3. Sovereign debt issuance trends in emerging-market economies
Emerging Market and Developing Economies (EMDEs) have faced various challenges since the outbreak of the pandemic in 2020. Many EMDE sovereigns experienced a considerable decline in their economic activity and tax revenues while having to increase fiscal stimulus and social spending to fight the negative impacts of the pandemic, which resulted in an unprecedented surge in debt issuance globally. Strong immediate policy support and accommodative financial conditions have helped to contain financial distress and allowed economies to recover to some extent. However, various risk factors such as inflationary pressures, monetary tightening in advanced economies and new COVID-19 variants may affect capital inflows to EMDEs and expose vulnerabilities in some countries.
This chapter presents an overview of sovereign debt issuance trends in EMDEs in 2021 and provides an update on the impact of the COVID-19 crisis on the issuance conditions of EMDE sovereigns.
Chapter 3 of last year’s Outlook explored the impact of the COVID-19 pandemic on debt issuance trends in emerging markets and developing economies (EMDEs) with a focus on currency and maturity structures. This year, the chapter on emerging market and developing economies (EMDEs) provides an overview of the most recent developments in borrowing conditions and sovereign debt issuance by different income levels and geographic regions, as well as an evaluation of debt quality and borrowing costs across regions during the pandemic.
The key source of information is a dataset comprising over 7 500 sovereign government securities issued by 95 EMDE sovereign issuers in 2021 (see Annex 3.A for details of the methodology used).
The impact of the COVID-19 pandemic spurred a rise in EMDE sovereign debt issuance. These country groups issued around a record of USD 3.5 trillion of debt in financial markets in 2021, roughly 40% higher than the pre-pandemic three year average. In 2021, the issuance amount remained stable at approximately the same level as in 2020, despite the increasing borrowing costs in most regions, especially towards the end of the year. In terms of net debt issuance, all income categories except low-income countries (LICs) decreased net issuance considerably in 2021 compared to 2020. Net debt issued by LICs reached record highs in 2021 despite having consistently decreased since 2015. In 2021, LICs issued USD 7.8 billion of net debt, more than double the USD 3.2 billion issued in 2020.
In 2021, China remained the largest issuer, although its share declined slightly, while Emerging Asia and China combined constituted more than half of the EMDE sovereign debt issuance. Despite significant differences within regions, the share of Middle East and North Africa (MENA), Sub-Saharan Africa (SSA) and Latin America and Caribbean (LAC) picked up above 2020 levels, suggesting a restoration of market access and increased financial needs for these regions.
Borrowing costs varied widely across regions with an overall increase in yields for all EMDEs in 2021. SSA and MENA faced the highest yields in foreign currency denominated securities, whereas Emerging Europe and Emerging Asia regions enjoyed relatively cheaper funding.
The share of foreign currency denominated debt issuance in total issuance continued to decrease in 2021, falling below 2020 levels. The decline was most pronounced in MENA and LAC regions where costs were fairly high. Though the share of FX denominated debt of SSA picked up considerably, it was still below pre-pandemic levels as access to international money markets remained constrained for most sovereigns.
In the face of high uncertainty and rising financing needs, sovereigns issued high amounts of short-term debt during the pandemic. This increased share of short-term debt has worsened the redemption profile of EMDE sovereigns, with high amounts of debt needing to be repaid within the next three years. LICs bear the highest rollover risk as 45% of their outstanding debt will need to be repaid or refinanced in the next three years.
In 2021, the average maturity of new borrowing decreased in almost all regions except SSA and LAC regions. Particularly in SSA, the average maturity increased mainly due to a few large issuances in international capital markets.
Debt quality in EMDEs has been deteriorating in some regions over the last two years, with a record of 59 downgrades issued in the wake of the pandemic and a further 15 downgrades issued in 2021, also reflected in increased risk premia and borrowing costs. The region bucking this trend is emerging Asia, where debt quality remained high and stable both before and after the pandemic.
As countries were slowly recovering from the COVID-19 pandemic, Russia’s invasion of Ukraine is expected to put additional strain on inflation, economic growth and fiscal accounts in many EMDEs. This coincides with increased refinancing needs and deteriorated credit conditions in some low- and lower-middle income countries. It is important for these countries to receive financial and technical support from international financial institutions to manage both the risk of short-term refinancing risk and long-term debt sustainability, and to prevent these countries from resorting to opaque borrowing methods.
At the initial outbreak of COVID-19, many EMDE governments faced considerably increased financing needs to deal with the turmoil caused by the pandemic and mitigate its economic consequences. This resulted in unprecedented levels of debt issuance in 2020, which reached USD 3.5 trillion, around 35% increase on the 3-year average before pandemic. Supported by major central banks’ asset purchase programs and generous pandemic recovery packages, accommodative financial conditions in many advanced economies helped to support global liquidity, allowing EMDEs to access funds and rollover their existing debt at relatively low cost. In 2021, however, the strengthening global economic recovery and rising inflationary pressures have led many advanced economies to reduce pandemic related policy support and tighten monetary policy. Moreover, several EMDEs central banks’ have also increased their policy rates in face of surging food and energy prices, which may pose new challenges for EMDEs, especially when refinancing their considerably high legacy debt from the pandemic.
