A remarkable feature of the globalization era was the enhanced credit position of many emerging economies.
This blog article is a short excerpt from Country Risk – The Bane of Foreign Investors (Springer, 2020) by Norbert Gaillard.
This development is perhaps best captured by the modest growth of external debt. During 1991–2016, the public and public-guaranteed external debt of 34 major emerging countries increased (on average) by 4% annually.1 This rate was much lower than that observed during the 1960s and 1970s.
This positive evolution was driven by the relative efficiency of the macroeconomic policies implemented in these economies. Measures designed to increase domestic savings, attract FDI, boost exports, and curb inflation enabled reductions in payments imbalances and mitigated the problem of “international original sin” (Eichengreen et al. 2005).2
Figure 1 plots the composition of public and public-guaranteed external debt. After accounting for almost a third of lending to emerging economies in the 1990s, bilateral loans saw their share decline dramatically during the subsequent two decades. In the meantime, the percentage of multilateral loans stabilized. Yet the most prominent development was the resumption of sovereign bond markets. During 1991–2016, the volume of bonds issued by major low- and middle-income governments increased by a factor of 11 and their share in total public external debt quadrupled.3
Notes: The data set’s 40 countries have low- and middle-income economies whose total public and public-guaranteed external debt exceeded $10 billion (US) in 2016. Those countries are Angola, Azerbaijan, Bangladesh, Belarus, Brazil, Bulgaria, China, Colombia, Costa Rica, the Dominican Republic, Ecuador, Egypt, Ethiopia, Ghana, India, Indonesia, Jordan, Kazakhstan, Kenya, Lebanon, Mexico, Morocco, Myanmar, Nigeria, Pakistan, Peru, the Philippines, Romania, Russia, Serbia, South Africa, Sri Lanka, Sudan, Tanzania, Thailand, Tunisia, Turkey, Ukraine, Venezuela, and Vietnam. The data set for 1991 excludes Azerbaijan, Belarus, Kazakhstan, Serbia, South Africa, and Ukraine because of insufficient data.
Source: Author calculations based on World Bank’s World Development Indicators.
The boom in sovereign bond markets can trace its roots to the financial disintermediation of the 1980s, but it was catalyzed by the Brady Plan. This initiative – which was launched in 1989 and amounted to transforming commercial bank loans into bonds – resolved the public debt crisis and encouraged an increasing number of emerging countries to tap capital markets. The growth of foreign government bond markets was accompanied by development of a new “business ecosystem” (Buckley 1997, 2006).
The most prominent feature of this trend was the inordinate power of credit rating agencies. Ever since credit ratings were incorporated into regulatory rules and investors’ prudential guidelines, bond issuers have been obliged to obtain a rating – and the higher, the better. Higher ratings corresponded to greater investor confidence and lower borrowing costs. Credit ratings are lagging indicators, not leading indicators (Gaillard 2011, pp. 175–183; Gaillard 2014). Yet a downgrade, a review for possible downgrade, or a negative outlook is likely to exacerbate risk aversion and trigger sell-offs.4
It is noteworthy that S&P and Moody’s methodologies compel borrowers to remain solvent on their bond debt: any missed payment or (even minor) debt restructuring is considered a sovereign default and results in a downgrade to the bottom of the rating scale. In addition, CRAs frequently use the FC sovereign rating as the ceiling for FC ratings of other debt issuers domiciled within that country; hence a reduction in the former rating leads to downgrading the latter.5 This policy – which aims to account for the risk of a government restricting access to foreign exchange – highlights the importance of sovereign ratings for all borrowers.
Major financial institutions took advantage of this propitious environment to expand their operations in emerging financial markets. An illustrative example is that of JP Morgan. In 1991, the New York–based bank created a special “emerging markets” group to provide an array of services to these economies (JP Morgan 1992). Later, it launched a series of indices that track foreign currency–denominated bonds – the Emerging Markets Bond Index (EMBI), the EMBI+, and the EMBI Global – as well as local currency–denominated debt instruments (see JP Morgan 1999). More importantly, JP Morgan was the most active underwriter of emerging government bond issues during 1993–2007 (Flandreau et al. 2009).
Another group of organizations gained ground during the globalization: bondholders’ associations. In addition to the IIF and the International Securities Market Association (ISMA, established in 1969), new organizations – such as the Emerging Markets Traders Association (EMTA) and the Emerging Markets Creditors Association (EMCA) – were set up to monitor sovereign bond market activity and to promote creditors’ rights (see EMTA 2015). The IIF is certainly the most influential among these associations; its members include investment and commercial banks, insurance companies, sovereign wealth funds, asset management firms, hedge funds, and central banks.
1 Author calculation based on the World Bank’s World Development Indicators. The countries under consideration are the low- and middle-income economies whose total public and public-guaranteed external debt exceeded $10 billion (US) in 2016. Six countries are excluded because of insufficient data for 1991. The 34 countries included in this data set are: Angola, Bangladesh, Brazil, Bulgaria, China, Colombia, Costa Rica, the Dominican Republic, Ecuador, Egypt, Ethiopia, Ghana, India, Indonesia, Jordan, Kenya, Lebanon, Mexico, Morocco, Myanmar, Nigeria, Pakistan, Peru, the Philippines, Romania, Russia, Sri Lanka, Sudan, Tanzania, Thailand, Tunisia, Turkey, Venezuela, and Vietnam.
2 For example, the so-called BRIC countries (Brazil, Russia, India, and China) were especially successful in cutting the share of their public debt denominated in foreign currency or indexed to a foreign currency.
3 Author calculations based on the World Bank’s World Development Indicators.
4 The pro-cyclical effects of rating downgrades were obvious in November–December 1997 during the East Asian crisis and between December 2009 and April 2010 during the Greek debt crisis.
5 Increased financial globalization prompted Moody’s and S&P to relax their policy on this matter in the 2000s. In 2011, however, very few debt issuers were assigned a FC rating higher than that of their government (see S&P 2011).
Buckley, R. P. (1997), “The Facilitation of the Brady Plan: Emerging Markets Debt Trading From 1989 to 1993,” Fordham International Law Journal, Vol. 21 (5).
Buckley, R. P. (2006), “A Force for Globalization: Emerging Markets Debt Trading From 1994 to 1999,” Fordham International Law Journal, Vol. 30 (2).
Eichengreen, B., Hausmann, R. and Panizza, U. (2005), “The Mystery of Original Sin,” in Eichengreen, B. and Hausmann, R. (Eds.), Other People’s Money, Chicago University Press, Chicago.
Emerging Markets Traders Association (2015), EMTA @ 25 (1990-2015).
Flandreau, M., Flores, J. H., Gaillard, N. and Nieto-Parra, S. (2009), “The End of Gatekeeping: Underwriters and the Quality of Sovereign Bond Markets, 1815–2007,” NBER Working Paper No.15128.
Gaillard, N. (2011), A Century of Sovereign Ratings, Springer, New York.
Gaillard, N. (2014), “How and Why Credit Rating Agencies Missed the Eurozone Debt Crisis,” Capital Markets Law Journal, Vol.9 (2).
JP Morgan (1992), 1991 Annual Report, New York.
JP Morgan (1999), “Introducing the J. P. Morgan Emerging Markets Bond Index Global (EMBI Global),” 3 August, New York.
Standard & Poor’s (2011), “Corporate and Government Ratings that Exceed the Sovereign Rating,” 3 June.