Bank, where he headed European Credit Flow Sales and Trading, which encompassed Investment Grade, High Yield and Loans. Before working at UBS, Mr Raber was with Lehman Brothers for eight years in Fixed Income credit trading and capital markets.
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