Eastern European countries pledge to develop local-currency bond issuance despite liquidity concerns
19 May, 2017
Eastern European governments are bolstering domestic debt issuance and driving through structural reforms to strengthen local currency markets, according to four market participants. They are seeking to break their dependency on foreign-currency investment, increase resilience and mitigate exogenous shocks to their economies.
Georgia’s five-year lari-denominated bond in April set the stage for an increase in sovereign issuances in local currency, said sources, with talk of wider Eastern European push for deals. But while this could ease volatility risks for the sellers, market participants looking at the region still believe that appetite is restrained by a lack of market liquidity.
The increase in demand for local-currency paper is all about “risk assessment”, according to André Küüsvek, director for local currency and capital markets development at the European Bank for Reconstruction and Development (EBRD).
“The primary reasons for the development of local currency capital markets are the overall indebtedness of a country and the exchange-rate risk, which guide both government and corporate markets,” said Küüsvek.
But Georgia has done well, he added, starting from a very low point following the collapse of the Soviet Union. For many years, much of the Georgian population lived below the poverty line. But over the past 10 years the country helped to improve its purchasing power through financial reforms. These included new legislation for capital markets, institutional frameworks, a more robust banking system and stable interest rates. In October, the World Bank ranked Georgia sixteenth among 190 economies in its Doing Business 2017 report.
This has provided a template for other countries in the region whose currencies have been devalued, such as Ukraine.
“We have seen the currencies in the region develop significantly,” said Küüsvek. “The Ukrainian hryvnia, for example, lost overall 70% of its value three years ago, and when these shocks happen the foreign-currency denominated debt increases, coinciding with a banking crisis.”
Notable currency stabilisations in the region include Belarus and Moldova, according to IMF data, both improved in the past six months after big depreciation against the US dollar in the previous two years. Such stabilisation has helped improve macroeconomic fundamentals and made local-currency issues less risky for borrowers.
“For local-currency issuance, the buyside takes the exchange-rate risk, not the sovereign,” said Mikhail Volodchenko, an analyst at Old Mutual Global Investors. “Countries can always print more currency and inflate themselves out of a crisis, whereas when there is a shortage of foreign currency they have to go and find it somewhere else, perhaps by issuing in US dollars.”
Another advantage of local-currency bonds is that issuers face less restrictions in coming to market. There is little requirement for roadshows and borrowers can issue under existing local regulatory frameworks.
“Regulation (regulatory framework) is not lagging behind,” said Laurent Develay, portfolio manager for emerging local debt at BlackRock. “It is not similar to developed markets, but it has improved over the years and very quickly. You simply can’t compare local-currency markets to those of countries relying on hard-currency debt.”
Ashmore, the emerging markets (EM) investment manager, published research on 16 May concluding that overall EM local bonds will likely outperform all other government bond markets in the world over the next five years.
“EM bonds should continue to yield at least 6% per year,” said Ashmore in the note. “This will keep real yields comfortably within positive territory, since EM inflation can be expected to rise gradually towards 5% over the period. After falling more than 40% between 2010 and 2015, EM currencies have room to recover at least half of their losses over the next five years under reasonable assumptions for the EM-US inflation differential. Taking into account both carry and FX upside, we expect total return to EM local currency bonds between 48% and 63% in dollar terms over the next five years.”
According to Develay, Hungary has set an example for the region with 74% of the country’s debt denominated in local currency and 26% in foreign currency (mainly the euro and US dollars).
“The country relies much more on local-currency debt because you have a stronger local investor base made of local pension funds, insurances, apart from foreign appetite,” he said.
Despite higher inflows towards Poland, Hungary, Czech Republic and Romania – where investors find more stable currencies – “yields in Eastern Europe remain relatively low, offering 2 to 3% over German bunds,” said Volodchenko.
Alongside lower-than-average EM yields, appetite for Eastern Europe may be lulled by lack of liquidity in the local markets, usually associated with low domestic savings.
“If there were more liquidity in the market, you would see a higher demand,” said Volodchenko. “Once you buy it, it is very hard to sell it because you don’t see a lot of liquidity, with the exception of Poland, Hungary, Czech Republic and Romania.”
For Develay, it is more a matter of the levels of capital controls than liquidity.
“Little-to-no capital controls in a country means more liquidity in the market,” he said, “which is the case for most Eastern European countries at the moment which are developing into more mature markets.”
The result of this, said a London-based trader, is that the overall local currency debt curve has tightened and yields are slowly increasing towards the 6% average forecast by Ashmore. This, said the trader, is “making these papers more attractive over time.”
“Markets are developing step by step, but there is still space for more,” the trader said.