Analysis: New emerging debt won't top this year's record in 2011

LONDON Thu Dec 16, 2010 10:57am EST

LONDON (Reuters) - Emerging market debt issuance is likely to fall in 2011 from this year's record levels, as competition from euro zone borrowers and rising U.S. Treasury yields sap demand for the asset class and raise funding costs.

Emerging market borrowers issued a record amount of new debt this year, spurred on by their own financing needs and by investor enthusiasm for riskier assets due to rock-bottom yields and money-printing in the developed world.

Comparatively healthy fundamentals compared with debt-laden developed economies are likely to cut emerging borrowers' debt needs next year.

Rising yield premiums for many euro zone sovereigns may also dim the relative attraction of emerging market debt, while rising U.S. Treasury yields are likely to lessen investors' appetite for risk. Signs the U.S. economy is recovering may also encourage a move out of fixed income assets and into equities.

Estimates of new emerging issuance for next year range from $240 billion to $276 billion, compared with up to $290 billion this year, and returns are also expected to fall.

Predicted volumes are still high compared with previous years, when issuance struggled to top $200 billion.

Debt-hungry euro zone sovereigns, on the other hand, need to raise at least 800 billion euros next year.

Some euro zone debt is already yielding more than that of better performing emerging markets countries. For example, borrowing costs for top-rated France, the No. 2 euro zone economy, have risen above those of Thailand in the past week.

"Emerging market and euro zone borrowers will be competing," said Agnes Belaisch, fund manager at Threadneedle. "I am not sure in this competition which side will win."

She said the outlook for the next few months is uncertain.

"There was a massive repricing of risk in November in the United States and the euro zone, (and) emerging markets stepped back into the risky asset class," Belaisch said. "There is a lot of fear and apprehension."

JPMorgan forecasts $240 billion in new international bonds by emerging market borrowers next year, below record levels of $280 billion in 2010.

Its forecast for sovereign issuance is $76.9 billion, in line with $75.5 billion issued by mid-December this year.

But the bank told clients that returns on emerging debt will decline, with equities benefiting more than debt from quantitative easing in the United States.

"After posting 13 percent year-to-date returns in 2010, it will be a struggle for emerging market fixed income assets to generate even half of that return in 2011," it added.

SPIRALLING YIELDS

One of the key themes for 2010 has been the record level of emerging corporate debt issuance, as continued constraints on bank lending have driven companies into the bond market.

With some emerging economies trying to row back the currency-ramping tide of money coming into their domestic debt markets, international bonds denominated in local currencies have also proved popular, particularly in Latin America.

Emerging sovereign debt spreads have held relatively steady against rising U.S. Treasury yields in recent weeks, but absolute yields and debt insurance costs have risen concerns about euro zone debt and U.S. tax cuts have rattled markets.

Russia and Nigeria are among borrowers to delay planned issues until next year.

"With the assumption that the bull-run in Treasuries has come to an end, you have to worry about rising borrowing costs," said Jeremy Brewin, fund manager at Aviva.

"Everyone will try to issue in the first quarter as borrowing costs may rise."

Investors are hoping this week's European Union summit will help soothe the euro zone situation, and if markets stabilize going into the New Year, issuance could still be high.

January is traditionally an active month for new debt, and Poland, for example, has already said it is likely to issue euro-denominated bonds then.

FRONTIER MARKETS

In the search for higher yield, investors are also awaiting new issues from frontier markets, in many cases debut bonds.

JPMorgan includes Kenya, Tanzania and Zambia among expected issuers next year, along with Nigeria.

Domestic debt issuance has also increased heavily this year, with investor interest strong, thanks to higher yields and the prospect of currency appreciation, despite the likelihood of more capital controls in the developing world.

ING estimates local bond issuance at a record $3.87 trillion for 2010, and forecasts $3.4 trillion for next year, as the local bond trade largely continues.

Giordano Lombardo, CIO of fund manager Pioneer, last week told the Reuters 2011 Investment Outlook Summit:

"Given the fact that most Asian currencies are very undervalued, and (that) they will probably be increasing in value, if you get exposure through local currency ... to emerging bonds, it is still a very, very good trade." (Additional reporting by Sujata Rao and Sebastian Tong; Editing by Catherine Evans)