ECB triggers explosive rise in emerging market euro borrowing

LONDON, June 13 Fri Jun 13, 2014 12:50pm EDT

LONDON, June 13 (Reuters) - Emerging market bond sellers and European funds are both revelling in an explosive rise in euro debt sales that offer cheap cash to borrowers while providing investors with higher yields than anywhere in the euro zone.

Borrowers had already turned to the euro market in recent months as expectation of policy easing by the European Central Bank cut borrowing costs and weakened the euro.

Those expectations were met last week when the ECB cut interest rates to record lows and launched a series of measures to pump money into the sluggish economy. And full-fledged money printing is only a matter of time, many reckon.

This has led emerging governments and firms to borrow over 41 billion euros so far in 2014, surpassing what was raised in the whole of 2013, according to data compiled by Thomson Reuters.

"The logical thing is to raise money in a currency whose supply will increase. The ECB has short-circuited euro appreciation and (interest) rates too are reacting to ECB signals," said Salman Ahmad, global fixed income strategist at Lombard Odier.

"From an issuer perspective, you have the ECB on your side."

That is not the case with the dollar, the currency which accounts for the majority of emerging external debt sales.

U.S. 10-year Treasury bonds, off which emerging dollar bonds are priced, currently yield 2.6 percent but they, as well as the dollar are likely to rise from here as the Federal Reserve moves steadily towards ending its money-printing programme.

But 10-year German Bunds, the benchmark for euro debt, yield 1.3 percent and are unlikely to rise as much as U.S. yields.

Hence the reason for the rush into euro issuance.

Issuers include South Korea which tapped the euro market for the first time ever and Abu Dhabi telecoms operator Etisalat which sold a two-tranche 2.4 billion euro deal, the first euro issue from the Gulf since last November.

And on Friday Morocco was marketing its first euro issue in four years, offering to pay a 225 basis points over mid-swaps for 10-year cash, equating to around 3.8 percent. Indonesia meanwhile picked banks to run its debut euro issue.

One big incentive to borrow in euros is that it is historically cheap to swap euro-denominated interest payments for dollars using cross-currency basis swaps.

That means issuers who plan to service debt with an income stream in dollars can borrow in euros and be compensated for the currency and interest rate risks.

"It has not been as good to issue in euro for a dollar-thinking (borrower) since 2007," said Jean-Marc Mercier, global head of syndicate at HSBC which helped launch the Etisalat deal.

DEMAND FOR NEW NAMES HIGH YIELDS

On the other side of the fence, investor demand for these issues is brisk. European fund managers who have a natural preference for euro assets are faced these days with frustratingly low yields across the single currency bloc.

Bond yields in peripheral Europe in particular have collapsed to record or multi-year lows with Spain, which barely avoided a bailout, now yielding less than the United States.

Ahmed said many European funds are required by regulation to invest in euro issues while pension funds, needing to balance assets and liabilities, cannot afford big currency mismatches.

"There is intrinsic demand for such (EM euro) issues. There are investors who are saying: 'I don't want to take the currency risk but I want extra yield.', he added.

The 3.8 percent offered by Morocco may seem low but the country enjoys a BBB-minus investment grade rating, one notch below Spain which is paying 2.6 percent on its 10-year bond.

No surprise then that Etisalat took 8 billion euros in orders for its 2.4 billion-euro two-tranche bond, with European investors snapping up 80 percent of the issue. The company's 12-year euro bond priced at 110 bps over mid-swaps.

Even Alfa Bank's 350 million euro deal, the first Russian issue in three months, saw bids of 1.3 billion, according to Thomson Reuters news service IFR.

Mercier of HSBC says European investors have never participated in huge numbers in dollar-based emerging market deals because of the currency issue. But many see the raft of new euro issuance, including from well-established emerging market names such as Indonesia, as a chance to diversify, he says.

"They love to buy these new names," he said. "Debt investors don't usually like to take currency positions."

For such investors there is a lot more euro issuance coming up. That potentially includes bonds from Russian banks, who may find more buying interest in euros than from U.S.-based funds. (Reporting by Sujata Rao; Editing by Toby Chopra)

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