Consider the case of Indonesia below. The country recently tried to sell foreign investor-aimed sovereign debt. To no one's real surprise, there were few takers at yields acceptable to the Indonesian authorities. This reflects the higher yields demanded by investors on emerging market sovereign debt, now demanding about a 3.3% yield premium over similar Treasuries according to JP Morgan's EMBI+ index. (Note to the FT: the newer GBI-EM index is a more accurate indicator in this instance for we are talking not about dollar-denominated EM bonds but of debt issued in EM currencies.)
Outflows from emerging markets bond and equity funds reached $29.5bn over the past three months, the highest level since at least 1995, with withdrawals gathering pace over the past week.
Investors headed for the exits as rising fears over slowing world growth and the state of the banking system over the past week added pressure on emerging markets – which were already reeling from weaker commodity prices, inflationary pressures, a stronger dollar and geopolitical concerns.
Investors switched $1bn out of equity and fixed income funds on Monday, one of the highest daily outflows since records began in 1995, said EPFR Global, the data provider. Last week there were outflows of $1.6bn, bringing the total since June 4 to $29.5bn, the largest three-month figure since 1995.
Nick Chamie, head of emerging markets research at RBC Capital Markets, said: “Since July, investors have finally become aware of the severity of the global slowdown. The emerging markets are a leveraged play on global growth, so in a serious downturn, investors will naturally sell them.”
David Lubin, emerging market strategist at Citigroup, said: “Emerging market asset prices rose strongly in a world of rapid growth and high commodity prices, creating something like a virtuous circle. “Now we’re faced with the risk that this process is unwinding. The strength of the dollar has put emerging economies’ currencies under pressure just at the point where a rise in global risk aversion is pushing investors away from exposure to developing countries.”
The benchmark MSCI emerging market index fell 1.27 per cent to 857.44, the lowest level since March 2007. The fall extended its decline to 4.8 per cent over the past week and 22 per cent over past three months.
The hardest hit stock markets in dollar terms are Ukraine, which has fallen 58.8 per cent this year in part on geopolitical worries; China, down 57 per cent amid fears it had risen too far on a bubble; Hungary, down 49 per cent on worries over growth; Pakistan, down 46.7 per cent amid political turmoil; and Vietnam, down 46.4 per cent in the face of a sharp rise in inflation...
Emerging market sovereign bond yield spreads have risen to 330 basis points over Treasuries – highs not seen since mid-2005 – from 300bp at the start of last week amid rising risk aversion. Bonds of the four Bric countries – Brazil, Russia, India and China – have also been hit by rising interest rates this year.
Indonesia failed to sell bonds in an auction on Tuesday in a sign of growing worries over emerging markets as concerns heightened over the health of the world economy. The finance ministry said it was unwilling to pay the higher coupon rates investors were demanding to compensate for the volatile market conditions.
The problems for Indonesia were reflected in the broader market as emerging market bond spreads rose against Treasuries with the benchmark Embi+ index rising 10 basis points to around 325bp – close to this year’s high in March just before the rescue of Bear Stearns.
Analysts say resource-rich nations, such as Indonesia, are particularly exposed to growing fears of a sharp global slowdown, which would sap demand for commodities. The scrapping of the auction followed a similar failure in April when the government was struggling with soaring oil prices and spiralling fuel subsidies.
Yields have since fallen but the ministry said in a statement they were still “higher than what the ministry can afford”. The ministry had hoped to raise Rp3,000bn rupiah ($321m) from the auctions of zero coupon bonds maturing in 2011 as well as fixed rate bonds maturing in 2015 and 2038. But officials said offers only totalled Rp2,900bn – the lowest this year – and some investors were asking for yields of 13.5 per cent. The government offered 10.5 per cent and 9.5 per cent.
Indonesia’s stock market fell 3.9 per cent Tuesday and the rupiah had its sharpest fall in 15 months on Friday. Nick Cashmore of CLSA in Jakarta said: “There’s not any immediate need to sell bonds but what’s happening shows that the whole credit crunch is still working its way through [the system].”
Indonesian corporates are finding it even harder than the government to sell bonds. Not one company listed on the Indonesian stock exchange has sold bonds this year – and many have tried – compared with some three dozen corporate bond offerings last year.
Fredric Teng, of Lehman Brothers in Hong Kong, said Indonesia’s woes were indicative of a broader regional malaise, citing a similar auction failure by the Philippines this year too. Analysts said countries had the option to sell foreign currency debt. Indonesia has twice this year sold dollar bonds and is intending to offer a $1bn sukuk bond next month. South Korea is also selling dollar bonds.