3.2.1. Funding needs remained high in 2021 while EMDEs face new challenges which may affect future capital inflows
As was the case for almost all sovereigns, EMDE sovereign funding needs drastically surged with the outbreak of the pandemic in March 2020, in response to lower fiscal revenues and higher expenditure on health and support for vulnerable groups. Sovereign debt issuance gradually increased and reached a record high in July 2020, stabilising afterwards at levels significantly higher than prior to the pandemic. In 2021, EMDEs’ financing needs remained elevated, in total, EMDE sovereigns issued more than USD 3.5 trillion, similar to the level issued in 2020. With this, they borrowed from financial markets at record level for two years in a row.
Monthly debt issuance was also volatile, as the relatively steady debt issuance in the first half soared significantly in the summer, reaching record highs in August, and stabilised again at levels slightly lower than 2020 in the last quarter of 2021 (Figure 3.1).1 Most of the debt issuance surge in August came from Argentina’s Sinking Fund/Amortisation Pay of USD 121.7 billion, which alone constituted 30% of the debt issuance in August. Excluding Argentina’s high amortisation pay, the monthly debt issuance by EMDE sovereigns has been mostly steady.
A number of factors played an important role in explaining the issuance trends during the pandemic; notably higher levels of gross issuance throughout the year; and the significant increase during the summer 2021. Despite recent increases in interest rates, financing conditions have been favourable in the period under review, as major central banks in advanced economies maintained a low interest rate policy, which supported global liquidity and mitigated financial distress in the markets, supporting capital inflows to EMDEs. In addition, substantial policy efforts were made to support recovery of low-income countries (LICs) from the pandemic such as the Debt Service Suspension Initiative (DSSI) and additional financing support programmes including new Special Drawing Rights (SDR) allocations by the IMF.2 These programmes helped to enhance debt resilience and further facilitated sovereigns to issue new debt and rollover existing ones at very low costs, allowing the unprecedented increase in EMDE debt issuance during the pandemic.
The outlook suggested a normalisation from the period of acute financial distress with relatively steady monthly issuances in 2021, but EMDE financing needs remain significantly higher in 2021 than pre-pandemic averages. Moreover, various risk factors posed challenges for EMDE sovereigns, affecting capital inflows into EMDEs as well as the sustainability and the cost of debt. Notably, the policy support which had created ample liquidity and buttressed investor sentiment has been gradually reduced. Many advanced economies have initiated or planned to reduce their monetary and fiscal support in 2021. Global financial conditions have also started to tighten in the face of increased energy and food prices. Although still being accommodative, policy rates in some advanced economies have increased, since the second half of 2021. Given already elevated debt levels and the high financing needs of EMDE sovereigns, interest rate hikes may expose vulnerabilities in some countries, especially if they come faster than anticipated (IMF, 2021[1]).
Another major source of concern is the recent Russian invasion of Ukraine, which may have adverse implications for EMDEs. Having pushed energy prices even higher, the war may also spur agricultural commodity price increases as both Russia and Ukraine are major exporters of grain (OECD, 2022[2]). Increases in the price of energy and food, which typically form a larger share of household consumption of EMDE countries, may bring additional inflationary pressures and accelerate interest rate hikes (FitchRatings, 2022[3]). Higher borrowing costs, on the other hand, could raise debt sustainability concerns and trigger rating downgrades and even sovereign defaults, especially in countries which have high amounts of debt maturing in the near-term. Global liquidity conditions have also tightened, reflecting greater risk aversion and uncertainty, with higher risk premia and currency depreciations also occurring in many emerging-market economies and Central and Eastern European economies with relatively strong ties with Russia (OECD, 2022[2]). One exception is that capital flow into other regions, for example the LAC region, is picking up as some investors shift away from the countries in conflict to other emerging economies (OECD, Forthcoming[4]).
3.2.2. Monetary policy normalisation is now occurring amid increased inflationary pressures
Global inflationary pressures have shifted central bank policy rate expectations upwards for advanced economies, creating a major challenge for EMEs, as the increased borrowing costs would aggravate their debt problems and risks. The surge in commodity and energy prices added to the existing pressure on price levels coming from the recovery in demand and encouraging developments in vaccination rollouts. In particular, the price of crude oil picked up by more than 50% between the end of 2020 and 2021 and the global commodity price index excluding fuel prices increased by around 14% over the same period.3 A rise in energy prices may allow some oil exporting EMEs to reduce their financing needs, but adds a negative drag on the economic activity of oil importing countries, which in turn affect their fiscal balances (IMF, 2015[4]).
Financial conditions have tightened globally, those countries who have borrowed in foreign currencies face higher exposure to currency risk and may have to refinance their debt under less accommodative terms. New COVID-19 variants and supply-chain disruptions have spurred price increases and accelerated interest rate hikes. In this regard, EMEs have faced a difficult trade-off between sustaining a stimulative financial environment to support the economic recovery or tightening monetary policy to maintain price stability as well as to preserve a real interest rate differential over US yields.
Source: OECD calculations based on Refinitiv data.
To this end, many EME central banks took an aggressive stance against rising inflation and increased their policy rates, especially during the second half of 2021, gradually widening the EME local-currency government bond yield spreads over ten-year US Government bond yields (Figure 3.2, Panel B). Along with others, the Central Bank of Brazil raised its benchmark rate seven times in 2021, from 2% to 9.25% and marked the steepest hike among EMEs. One exception to the trend was the Central Bank of Turkey, who cut its policy rate several times in 2021 despite soaring inflation. The policy rate set below inflation spurred further currency depreciation as well as a rise in inflation expectations and a surge in risk premia (OECD, 2021[5]).
