Emerging market debt grinds to record tights, Philippines holds on despite coup attempt

By Reshmi Basu and Paul A. Harris

New York, Feb. 24- Emerging market debt again tightened to another record low on positive technicals and strong flows into the asset class.

In other developments, Philippines president Gloria Macapagal Arroyo declared emergency rule on Friday after the military said it foiled a coup attempt.

The sovereign saw a reasonable amount of two-way flow on Friday, but in a range that was fairly narrow given the headline noise, according to a trader who focuses on Asian fixed income.

Philippines has been "noisy, but it's holding in okay," he observed.

In the last 24 hours, the Philippine 7¾% due 2031 traded as high as 100.875 bid and as low as 99.375 bid. But during the New York session, it traded within a 99.75 bid, 100.0 offered range, "right in the middle of the overall range for the past 24 hours," said the trader who spoke to Prospect News near the close of the New York trading session.

For the past five trading sessions the bond has been as low as 99.875 and as high as 100.875, only trading off on Friday.

"It looks as though it has the potential to remain fairly benign. But Arroyo's behavior today [Friday] leaves you with the feeling that there is something more there than meets the eye.

"But against all that, with these markets being this bid, the markets are very forgiving. The over-riding flow has been from accounts looking to buy weakness," he said.

In other news, Indonesia starts a roadshow on Feb. 27 via Barclays Capital, JP Morgan and UBS Investment Bank.

Bits and pieces of high-yield supply are coming into view, according to the trader, adding that the Asian high-yield market has pretty well kept its bid.

In the primary market, Banco Industrial e Comercial SA (BicBanco) sold an upsized $120 million offering of 10-year tier I notes at par to yield 9¾%.

The deal, increased from $100 million, came at the tighter end of price guidance which put the yield at 9¾% to 9 7/8%.

Dresdner Kleinwort Wasserstein was the bookrunner.

EM scores higher

Emerging market debt closed out the week on a strong note, pushed higher by strong investor sentiment and inflows into the market.

On Thursday, the market rallied on news that Brazil would redeem $6.64 billion of Brady bonds while Mexico launched a tender offer for $5 billion in foreign currency bonds.

Those announcements cemented market expectations that the market will see less external issuance this year, a plus for the technical story.

In trading Friday, the spread on the JP Morgan EMBI+ Index tightened by 2 basis points to 187 basis points more than U.S. Treasuries.

During the session, the Brazilian bond due 2040 lost 0.30 to 133 bid. 133.05 offered.

The Venezuelan bond due 2027 gained 0.20 to 126.75 bid, 127.25 offered.

And Russian bonds moved higher, catching up to Thursday's Latin American rally. The Russian bond due 2030 added 0.25 to 112.75 bid, 113 offered.

"One of the reasons why we may see lingering of asset prices around current levels or perhaps even higher, bottomline it's a different world," according to Alberto Bernal, Latin American fixed-income analyst at Bear Stearns.

"Granted, from a historical perspective it is very difficult to come up with compelling stories to explain the current rally. Yet flows right now and technicals are simply too positive," he said.

Rotation to local currency market

Bernal noted that the rotation to local currency from dollar-denominated debt is not a new phenomenon. This trend dates back to 2003 and 2004 when countries began to see an increased interest in local market assets by investors. And countries such as Brazil, Colombia, Mexico and Peru are taking advantage of this trend.

They are seeking finance alternatives in local markets, thereby reducing their exposure to external shocks.

"This is a technical positive for these countries because if they are indebted in their own currencies, it's going to be easier to pay those debts in the future because the exchange rate will no longer be an issue," he noted.

Nonetheless, Bernal remarked that this is no longer an issue of solvency.

"It's an issue of an evolution of a trend that has to do with high levels of liquidity around the world and dollar weakness, as well as higher commodity prices.

"Once you plug them together, you see that local market instruments have and will probably remain one of the best choices of investment for many of these accounts."

"It's a new trend. It's a new thing. And markets are getting adjusted to it."

Much of the recent rally is function of exogenous events rather than country specific. One example is the appreciation of Venezuelan bond prices, where the gains have very little to do with the country's social and economic policies but more to do with high oil prices and high levels of liquidity.

"I don't think there are too many people in the Street who have a positive outlook regarding the potential long-term rate of growth of the Venezuelan economy nowadays.

"If and when commodity prices change, the mostly likely scenario is that the dynamic of this economy will change very dramatically."

The evolution of local markets means that investors will need to be more knowledgeable about the specifics of local markets. And investors are also entering a market which is more complicated than the sovereign dollar-denominated bond markets.

"On top of forecasting or having a strong opinion on the fundamentals of the political and economic situation of the countries, you also have to have some type of interesting or capable model to forecast what is going to happen with the exchange rate."

The dying of original sin

The current trend marks the "dying of original sin," according to Bernal, referring to Harvard economist Ricardo Haussman's theory, which discusses the incapacity of countries with less than established currencies to fund themselves in their own currencies.

"And this has changed dramatically in the last few years," he said.

Local markets are "welfare-enhancing for these countries," Bernal observed.

"It's an evolution. We will only know if there is a downside once and if something happens. But from the perspective of the sovereign issuers, it's a very good thing because it reduces the risk of debt events taking place in the future - and because it goes against the theory of original sin."

Nonetheless, political stories cannot be cast aside. This is Latin America after all.

"We still have to look at the events that affect politics in these countries. Many people tend to believe the stories that many politicians try to sell as magic.

"People have shown in the past that they vote with their hearts. And there is a risk that that will happen again."

Haussman's theory is that the reason emerging markets countries have such volatile business cycles and go through periodic financial crisis is because they borrow in foreign currencies, currencies that are harder than their own. But when a country which already has an external borrowing problem is faced with other challenges such as rising domestic demand or a change in terms of trade, the results can be dangerous.

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