Developing countries issuing bonds in local currency

[quigleydoor]

The Financial Times ran two articles (links below) in recent days on a growing trend: developing countries are issuing bonds denominated in their own currencies, instead of dollar- or euro-denominated bonds. It is another theme in the credit markets, indicating another group of foreigners who are losing faith and dependency in the American-led financial system and American paper. While today we have one big liquidity spigot, slowly being shut as interest rates rise, it seems like the future will be a system with many small liquidity spigots. The governments of countries like Egypt are nurturing their own financial institutions, so that someday they will be able to create money on their own terms.

The Financial Times quoted Egypt's finance minister as saying:

We are going to the international markets in order to connect them to our own domestic capital markets. . . . Turmoil in the market has not affected the appetite for Egypt. Our offering was 2˝ times oversubscribed. People are convinced Egypt has a serious story to tell, and that we are operating a serious programme of reform that has already proven its effectiveness. . . . Investors already see Egypt as investment grade - the ratings agencies will catch up soon enough.

The Egyptian issue is a 5-year sovereign bond with a yield of 8.875%. It is payable in dollars, even though it is denominated in Egyptian pounds. Egypt plans to follow this issue with longer maturity bonds later this year.

Just like with the scary stories of Iran pricing oil in yen, it is still easier for everybody to transact in dollars, even if the underlying assets are not priced in dollars. So Egypt is not really creating its own independent money, yet! However, as FT explains, these new types of bonds will assure greater stability in emerging markets' finances:

The growing interest in local currency bonds is likely to sustain development in instruments that can help emerging economies protect themselves from potential external financial shocks. In the past, denomination of debt in dollars or another foreign currency has played a key role in virtually every financial crisis in the emerging market world since the early 1980s. According to a recent report into the subject by the Bank for International Settlements, “the conscious nurturing of local currency debt markets became a major objective of financial policy in many countries,” in the past decade.

Another reason to be interested is that this is a new asset class, distinct from the more well-known "emerging market debt" asset class, which usually considers only dollar-denominated securities, issued in the Washington Consensus format of the 1990s (see Brady bonds). In the case of local-currency-denominated debt, investors can obviously benefit from exposure to other currencies. And emerging market currencies as a group have shown strong, steady appreciation against the United States dollar, since at least the 1980s. (I remember seeing a chart of this remarkably smooth line, but I don't have a source for you.)

Local currency fund flows have been considerably stronger than those into hard currency funds [sic] this year in percentage terms, with $1.7bn of inflows into pure local currency funds, 28 per cent of their total assets, compared to $2.2bn of inflows into hard currency funds, only 6.6 per cent of their total assets. “Local currency funds are capturing a greater share of flows and this is certainly clear over the past four weeks,” he says.

I am amused by the bond market doublespeak of calling USD-denominated bond funds, "hard currency funds", so I had to stick a [sic] in there. The point is that, as an asset class, investors are piling into local currency bonds at a very high rate, relative to the size of already invested funds.

[jk]

Re: Developing countries issuing bonds in local currency

for those who might be interested, pimco has a mutual fund - "developing local markets" - which invests in this market.