The capacity to use fiscal policy varied widely among countries as the pandemic has weighed differently on various regions and income categories. In several LICs, recovery from the pandemic has lagged far behind the rest of the world due to their weak macroeconomic fundamentals, low vaccination rollouts and pre-existing vulnerabilities (IMF, 2021[6]). Lacking fiscal space, these countries may find it more challenging to balance the opposing needs of supporting the economy through the recovery and combatting inflation by monetary tightening.
3.2.3. Central bank bond purchases in EMEs have helped to restore financial stability in times of acute market distress
In response to financial market strains in the wake of the pandemic, central banks of EMEs deployed a number of measures, including liquidity support, and foreign currency interventions and swap lines. Some emerging-market economy central banks have also launched asset purchase programmes – for the first time since the adoption of inflation targeting frameworks in the late 1990s – in response to the massive government bond sell-off during the initial months of the COVID-19 crisis. For example, Brazil, India, Indonesia, South Africa, Thailand and Turkey have engaged in asset purchases with a particular focus on government bonds. These purchases, while often small compared to those of major advanced economies, were effective in restoring financial stability, guided price discovery and curbed further surges in local benchmark bond yields (Box 3.1).4 Overall, bond purchases by EME central banks remained limited in 2021.
This box sketches a model (Figure 3.3) to assess the efficacy of central bank (CB) asset purchases in EMEs (Sunel and Mimir, forthcoming[7]). The environment is a small open economy with a bank-based financial sector. Banks collect local-currency deposits from households and foreign-currency funds from foreign lenders. Banks then make loans to producers of intermediate goods by purchasing local-currency securities issued by these firms – financing their demand for physical capital – and to the government by purchasing local-currency, long-term government bonds. These latter bonds are also held by non-resident investors. Foreign holdings of sovereign bonds are subject to investor sell-off shocks and respond negatively to rising country risk premia. Government bonds may be purchased by the CB on the secondary market if there is exceptional financial stress.1 These purchases, financed by issuing interest bearing reserves to banks, are mainly designed to compensate for the market dislocation from bond sell-offs.
In such an environment, the exposure of EME sovereigns to foreign investors can tighten overall financial conditions when foreign lenders sell off government bonds of these countries during a stress episode (Figure 3.4). If the CB does not undertake asset purchases, domestic commercial banks absorb the bonds sold off by foreigners, which pushes down their price and raises the excess yield on sovereign bonds over US interest rates. This crowds out bank credit to non-financial firms, bids down private firm bond prices and leads to a widening of intermediation margins.2 Hence, the external bond sell-off shock has spill-over effects on domestic financial conditions. The foreign borrowing capacity of domestic banks is hindered by their weaker balance sheets due to depressed asset prices exacerbating the initial net capital outflows from the sovereign bond sell-off. The ensuing depreciation of the currency raises import prices and passes through to aggregate prices, inducing conventional monetary policy to tighten to stabilise inflation.
CB bond purchases could address the market dislocation so that commercial banks are no longer required to absorb the bond sell-off by foreign investors.3 This would limit the crowding out of credit to firms and the collapse in sovereign bond and non-financial corporate bond prices. Stronger asset prices would in turn reduce the tightening of financial conditions as measured by excess bond yields and loan-deposit spreads. Stronger private domestic bank balance sheets would provide better foreign-borrowing prospects for banks, limit capital outflows, reduce currency depreciation and create room for manoeuvre for monetary policy.
← 1. Purchases on the secondary rather than the primary market (hence not monetising newly issued public debt) reflect the commonly observed modality of EME government bond purchases during the COVID-19 crisis (Fratto et al., 2021[8]).
← 2. Domestic banks absorbed around 90% of the increase in outstanding local-currency government bonds in emerging-market economies that implemented asset purchases between February and June 2020 (IMF, 2020[9]). CB holdings represented close to 30% of that increase, slightly exceeding the decline in non-resident investor holdings (about 25% of the change in total bonds).
← 3. For a quantitative analysis of the transmission of CB government bond purchases upon bond sell-offs, see (Sunel and Mimir, forthcoming[7]).
Although potentially useful in extreme stress episodes, central bank bond purchases in EMDEs are not always effective. Firstly, high-frequency estimates suggest that asset purchases during the pandemic resulted in only short-lived reductions in bond yields. This was because the level of bond purchases in EMDEs was not large enough to bring a sizeable and persistent easing of financial conditions (Sunel and Mimir, forthcoming[7]). Secondly, if bond purchases lead to a de-anchoring in inflation expectations, they bring a smaller reduction in real excess bond yields while leading to higher and more persistent inflation. Finally, a larger central bank balance sheet, especially if not scaled down once domestic financial conditions normalise, could elevate fiscal dominance risks and raise concerns that investors perceive future monetary policy tightening as less likely because of the potential for central bank losses on bond holdings.
3.2.4. An uneven recovery from the pandemic affected issuance amounts across regions and income levels
Similar to the total issue amount, shares of issuance by income categories in 2021 presented a similar picture as in 2020. In EMDEs in 2021, upper-middle income countries (UMIC) continued to be the largest group in terms of their gross issuance, representing 61% of the debt issued in 2021. It is worth noting that some major issuers, such as Brazil and China, significantly decreased their new debt issuance in 2021, as their new funding needs reduced compared to 2020. In contrast, several countries including Kazakhstan, Malaysia, Mexico, Peru and Thailand issued more sovereign bonds than their 2020 levels. High income countries (HIC) in EMDEs accounted for 10% of the gross debt issuance in 2021, slightly higher than their share in 2020. The rise in the share of HIC was mostly driven by Chile’s increased issuance, followed by Bahrain, Oman, Panama and Uruguay. The share of lower-middle income countries (LMIC), on the other hand, slightly reduced from 30% in 2020 to 28% in 2021. Their issuance in the financial markets somewhat reduced in the fourth quarter of the year, when interest rates started to rise slowly (Figure 3.5, Panel B).
