Fears mount over rise of sovereign-backed corporate debt

More than $800bn of emerging market sovereign debt is being camouflaged by the growing use of bonds that offer implicit state backing without always appearing on government balance sheets, according to new research.

The stock of so-called quasi-sovereign bonds issued in dollars and other hard currencies by emerging markets has risen sharply in the past 12 months to overtake that of all external emerging market sovereign debt by the end of 2015.


The growing use of such bonds suggests that developing countries are increasingly transferring debt obligations to third parties that have taken advantage of historically low interest rates to load up with cheap debt.

Emerging markets are already under strain as the US dollar strengthens against the renminbi and other emerging market currencies, making the cost of servicing debt denominated in dollars harder to bear.

Although official debt-to-GDP levels of countries such as India, Russia and China remain low by global standards, the growth of less visible debt which they might still have to guarantee in a crisis underlines the potential scale of their liabilities.

“This has been a source of worry for some time, in part because it does not always appear on government balance sheets.” said Lee Buchheit, a partner at Cleary Gottlieb and expert on sovereign debt default.

“Emerging markets have benefited from interest rates at historic low levels and commodity prices at historic highs,” he said: “In the last year both of these have begun to unwind. If the resulting strains on a country compel a sovereign debt rearrangement of some kind, these contingent liabilities of the sovereign will need to be addressed.”

New figures from JPMorgan and Bond Radar show that issuance of quasi-sovereign bonds outpaced that of sovereign bonds in emerging markets last year, raising the stock of such debt from $710bn in 2014 to a record $839bn by the end of 2015.

By comparison, the stock of all external emerging market sovereign debt stood at $750bn at the end of last year, according to JPMorgan.

The cost of selling bonds with either an explicit or implicit guarantee of the government is lower than other corporate bonds.

Quasi-sovereign borrowers include 100 per cent state-owned entities such as Mexico’s Pemex, local governments in countries such as China, and entities in which the government owns more than 50 per cent of the equity or has more than 50 per cent of the voting rights — a description that encompasses Brazil’sPetrobras.



However, the treatment of such debt is not uniform. Bonds issued by Pemex are included in debt-to-GDP calculations for Mexico, but this is unusual, and only 19 of the 181 quasi-sovereign bonds tracked by JPMorgan carry an explicit sovereign guarantee.

In 2009, investors were shocked when Dubai refused to guarantee the debts of Dubai World, a state-owned holding company with $59bn in liabilities, saying it had never offered a sovereign guarantee.

Neighbouring Abu Dhabi later provided a $10bn bailout.

Emerging markets’ quasi-sovereign bonds are now suffering from the same diminishing capital flows and rising borrowing costs plaguing the developing world, thanks to the strengthening US dollar, weakening commodity prices and fears of slowing Chinese growth.

Poor performance has already hurt the credit ratings of countries that back them. Last year, Standard & Poor’s and Fitch, two of the world’s three big credit rating agencies, cut Brazil’s rating to junk in part because of the growing risks associated with Petrobras.

“What can really break the dam is the quasi-sovereign element in EM external debt,” says Gary Kleiman of Kleiman International, an emerging market investment consultant. “People have always assumed there is an implicit backing, but that capacity has not been called into question explicitly.”



During previous emerging market debt crises, governments from Mexico to Russia to South Korea stepped in to save indebted quasi-sovereigns.

“Today, the scale of the problem is much greater and the fiscal power of emerging governments is much less,” Mr Kleiman said. He pointed to Petrobras, the crisis-stricken Brazilian oil group with $104bn of net debt; PDVSA, its Venezuelan counterpart; and Eskom, the South African electrical utility, as sources of particular concern.

“A company like Petrobras getting into deeper trouble would represent a workout problem more complex than a sovereign workout because of the multiple jurisdictions involved,” he said.

Analysts say that the problem extends beyond that of dollar-denominated debt. Emerging market companies had issued an estimated $23.7tn in bonds by the middle of last year, according to the Bank for International Settlements, including dollar and local currency debt, up from about $5tn a decade earlier. Many such issuers are quasi-sovereigns. About $16.7tn had been issued by companies in China, according to the BIS, almost all of which carry an implicit or explicit state backing.




Fonte: FT