Daniel Bases - The downing of a Malaysian passenger jet over eastern Ukraine on Thursday is likely to keep fixed income investors shunning Russia, and eastern Europe more broadly, in favour of other emerging markets.
The eruption of conflict earlier this year over Ukraine’s borders and subsequent economic sanctions against Russia has caused a sharp drop-off in corporate debt issuance from Eastern Europe, including Russia, and massive capital flight from that country.
The latest incident - the shooting down of Malaysian Air flight MH17 - will keep issuance tepid and tip the flow of funds even further toward Latin America and Southeast Asia. Already, this year’s biggest emerging-market issuers have come out of Brazil, despite the lack of economic and fiscal reforms investors want.
The biggest corporate deal in emerging markets so far in 2014 was BB Leasing SA Arrendamento Mercantil of Brazil, with an $8.6 billion issue, followed by an $8.5 billion offering from state-owned energy company Petrobras. ‘Volatility in Eastern Europe, especially the effects of the Russia/Ukraine conflict, has forced investors typically focused on that region to look elsewhere in deploying their cash, with Latin America and Asia being big beneficiaries,’ Clayton Pope, head of emerging market bond syndicate at Credit Suisse in New York, told Reuters.
Since February, when Russia began its takeover and eventual annexation of Crimea in southern Ukraine and massed and then withdrew troops on its former Soviet-era satellite nation’s borders, investors have grown wary of embarking on new business in Russia.
Additional sanctions upon Russian businesses on Wednesday by the United States are likely to further weaken Russia’s stagnating economy and make it more difficult for large companies, like Rosneft, its largest oil producer, to refinance loans.
U.S. President Barack Obama said on Friday the United States has the capacity to further increase sanctions on Russia. According to Thomson Reuters LPC data, Rosneft, along with three large Russian banks, have a combined $32.3 billion in syndicated loans outstanding in the next five years.
Capital flight out of Russia has been massive. In the first six months of the year, $75 billion has left the country, far surpassing the $62.7 billion for last year, according to data from the Central Bank of Russia. For the first half of 2014, Thomson Reuters Deals Intelligence Service data shows a sharp drop-off in corporate debt issuance by eastern European borrowers, contrasting sharply with new corporate deals from Latin America and Southeast Asia.
Eastern European corporate issuance is down 65 percent although sovereign debt issuance is up 34 percent, with Slovenia and Hungary among the top overall issuers, according to the Deals Intelligence data that combines local and hard currency issues.
However, sovereign debt issued from South and Central America is up 86 percent in the first half of this year compared with 2013, and corporate debt issuance from these regions is up 38 percent. Issuance from Southeast Asia was up 82 percent for sovereigns and 15 percent for corporate borrowers.
Returns on emerging market sovereign and quasi-sovereign debt, measured by JPMorgan, show Latin America leading with an 11.4 percent return in the first half of 2014. Russia is up 3 percent while Ukraine is up 6.6 percent.
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Latin American corporate issuers have borrowed an equivalent of nearly $71 billion in the first half versus $29 billion in Southeast Asia and just under $20 billion for Eastern Europe.
Some analysts, however, are worried that cheap funding from global central banks keeping rates low will become overdone, especially as they believe Latin American nations still need to engage in economic reforms.
Nor does the region being far removed from geopolitical tensions mean a one-way rotation for investor cash out of central and eastern Europe, Luis Oganes, global head of emerging markets research at JPMorgan, said during a recent panel discussion at the New York Society of Security Analysts. ‘Latin America is not getting the fair share of foreign direct investment that it could relative to other EM regions because of the lack of reforms,’ Oganes cautioned investors, referring to long-term investments rather than hot-money inflows into the region.
There is one outlier though, and that is Mexico, where historic reforms of its energy sector as part of a broader package of changes has made it again the darling of emerging markets. Mexico issued the equivalent of over $6.7 billion so far this year, making it the biggest sovereign issuer. ‘The Mexican energy sector is expected to be a particular engine of growth and a potential source of new debt issuance, as it is expected that the reforms will enable (state-owned) Pemex to work more closely with the private sector to enhance oil production,’ said Marcelo Delmar, head of Latin American debt capital markets at BNP Paribas in New York.
At the start of the year, bankers and analysts worried about Brazil ahead of a presidential election in October. Investors now are betting the opposition has a chance of beating incumbent President Dilma Rousseff, defeating a government they accuse of intervening excessively in the economy.
‘Their political process, the lack of growth were some of those concerns, but Brazil, while facing realities, seems to be muddling through,’ said Delmar. Deals such as Petrobras and Arrendamento Mercantil suggest as much. ‘Emerging market debt issuance across both corporate and sovereign is running at a rate of 25-30 percent above last year. That’s a huge increase when you compare what’s happening elsewhere in the bond market. We are positive about the second half of the year and 2015,’ said BNP Paribas’ Delmar.
Grabove, UKRAINE: A local resident stands among the wreckage at the site of the crash of a Malaysia Airlines plane carrying 298 people from Amsterdam to Kuala Lumpur in Grabove, in rebel-held east Ukraine. Ukraine and pro-Russian insurgents agreed on July 19 to set up a security zone around the crash site of a Malaysian jet whose downing in the rebel-held east has drawn global condemnation of the Kremlin. –AFP