Source: OECD calculations based on Refinitiv data.
The regional composition of EMDE sovereigns’ gross debt issuance has changed widely in 2021 (Figure 3.5 Panel A). Emerging Asia including China accounted for more than half of the EMDE debt issuance in 2021, while the relative share of China, which is the largest single issuer, fell from 32% to 29%, approaching its lower pre-pandemic levels. Excluding China, the share of the Emerging Asia region has continued to grow, accounting for almost one-quarter of the total EMDE issuance as of 2021.
After falling below its historic share in 2020, the share of Latin America and the Caribbean (LAC) of the gross debt issuance remained at the same level of 21% in 2021 as in 2020. Sub-Saharan Africa and MENA, which had also fallen short of their pre-pandemic averages in 2020, increased their issuance both in relative and nominal terms in 2021. Particularly, MENA’s issuance share exceeded its 3-year pre-pandemic level, while Sub-Saharan Africa remained below their pre-pandemic average. Although it was important for MENA countries to increase fiscal spending to finance public health expenditures and support the most vulnerable households and businesses, the pandemic debt also came with a cost. Many MENA countries faced higher borrowing costs, despite the global low interest rate environment, as their default risk picked up sharply in 2020 due to their elevated debt levels, chronic low growth compared to peers and pre-existing vulnerabilities including governance and low transparency (Gatti et al., 2021[10]).
In 2020, net debt issuance by EMDE sovereigns soared drastically for all income categories compared to pre-pandemic levels and reached USD 1.5 trillion, as governments turned to bond markets to meet their increased financing needs in the face of restricted economic activity, lower tax revenues and additional health and social expenditures (Figure 3.6). Upper-middle-income countries (UMICs) with high financing needs and developed institutional frameworks had strong demand following the recovery of money markets from the initial shock. UMICs issued a record level of USD 970 billion which constituted 66% of the total net debt issuance in 2020. Similarly, lower-middle income countries (LMICs) also drastically increased their net debt issuance and issued 69% more than their pre-pandemic level. On the other hand, high income countries (HICs) and LICs increased their net debt issuance only by about 30% and issued substantially lower amounts of net debt. However, it should be noted that, even though the level of net debt issuance by HICs is considerably lower than the amount issued by UMICs, these categories are a subset of EMDEs. The USD 138 billion net debt issued by HICs in 2021 came from 18 sovereigns whereas USD 668 billion was issued by a higher number of 43 UMIC countries.
Sovereign net debt issuance in EMDEs declined in 2021 compared to 2020 but remain higher than pre-pandemic levels. As a result, indebtedness in EMDEs continues to grow and raises sustainability concerns in the future give the macroeconomic and macro financial context. In 2021, EMDE sovereigns issued USD 1.1 trillion net debt, 22% lower than the 2020 levels. While UMICs remained the largest group in terms of net debt issuance, their share of the total net issuance declined more than 8% but increased in all other income groups. In nominal terms on the other hand, LICs were the only group that increased their net issuance in 2021 compared to both 2020 and pre-pandemic levels.
Notwithstanding the consistent decline of net debt issuance by LICs since 2015, the pandemic resulted in record levels of LIC net debt issuance, marking the steepest increase among other income groups. In particular the amount of net debt issuance by LICs declined from USD 5.4 billion in 2015 to USD 1 billion in 2019. This number picked up to USD 3.2 billion in 2020 and reached more than USD 7.8 billion in 2021. In all other income categories, the volume of net debt issuance fell significantly below 2020 numbers, reflecting the uneven recovery for LICs who were more negatively affected by the pandemic. Due to their structural challenges and slower access to vaccines, LICs are still struggling to recover from the pandemic and face high financing needs. In this regard, international policy efforts were made to help ease the liquidity constraints in these economies such as the DSSI led by G20 countries and IMF financial assistance through various lending facilities, including the Rapid Credit Facility (RCF), the Rapid Financing Instrument (RFI) and the Catastrophe Containment and Relief Trust which have in total provided USD 250 billion to member countries since March 2020, a quarter of IMF’s USD 1 trillion lending capacity.5
While foreign currency denominated debt is often avoided due to the risk of potential currency mismatch on the sovereign balance sheets, issuing foreign-currency securities in international markets allows EMDE sovereigns to borrow in longer maturities and face lower refinancing risk, and alleviate the pressure on domestic investors particularly when funding needs surge suddenly. In this context, the global pandemic and the resulting heightened financial needs of EMDEs have made access to international financial markets more critical than ever. At the same time, especially in periods of financial crisis, the cost of issuing in hard currency soars drastically due to the deterioration in investor risk sentiment of investors and higher risk premium. In periods of financial stress there have been declines in foreign currency denominated debt issuance.
