‘Original Sin’ Returns as Emerging Markets Plan Bonds (Update1)

By Lester Pimentel
Dec. 31 (Bloomberg) -- Developing nations plan to sell the most dollar-denominated bonds since 2005, reversing a shift into local debt, as commodities prices fall, foreign reserves diminish and emerging-market currencies weaken.
International sales may rise 68 percent to $65 billion next year, according to estimates by ING Groep NV. Mexico raised $2 billion in a Dec. 18 offering. Peru’s Finance Minister Luis Valdivieso met with investors in New York, Boston, London and Madrid this month to drum up interest for the country’s first foreign sale in almost two years.
Governments are growing more dependent on international markets after the six-month drop in raw materials reduced earnings from exports and caused budget deficits to widen. Dollar borrowing will increase foreign-exchange risk, a pattern that led countries across Latin America to default in the 1980s, said Ricardo Hausmann, director of the Center for International Development at Harvard University in Cambridge, Massachusetts.
“Countries will be forced to issue in dollars,” said Hausmann, a former Venezuelan planning minister who called developing nations’ reliance on foreign markets the “original sin” in a 1998 article in Foreign Policy magazine. “Debt structures will deteriorate again.”
Dollar bond sales fell 43 percent in the past three years from $68 billion in 2005 as a 134 percent surge in commodities, as measured by the UBS Bloomberg CMCI Index, helped countries repay foreign obligations, according to Amsterdam-based ING. Local-currency debt offerings rose 23 percent annually since 2005, according to the Bank for International Settlements in Basel, Switzerland.
Declining Reserves
Colombia moved 71 percent of its debt into peso-based securities, up from 48 percent in 2002, according to Finance Ministry data. Eighty percent of Mexico’s obligations were in pesos in 2007, up from 55 percent seven years earlier, according to government figures.
The combination of slumping commodity prices since July and the worldwide credit crunch dried up dollar inflows, pushing down emerging-market currencies and draining foreign reserves. Oil, the biggest export from Mexico, Russia and Venezuela, plunged 75 percent from a record $147.27 a barrel.
Russia’s central bank used a quarter of its $598 billion of reserves in less than five months to limit the ruble’s slide against the dollar, according to Bank Rossii. Mexico’s $2 billion sale of 10-year bonds came after its central bank used $15.2 billion, or 18 percent, of foreign reserves to prop up the peso when it fell to a record low in October.
Twin Deficits
Budget needs are swelling. Russia will post its first deficit in a decade next year, Finance Minister Alexei Kudrin said Dec. 27. Mexico forecasts a shortfall equal to 1.8 percent of gross domestic product next year, a gap that UBS AG says would be the biggest since 1990. The forecast is based on an oil price estimate of $70 a barrel, 89 percent higher than today’s $37.11.
Venezuela, which gets about 90 percent of export receipts from oil, may have a deficit in the current account, the broadest measure of trade, equal to 4.3 percent of GDP in 2009 after posting a surplus of 12.5 percent of GDP this year, according to Standard & Poor’s.
“Pressures are mounting,” said David Spegel, head of emerging-market strategy at ING in New York. “Most budgets will be in deficit. They’re going to have to be financed.”
Borrowing costs in dollars rose this year as the credit squeeze triggered by $1 trillion in losses and writedowns at the world’s biggest financial companies eroded demand for all but the safest securities. Investors demanded an average 12 percent yield on emerging-market dollar bonds on Oct. 24, up from 6.92 percent on Aug. 29, according to data compiled by New York-based JPMorgan Chase & Co.
Bond Rebound
Yields on Argentine bonds due in 2033 have soared to over 22 percent from 11.2 percent four months ago after the government seized private pension funds, a move analysts said was aimed at cobbling together financing. Ukraine, Hungary and Pakistan, strapped for cash amid the crisis, reached loan agreements with the International Monetary Fund in November. Ecuador’s President Rafael Correa defaulted this month on $3.9 billion of foreign bonds, calling the debt “illegal.”
The average emerging-market yield fell back to 8.95 percent as the Federal Reserve took unprecedented steps to support the U.S. economy. The Fed cut its target interest rate for overnight loans between banks as low as zero, helping push yields on Treasuries, the benchmark for emerging-market rates, to a five- decade low.
‘Window of Opportunity’
Emerging-market local bonds have also rebounded, posting a 7.7 percent gain in dollar terms this month, as investors anticipate interest-rate cuts in Brazil, Indonesia and India, according to Merrill Lynch & Co.’s LDM Plus Index.
Gerardo Rodriguez, head of public credit at Mexico’s Finance Ministry, said in an interview Dec. 18 that he used a “window of opportunity” to sell the $2 billion of 10-year bonds at a yield of 5.98 percent.
Valdivieso, Peru’s finance minister, said Dec. 22 in Lima that meetings with investors suggested there’s demand for at least $600 million of notes. Russia is also considering an international sale, Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, said in a Dec. 24 telephone interview.
The increase in dollar bonds is unlikely to lead to a wave of defaults like those in the 1980s because developing nations have reduced spending and curbed inflation, Spegel said.
Currency Rallies
Brazil trimmed its budget deficit to the equivalent of 1.2 percent of gross domestic product from 8.8 percent a decade earlier. Inflation fell to 6.4 percent from a high of 6,821 percent in 1990.
“They are coming into the crisis in better shape,” said Igor Arsenin, an emerging-market strategist at Credit Suisse Group in New York. “Increased dollar issuance only poses a risk if we see a protracted period of global slowdown.”
This month’s rebound in emerging-market local-currency bonds left them up 0.7 percent for the year, according to Merrill’s LDM Plus index.
The bonds returned 13.9 percent in 2007 and 12.7 percent in 2006 as currencies rallied. Brazil’s real strengthened 62 percent against the dollar in the four years through 2007, the best performance among the 16 most-traded currencies, while Poland’s zloty rose 52 percent and Colombia’s peso climbed 38 percent.
‘Double Whammy’
Currency gains combined with yields of more than 10 percent in countries including Brazil, Turkey and Philippines proved irresistible to investors, said Jonathan Binder, who manages more than $2 billion of emerging-market assets at INTL Consilium LLC in Fort Lauderdale, Florida.
“It was a double whammy that was highly lucrative,” Binder said. “But it took a short time to reverse” gains, he said.
The real weakened 33 percent from a record high in August. Turkey’s lira slid 24 percent against the dollar over the same period while Hungary’s forint dropped 22 percent.
“You’ll see investor reluctance to fund locally,” said Michael Atkin, who helps oversee $12 billion of fixed-income assets as head of sovereign research at Putnam Investments in Boston. Countries may “find it much more difficult to issue locally and might find it more attractive to issue internationally,” he said.