* Low-rated sovereigns jump into market
* Yields do not reflect political risks
* Political risk insurance fails to find favour
By Christopher Langner and Sudip Roy
SINGAPORE, April 9 (IFR) - Investors desperate for
higher-yielding securities are snapping up bonds from
speculative-rated countries, potentially ignoring their
political risks in the process.
Pakistan, a country with a near-default rating from Moody's
and a history of political and economic strife, sold $2 billion
of US dollar-denominated bonds on Tuesday and paid less for
selling a 10-year bond than Zambia, a slightly higher rated peer
among so-called frontier credits.
The two-part offering was Pakistan's first in seven years
and was sold a day after other junk-level credits, including Sri
Lanka as well as Zambia, sold new bonds.
More offerings are expected from some of the most
bottom-rung sovereigns as frontier countries attempt to beat an
expected hike in funding costs later this year as US interest
Ecuador, which defaulted on foreign debt in 2008 in spite of
being able to repay, is in active discussions about a possible
transaction, while even Ukraine is mulling the idea of a
comeback in the second half of the year.
An emerging markets banker was unequivocal when asked
whether investors are considering political risks when they buy
frontier credit bonds. "No they're not," he said.
This is especially surprising given how political tensions
in Ukraine, Russia, Turkey and Thailand have dominated headlines
and roiled markets in recent months. Big elections also promise
to shake up the political landscape in several developing
countries, with Brazil and India among others, going to the
WILLINGNESS TO PAY
Bond investors focus on the ability of a borrower to repay
its debt. For sovereigns, that can easily be assessed with
models that factor in fiscal policies, gross domestic product
and inflation trends, among other public finance issues.
These models, however, do not take into account the
willingness of the borrower to pay, a problem Ecuador
highlighted when it defaulted. That is the essence of political
"We are all good at relative value assessment but we not
good at evaluating absolute risk," said an emerging markets
portfolio manager at a US firm in Singapore.
The return of Pakistan to the global bond market just as the
yield on its outstanding bond reached all-time lows, however, is
forcing some investors to reflect on what kind of premium should
be granted to a country where political legitimacy has been in
short supply since it gained independence in 1947.
The bond also priced amid a flare-up in tensions related to
a separatist insurgency in Pakistan's Baluchistan province, a
sign that political conflict afflicts the country.
The problem of political legitimacy is not exclusive to
Pakistan. Sri Lanka sold a 5.5-year dollar bond on Monday to
yield 5.125%, the lowest coupon it has paid, although the
country ended a decade-long civil war just four years ago.
On the day of the bond sale, Sri Lanka's foreign minister,
Gamini Lakshman Peiris, told the United Nations the country
would not cooperate with an investigation into potential war
crimes in 2009. That was the year Mahinda Rajapaksa, the current
president, led the dismantling of the Tamil Tigers and brought
the civil war to an end.
Investor perception of Sri Lanka and Pakistan, though, are
quite different. On Monday Sri Lanka achieved its tightest
coupon on a dollar bond, which paid a yield about 250bp lower
than what Pakistan paid for its five-year bonds.
Rajapaksa is widely expected to win the next general
election, while Pakistan undertook its first democratic
transition in its 66-year history in June 2013. Prime Minister
Nawaz Sharif's PML-N party holds 190 seats in Pakistan's
341-seat parliament after a recent election.
Sharif, who has survived corruption allegations,
imprisonment, exile and a military coup, is promising business
friendly policies and moved quickly to sell dollar bonds for the
first time since 2007. He also secured a US$6.7bn three-year
loan from the International Monetary Fund last September.
Pakistan issued a US$1bn five-year bond yielding 7.25% and a
US$1bn 10-year bond yielding 8.25% on Tuesday amid US$7bn in
The 10-year note priced with a lower yield than the 8.625%
Zambia paid on a US$1bn 10-year bond on Monday. Yet, Zambia is
rated B+/B by Standard & Poor's and Fitch while Pakistan is
rated Caa1/B- by Moody's and Standard & Poor's. Sri Lanka is
The three countries are at the lowest rungs of junk, but
Moody's assessment of Pakistan is that default is a real
possibility, while Zambia and Sri Lanka are a few more steps
removed. That alone suggests that Pakistan's bonds should yield
more than Zambia's.
At US$130bn, Pakistan's economy is about 13 times the size
of Zambia's. But the African nation has been growing more than
5% a year, while Pakistan's average GDP expansion in the past
five years has been 3.2%. Moody's predicts it will be 2.8% this
When Pakistan, began a roadshow earlier this month, a
portfolio manager in London indicated the sovereign would have
to pay double-digit yields to overcome the perception of
political risk to get a deal done.
Another investor believed the final pricing did not
accurately reflect Pakistan's risks. "We passed on the deal as
we thought that it priced slightly too expensive given the
potential downside risks surrounding the credit. We think that
there is room for disappointment at this stage rather than
further good news," said Anthony Simond, investment analyst, at
Aberdeen Asset Management.
A hedge fund manager in Singapore questioned if the deal
made sense at all. "I might as well buy Mongolia, which is
offering 8% [in secondary markets]," the manager said.
The Singapore emerging market portfolio manager argued
credit investors may not be pricing the political risk of the
Mongolia correctly either. "We live in a relative value world,"
RATING POLITICAL RISK
Measuring political risk in addition to credit risk is not
common in global credit markets, although banks that lend in
frontier countries have long accounted for it. Large insurers,
such as AIG, will insure banks against political risks typically
by covering against such issues as expropriation,
inconvertibility and political violence.
The cost of insuring one coupon payment on a loan could cost
about 20bp a year, depending on the loan terms and the country
Political risk insurance wraps, though, have never really
taken off for bonds. "If you're an issuer and you go to market
with a PRI wrap it sends a weak signal about your
creditworthiness," said one banker.
Moreover, as the London-based banker pointed out, investors
prefer to take their chances rather than buy a credit-enhanced
product. "Emerging markets investors would rather be paid," he
Instead, fund managers rely on reports and statistics from
the likes of the IMF and Eurasia Group to analyze a credit.
Country Insights, part of Roubini Global Economics, has
begun to produce shadow ratings for lesser known countries to
address this gap.
"We figured we needed to come up with a consistent way of
measuring political risks," said Paul Domjan, managing director
at Roubini Global Economics in London.
"We have an algorithm that takes into account more than 200
factors and offers us a shadow rating, which is then vetted by
an analyst," Domjan explained.
The firm rates Pakistan four notches lower than Zambia,
offering further proof political risk premiums are not being
incorporated into bond prices.
For now, investors in these frontier bonds may want to
brace themselves for a rough ride. Pakistan's bonds due 2017
reached yields as high as 25% in December 2008. Most of the
volatility was a reflection of the wild swings in the country's
internal and foreign politics, factors most investors are not
used to evaluating.
(Reporting By Christopher Langner and Sudip Roy; additional
reporting by Davide Scigliuzzo; edited by Abby Schultz)