3.3.1. Foreign currency denominated debt issuance decreased across EMDE groups with the exception of Sub-Saharan Africa
Domestic currency securities have dominated EMDE issuance in the last decade, representing about 88.7% of all debt being issued in domestic currencies before the pandemic, suggesting a deepening of local currency bond markets and an improvement in currency risk exposures in EMDEs. The share of debt issued in domestic currencies increased further in 2020 and reached 91% as the foreign currency (FX) debt share shrunk drastically for some regions. Some countries with weak fundamentals could not regain market access following the initial shock of the pandemic. In 2020 for instance, Sub-Saharan Africa, despite its considerable foreign currency needs, could only issue 7.4% of its total debt in foreign currency, less than half of the 16.4% share before the pandemic, reflecting a loss of international market access in the wake of the COVID-19 crisis (OECD, 2022[11]).
In 2021, the overall share of foreign currency denominated debt in EMDEs fell further to 7.5%, lower than the pre-pandemic and 2020 levels (Figure 3.7). Emerging Asia and other emerging Europe countries who enjoyed relatively lower borrowing costs, both increased their share of foreign-currency denominated debt in 2021. Emerging Asia, which has deep and strong local-currency bond markets, issued about 4.2% of its total debt in foreign currencies, higher than its 2020 levels. On the other hand, Sub-Saharan Africa, which had experienced a significant loss of market access following the pandemic outbreak, issued around 16% of its total debt in foreign currency, despite the considerably higher costs.6 It should be noted that the majority of the large Eurobond issuance in 2021 came from Benin, Ghana and Nigeria, together constituting 65% of the total foreign-currency denominated debt issued in Sub-Saharan Africa. Overall, only 9 out of 30 sovereigns in the region issued FX-denominated securities, suggesting that the international market access for many Sub-Saharan Africa countries remained constrained in 2021, with the exception of a few, who managed to borrow large amounts of foreign denominated debt with fairly long maturities. In addition, sovereigns who issued ESG labelled securities, enjoyed strong investor demand and were able to borrow at longer maturities and at relatively low costs, allowing them to extend their debt maturity profiles and lower their exposure to future interest rate hikes and rollover risks. For instance, Benin raised USD 1.2 billion with its 14-year ESG labelled Eurobond, at a yield of 5.25%, one of the lowest yields achieved in the region. On the other hand, many Sub-Saharan Africa countries also relied on domestic markets and official creditors, as well as various debt relief programmes and restructuring.
MENA and Latin America and the Caribbean regions reduced their foreign-currency denominated debt issuance significantly in 2021. This took place amid increasing cost of FX-denominated debt issuance for most sovereign issuers in these regions, particularly in MENA.7
Although the foreign currency composition of total EMDE sovereign debt issuance in global markets has been limited in recent years, the results should be interpreted with caution with respect to currency risk assessments in EMDEs. First of all, the higher share of foreign-currency debt issuance in countries like Argentina,8 Bulgaria, Romania and Turkey may make these economies more vulnerable to abrupt fluctuations in exchange rates. The rapid rise in foreign currency debt issuance by Benin and Nigeria is also worth noting. In addition, in some EMDEs, the rise in foreign-currency private sector liabilities has also been very substantial and needs to be considered when assessing overall currency risk exposure of countries.
3.3.2. Foreign currency borrowing costs for EMDEs increased, with wide variations between countries
In 2021, nearly one-fifth of the EMDE total fixed-rate USD-denominated government bonds were issued with a yield under 3%; 37% with a yield between 3% and 5% and 43% with a yield above 5% in the primary markets (Figure 3.8).9 The share of FX-denominated bonds sold with a yield of 5% or more increased from 37% in 2020 to 44% in 2021.
Looking at regional groups, the cost of USD-denominated bonds was relatively favourable for Emerging Europe issuers with 42% of their issuance having a yield of less than 3%. Sub-Saharan Africa on the other hand, issued USD denominated debt with the highest cost, all of it with a yield above 5% and about one-third being with a yield of more than 8%, followed by MENA who issued more than two-thirds of its USD denominated debt with a yield above 5% yield. Out of ten EMDE issuers who borrowed with the highest yields on fixed-rate USD-denominated bonds, eight belong to either Sub Saharan Africa or MENA, with the exception of Turkey (5.5%) and Ukraine (6.7%).
Overall in EMDEs, the weighted yield-to-maturity (YTM) increased from 4.1% in 2020 to 4.6% in 2021 when all EMDE issuances are included. However, this finding should be interpreted with caution. Restricting the countries to those that issued fixed-rate USD denominated bonds in 2021 (35 EMDE sovereigns) and comparing their YTM between 2020 and 2021 shows that the change is much more moderate, from 4.5% to 4.6%. This difference suggests that the change in EMDEs’ overall yield was mainly affected by the composition of countries who issued each year, the presence or absence of countries with high yields and their volume share of issuance, rather than a drastic change in yields for each given issuer. A number of countries who issued fixed-rate USD-denominated government bonds with high yields in 2020 did not issue in 2021. For instance, Bahamas and El Salvador who issued with 9.5% and 9.2% yields in 2020 did not issue in 2021, while there are countries where the opposite is also true. Countries with relatively higher yields such as Kenya (6.3%); Nigeria (7.3%); Pakistan (7.1%) and Rwanda (5.5%) who did not issue fixed-rate USD-denominated securities in 2020 issued in 2021, contributing to the overall yield increase. In LAC region, more than 90% of the fixed-rate USD-denominated government bonds were issued with yield less than 5%.
Notes: Yields are calculated using fixed-rate USD-denominated securities with maturity longer than 365 days. Comparison between EMDE yields between 2020 and 2021 is based on the same 35 EMDE sovereigns who issued fixed-rate USD denominated bonds in 2021 and their corresponding yields in 2020.
Source: OECD calculations based on data from Refinitiv.
