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Johannesburg - Sovereign debt markets have deepened and transformed over the last 15 years, defying the traditional view of the inability of emerging economies to borrow in their own currency, according to a Moody's report released on Wednesday.
The report took a close look at the emerging market sovereign debt market.
“The deepening of local sovereign bond markets has allowed governments to shift a growing portion of their funding to local currency instruments.
"This suggests they will be less susceptible to shocks and it should also contribute to the development of domestic financial markets for use by other borrowers, not only sovereigns,” said Elena Duggar, senior vice-president, credit policy and a co-author of the report.
Moody’s research shows that local currency sovereign debt outstanding grew on average by 14.4% each year between 2000 and 2014, well above the annual average 2.3% growth rate of foreign currency sovereign debt, and going against the traditional view that emerging economies can sometimes struggle to borrow in their own currency.
It also found that an improved inflation record, stronger institutional enforcement, improved protection for creditors and a strong macroeconomic performance have supported the development of domestic markets in recent years.
Mike Schüssler of Economists.co.za told Fin24 this is actually good news. That is because Moody's is saying that emerging markets have grown up somewhat and that, while they now have more debt, more of that debt is in local currency and the payback over time is more structured for their economies.
"This means that big falls in currency values that SA or Brazil have at present, for instance, will not have the same negative effect as in 2000. Emerging markets are, therefore, a little more robust than they were during the Asian/Russian crisis of 1998," said Schüssler.
"We are seeing emerging market currency values drop, so this information is timely and it is probably helping many of the countries to explain themselves to the investor of the world in a more realistic way."
READ: Nene cautions on growing government debt
This change in the mix of how debt is made up is important, Schüssler pointed out, as in local currency governments only pay the interest and the foreign loans, while often at cheaper interest rates. Vulnerability often ensues when currencies fall dramatically, as is the case in almost all emerging markets.
"Emerging markets will be able to withstand larger falls in the value of their currencies than before. Good news in a sea of red, but is anybody listening?" asked Schüssler.
"The fact that the world's second largest ratings agency feels it needs to put out the fact that big emerging markets have become more dependent on local debt rather than foreign debt, may also actually show how big the current 'crisis' is becoming, as currency falls have been huge.
"Overnight the market again 'tanked' and that, perhaps more than anything, shows that often, once panic sets in, even calm and reasonable facts are thrown out with the bathwater and nobody is looking at good news."
Finance Minister Nhlanhla Nene also recently referred to the impact of South Africa’s low dollar debt levels, which are helping to shield Government finances from a weakening rand.
“Our debt is mainly rand-denominated, only a very small percentage of our debt is dollar-denominated. So it does have an impact, but it’s not as bad as it would’ve been if we were exposed beyond where we are,” Nene said in a Bloomberg interview.
The Moody's report found that the growth of local institutional investors, such as pension funds and insurance companies, further supported domestic demand, while the backdrop of high liquidity and low interest rates in advanced economies after the financial crisis contributed to foreign investors moving into emerging market asset classes.
The fastest growth in emerging market sovereign debt was seen in Asia, where it has expanded sixfold since 2000 to $5.7trn, with an average annual growth rate of 14.5%. Debt in Latin America has grown at an annual average of 9.3%, followed by the Middle East and Africa at 8.4% and Central and Eastern Europe at 7.6%. At the end of 2014, Africa and the Middle East accounted for 9.7% of total emerging market sovereign debt.
Africa and the Middle East regions issued most of their large sovereign bonds in foreign currency under foreign law.
"Overall, the deepening of local sovereign bond markets has allowed governments to shift a growing portion of their funding to local currency instruments. The associated decline of currency (and maturity) mismatches reduces the vulnerability of these countries to economic shocks and increases the effectiveness of monetary and fiscal policy," said Duggar.
"Nevertheless, developments are not uniform across countries. The positive effect of the switch to local currency financing depends on the maturity profile of new debt issuances and also on the extent of foreign investor participation in local currency markets. Research shows that foreign participation provides additional source of financing and reduces sovereign yields, but at the same time may transmit global financial shocks to local-currency sovereign bond markets and increase yield volatility."
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