The international financial institution expects that the upcoming interest rate cuts by the Federal Reserve (Fed) will help revive bond flows towards emerging and developing economies.
In recent decades the Capital flows to emerging market and developing economies come from several boom and bust cycles, often hand in hand with external events such as monetary policy decisions in major advanced economies. So now, as the end of the crisis looms, reversal of the global monetary contraction cycle, Hopes are growing that the flows return with greater vigor to emerging markets, in search of better returns, as projected by, among others, the International Monetary Fund (IMF) itself.
It is worth noting that during the recent international cycle of monetary austerity, Capital inflows into many emerging and developing countries proved relatively resilient, thanks to the strength of their policy frameworks and the good position of their international reserves. However, some of the most vulnerable countries were disproportionately affected by the rising external borrowing costs, as reflected in the sharp slowdown in Eurobond issuance.
What are Eurobonds?
Eurobonds are international instruments of debt issued by countries in a currency other than their own, In general the dollar or euro. Emerging and underdeveloped countries at higher risk resort to these instruments especially because they allow them to circumvent the limitations of their local capital markets, and access foreign capital and diversify sources of financing. But unlike bonds in domestic currency, Eurobonds involve a currency risk for the borrower, and their interest rates are particularly sensitive to the monetary policy settings of the currency of issue.
According to a calculation by the Fund’s economists, Paula Arias and Robin Koepke, the sharp slowdown in net Eurobond issuance by emerging and underdeveloped countries, which fell to $40 billion annually in 2022-23, 70% less than in the previous two years. They point out that during this period, 26 of the 75 countries recorded net outflows of Eurobonds, totalling $58 billion (including countries such as Bolivia and Mongolia), and these outflows were due to maturing Eurobonds outstripping new issues, rather than direct sales by international investors. “The sharp rise in US Treasury bond yields triggered a drop in Eurobond issuance by emerging markets,” Arias and Koepke explain.
Now, the reduction in Eurobond flows “was the result of a combination of tightening external financial conditions and pre-existing vulnerabilities in the affected economies, such as challenges in fiscal and external sustainability.” Some countries with stronger economic fundamentals and policy frameworks have thus been able to replace foreign currency issuance with local currency debt, partly financed by domestic investors, while many countries responded by cutting investment to reduce imports, weighing on economic growth; and many others also drew on their reserves, potentially reducing their ability to cope with future shocks.
The rate in the US is key
According to Arias and Koepke, the net issuance of Eurobonds has a strong negative relationship with interest rates in advanced economies, like the 10-year US Treasury bond yield: When bond yields in the US and other advanced economies plummeted during the pandemic, Emerging and developing country borrowers took advantage of low borrowing costs to issue debt.
So during the subsequent tightening of monetary policy by the Fed and other major central banks, Eurobond inflows into many lower-rated emerging and underdeveloped countries evaporated as lending rates reached prohibitive levels. “Eurobond issuance declined even as interest rate differentials widened in emerging and underdeveloped countries, pointing to the importance of external interest rates for such capital flows”they argue.
In 2024, global interest rate conditions began to become more favorable for borrowers, as major central banks began to ease monetary policy. “This development contributed to the recovery of Eurobond issuance, up to $40 billion in the first quarter of 2024, with the return to the market of countries such as Benin and Ivory Coast”the Fund’s economists point out.
Hence, they suggest that the start of a Fed easing cycle may support a new rebound in Eurobond issuance and a broader revival of capital flows to emerging and developing economies. Which could be taken advantage of by Milei’s Government, as long as not only things are done well, but everything turns out well.
It should be noted that some higher-risk countries still face high costs for selling foreign-currency-denominated debt to investors after major central banks raised interest rates. That is why the dynamics of monetary easing by the Fed, the ECB and other major central banks around the world.
Source: Ambito
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