During the past two decades, EMDEs have weathered several financial crises, which commonly stemmed from currency and maturity mismatches. When sovereigns have large amounts of short-term debt and the economic outlook worsens, debt service becomes extremely costly and sometimes even impossible, leading to a sovereign default. Although issuing short-term debt is associated with higher risks and rollover vulnerabilities, options for EMDE sovereigns to shift towards longer maturities are often limited due to a number of factors. Most importantly, facing a higher risk premia and hence higher borrowing costs on long-term debt, it is more attractive for many EMDE issuers with shallow local bond markets to borrow at shorter maturities. Moreover, investor demand may be lower for fixed-rate long-term domestic-currency denominated securities from risky borrowers due to the moral hazard problem, that the governments are able to create inflation to lower the real value of their debt. This is not an issue with foreign currency denominated debt and less likely to occur for a shorter maturity debt (Broner, Lorenzoni and Schmukler, 2011[12]). Given that longer-term debt is often issued in foreign currency, issuing short-term debt also goes hand in hand with a higher share of domestic currency denominated securities. This is especially the case during crisis periods where the cost of longer-term debt soars drastically, and issuers depend more heavily on short-term domestic securities. Overall, EMDE sovereigns face a tough choice between issuing long-term debt, which mitigates the rollover risk, and short-term debt which reduces the cost of borrowing.
Notes: Data used on ATM calculation includes all gross issuances by EME sovereigns except short-term securities which had to be repaid in less than 31 days as these are mostly used for cash management purposes rather than debt management.
Source: OECD calculations based on data from Refinitiv.
Between 2009 and 2019, EMDEs have managed to lengthen the average maturity of their new debt issuance from 5.7 to 7.4 years, allowing EMDEs to improve their risk profile, which is particularly important as they are more prone to capital outflows and sudden stops during times of financial crises (Figure 3.9) (See Annex 3.A for details of the methodology used). Mitigating sovereigns’ exposure to rollover risks with higher maturities came at the expense of higher currency risk, as the majority of the longer-term securities have been issued in foreign currencies over the past years, making EMDE sovereigns vulnerable to exchange rate shocks (Chen et al., 2018[13]). In times of financial distress, EMDEs long-term and foreign currency denominated debt issuance often decreases due to the lack of investor demand and higher hard currency borrowing costs. Meanwhile, sovereigns turn to their domestic markets where they can borrow for shorter maturities from domestic investors. Following both the burst of the 2001 dot-com bubble and the 2008 Global Financial Crisis (GFC), the weighted average maturity for EMDEs’ new debt issuance decreased by about two years, and the numbers suggest that a similar pattern is occurring in the aftermath of COVID-19 pandemic. Looking at the maturity structure of EMDEs (Figure 3.9), overall maturities have decreased both in 2020 and 2021, falling from 7.4 years in 2019 to 6.1 years in 2021. Nevertheless, this decline is much less pronounced on the average maturities of outstanding debt, suggesting that the rollover risk associated with shortened maturity of new debt issuance during the pandemic remained relatively constrained. At the regional level, average maturity decreased considerably across all regions with the exception of Sub-Saharan Africa, which lengthened its maturity from 7.1 years in 2019 to 8.7 years in 2021, becoming the region with the longest average maturity among EMDEs. Average term-to-maturity of debt issuance by the Latin America and the Caribbean (LAC) has remained the same in the review period. Despite the general outlook of the region, 10 out of 12 LAC sovereigns who issued debt in 2021 managed on average to borrow with maturities higher than five years.
In the Sub-Saharan Africa, a country specific breakdown shows that the average maturity of new debt issuance varied widely between issuers, notably some large issuers like Benin and Nigeria had 14.6 and 9.4 years of ATM respectively (partially due to the recent Social bond issuance by Benin and long-term borrowings in Nigeria for infrastructure investments) while countries like Mauritius and Zambia had average maturity around three years, which raises concerns about debt sustainability and rollover risks in the short-term. However, it is worth noting that many Sub-Saharan African sovereigns also benefit from official creditors’ lending (such as World Bank, IMF and Development Banks) which is not included the data used for this report. Often given in foreign currency with long maturities, a decade or longer, official creditors’ funding helps buttress financial resilience and debt sustainability in the region. In addition, several Sub-Saharan Africa countries who had maturity less than three years in 2020 improved their maturity profile significantly, notably Cameroon, Rwanda and Senegal increased their average maturity from less than six months to 11 years; from three years to ten years and from 2.9 years to 12 years respectively. This suggests that some non-investment grade countries who were shut out of the markets at the wake of the pandemic were able to borrow at longer maturities in 2021 amid improved risk sentiment in 2021 largely due to global monetary and fiscal policy response to the crisis.
Source: OECD calculations based on data from Refinitiv.
In the wake of reduced investor risk sentiment and uncertainty about the future at the height of the pandemic, EMDE governments increased their T-Bill issuance as their long-term instruments faced less demand and became more costly.10 In March 2020, at a time of acute market distress, the share of local-currency T-Bills surged dramatically (Figure 3.10), accounting for 61% of total issuance by non-investment grade and 59% for investment-grade categories. On average, T-Bills accounted for 33% and 39% for the investment and non-investment grade sovereigns in 2020 as the former were able to switch towards longer maturities in the months following the pandemic and benefit from favourable financial conditions, whereas non-investment grade issuers had to depend more heavily on shorter-term debt. In 2021, the share of T-Bill issuance constituted 40% of the total issuance of investment-grade issuers, lower than the 42% bill share issued by non-investment grade sovereigns (Figure 3.10). Monthly figures indicate that share of T-Bill issuance increased towards the end of 2021 for both investment- and non-investment grade issuers.
A total of 20 investment grade EMDE sovereigns issued more than USD 900 billion worth of T-Bills while 60 non-investment grade sovereigns issued USD 664 billion of bonds in 2021. It is important to note that the increase in the share of T-Bill issuance by investment-grade sovereigns has been mainly driven by China, which alone accounted for about 30% of the investment grade bill issuance in 2021, followed by India (20%) and Thailand (16%).
Given the reduced share of foreign investors in local bond markets, much of the pandemic-related debt was bought by local banks in EMDEs. For example, between 2019 and 2021, domestic bank holdings of government securities increased by more than 10% in Argentina, Chile, Egypt and Thailand (Arslanalp and Tsuda, 2014[14]). This highlights the importance of a resilient banking system in helping to absorb shocks, but at the same time raises concerns about the sovereign-bank nexus, particularly in jurisdictions where the government has a high level of debt. This suggests a need to develop deeper local markets to absorb medium to long-term local sovereign debt. This will help foster a broader domestic investor base that can mitigate the impact of outflows of foreign capital (Box 3.1).
The sharp increase in short-term borrowing associated with the COVID-19 pandemic has affected the redemption structure of debt, increasing the rollover risk for EMDEs. In 2020, higher financing needs and the decline in revenues resulted in increased borrowings by EMDEs with a considerable amount of new short-term debt being issued. Against this background, a considerable share of EMDE government debt will be repaid in the next three years. The amount of outstanding debt maturing by the end of 2024 constitutes 36% of debt held by EMDEs, 18% of which is due in the next year (Figure 3.11). The income category which has the lowest share of debt due in the next three years is Lower Middle-Income countries (LMIC). Nevertheless, the amount of debt to be rolled over by LMICs is still high, with nearly half of it being due in the next year. The LICs on the other hand, bear the highest rollover risk as 45% of the outstanding debt of these countries will need to be repaid or refinanced in the next three years. Given LICs’ lower vaccination rollouts, weak macroeconomic fundamentals and already elevated debt levels, refinancing their short-term debt might be challenging for some countries, especially under less accommodative financial conditions. Despite their high rollover risk, there is also a slight improvement in the redemption profile of LICs in 2021, as both the share of outstanding debt maturing in the next year (19%) and the following two years (26%) have decreased in 2021, suggesting a slight improvement in the redemption profile and a reduction in the rollover risk relative to 2020.
Source: OECD calculations based on data from Refinitiv.
Source: OECD calculations based on data from Refinitiv.
Following the pandemic outbreak in March 2020, a record number of 59 downgrades were issued to EMDE sovereigns, reflecting a surge in the perceived risks associated with investing in EMDE debt (Figure 3.12). In 2020, a number of sovereigns including Lebanon, Oman, South Africa and Zambia were downgraded several times by different rating agencies as the macroeconomic outlook continued to worsen amid the pandemic. In particular, nine EMDE issuers (such as Bahamas, Cameroon and Gabon) who were classified as investment grade before the pandemic were downgraded to non-investment grade in 2020. This is particularly important for sovereigns that rely on foreign investors, as the inclusion of bonds in benchmark bond indices is mainly driven by credit ratings. It is worth noting that the majority of the downgrades in 2020, namely 44 out of 59, occurred in the non-investment category while only seven investment grade sovereigns (including Bulgaria, Chile, India and Mexico) were downgraded. In 2021, a considerably smaller number of EMDEs were downgraded. In total, 15 downgrades and nine upgrades were given to 9 and 8 countries respectively. In contrast with 2020, the majority (9 of 15) of downgrades were issued to investment grade category while only six out of 15 downgrades were issued to four non-investment grade countries. In addition, none of the countries were pushed towards non-investment grade rating in 2021. More than half of the downgrades in 2021 were given to Latin America and the Caribbean countries (8), followed by MENA (5); Sub-Saharan Africa (1) and Asia (1).
Note: Debt quality reflects the average rating of gross debt issuance at each quarter, it is not a measure for rating quality of outstanding debt.
The value of 12 for the weighted rating constitutes a threshold for investment grade issuance (Annex 3.A.).
Source: OECD calculations based on data from Refinitiv.
Figure 3.13 shows the change of EMDE sovereign credit ratings weighted by their issue amounts between 2015 and 2021. Given the pandemic spurred a rating downgrade wave in EMDEs, a sharp decline in the weighted debt quality was observed in 2020, mainly driven by MENA and LAC regions. The decline was most pronounced in the second and third quarters as the majority of the downgrades occurred in March, April and May, which was reflected in the weighted debt quality in the following months, as downgraded sovereigns issued new debt. An exception to this trend was the Asia region, which received only seven out of 59 downgrades issued to EMDE sovereigns in 2020 and remained on average in the investment grade category during the pandemic.11 In particular, 5 of these 7 downgrades were given to Sri Lanka, which explains the overall stable outlook of the region during the pandemic. All other regions, namely Latin America and the Caribbean, MENA and Sub-Saharan Africa, were below the investment grade rating throughout the pandemic. While MENA and Latin America and the Caribbean regions received 16 downgrades each (including Argentina, Chile, Lebanon, Mexico, and Oman), Sub-Saharan Africa countries were given 17 downgrades, the highest number issued to a region in 2020. In particular in Africa, the ten biggest issuers were rated below investment grade in 2021, with the exception of Mauritius. However, the weighted debt quality seems to have improved in Sub-Saharan Africa, increasing from 8.21 at the last quarter of 2019 to 9.02 (approximately from B+ to BB- or B1 to Ba3) in the third quarter of 2020. Given that no upgrades were given to Sub-Saharan Africa during this period, the reason for the increase observed in the debt quality of the region was mainly due to the change in the composition of issuers between quarters and their relative issue amounts. For instance, Gabon who had issued debt in the first quarter of 2020, did not issue any debt after being downgraded by Fitch on April 2020. Angola, who had been downgraded by all three rating agencies, also did not issue any debt throughout 2020, and therefore is not reflected in the debt quality of issuance in the region. Zambia, who received the highest number of downgrades given to a single country in Africa (six downgrades in total, three times each by Fitch and S&P), issued the least amount of debt in each quarter, which conceals the overall impact of the downgrades in the weighted debt quality of the region.
A similar story is also true for 2021, in the Latin America and the Caribbean region, where the improvement in debt quality is not mainly due to rating upgrades (only one upgrade was given to Ecuador in 2021) but rather due to large issuers’ (such as Argentina and Mexico who were downgraded two and three times in 2020 respectively by three rating agencies) lower gross issuance in the first half of 2021 compared to previous two quarters. Overall, the rating quality of gross debt issuance has not recovered from the unprecedented number of downgrades given at the wake of the COVID-19 pandemic. Regions, which were hit hardest by downgrades in 2020, received only four upgrades in 2021, suggesting that negative implications of downgrades (e.g. higher borrowing costs) mostly remained in place for countries in 2021.
This chapter highlights growing vulnerabilities in EMDEs, in particular in LICs, in terms of elevated refinancing needs and deteriorated debt credit quality over the last two years. Financial conditions have already tightened in financial markets around the world since late 2021, reflecting greater risk aversion and uncertainty, with higher risk premia. Tighter global financial conditions, weakened credit ratings and shallow domestic debt markets in many developing countries may pose a challenge for governments to support the economic recovery through debt financing.
Due to the surge in EMDE debt issuance since the onset of the pandemic, refinancing needs are significantly higher than pre-pandemic levels. While recovering from the pandemic gradually, fiscal policy space in many EMDEs is more limited after two years of COVID-19-related budgetary support. Yet, other factors may put pressure on sovereign borrowing needs in EMDEs. Given that the DSSI, which provided the most vulnerable countries some breathing space, has ended as of the end of 2021, the recipient countries of this programme may now turn to international capital markets for their funding needs. With increased refinancing needs and deteriorated credit ratings LICs are more vulnerable to risks stemming from changes in funding conditions. In particular, the depreciation of EM currencies may present challenges for the issuers that have substantial FX-denominated debt that needs to be repaid or refinanced in coming periods.
In addition to elevated refinancing needs, many EMDEs will require additional sovereign funding support due to the economic and financial fallout from the war in Ukraine. Already, the war has produced substantial downward revisions to global growth forecasts, and upward revisions to already rising inflation (OECD, 2022[2]).12 Soaring energy prices can add significant inflationary pressures and worsen the current account balances of net energy importing EMDEs, including Chile, India, the Philippines and Turkey. In particular, the war will have substantial consequences for neighbouring countries that have close trade and payment-system links with Russia and Ukraine. In addition, governments may need to introduce fiscal measures such as raising well-targeted government subsidies to mitigate the economic impact of the crisis on consumers and businesses, which in turn would increase sovereign borrowing needs. On the other hand, higher commodity prices should bolster fiscal revenues in commodity-exporting countries, providing some leeway to cushion the shock of higher food and energy prices on household incomes.
Debt financing, through security and loan issuance, is especially critical for development in EMDEs. At the same time, unsustainable debt levels as well as poor debt management and transparency practices pose important challenges, in particular for LICs. For the less developed economies, sovereign lending is often characterised by widespread informational opacity that not only impedes access to funding and undermines investor confidence but also contributes to less-informed policy formulation and an increased risk of financial instability (The Bretton Woods Committee, 2022[15]). In this context, efforts were made to improve debt management capacity and transparency through international initiatives such as the World Bank’s strengthening of debt management capacity in low and middle income countries, and the OECD’s Debt Transparency Initiative, which operationalises the Institute of International Finance’s (IIF) Voluntary Principles on Debt Transparency are most welcome.
Looking forward, in view of global risk factors, the increasing financing needs of EMDEs may need to be met in less favourable conditions. The sovereign issuers that have access to market funding may benefit from lengthening debt maturities and build-up contingency buffers through pre-financing programmes. On the other hand, the sovereign issuers with weak macroeconomic fundamentals, heavy debt repayments and underdeveloped local currency bond markets can be significantly challenged by the trade-off between expected cost and risk involved short-term and long-term financing strategies. An increase in the interest rate of the borrowing would put additional interest burden on budgets, and the decrease in the borrowing maturity would worsen the sovereign refinancing risk. In this context, lending and other financial support such as grant facilities by the IFIs to these countries will be critical in terms of the sustainability of their debts and supporting their economies, as well as preventing them from turning to non-traditional sources of funding and use of opaque lending facilities.
References
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The key source of information is a dataset comprising over 7 500 sovereign government securities issued by 95 EMDE sovereign issuers in 2021. Primary sovereign bond market data are based on original OECD calculations using data obtained from Refinitiv that provides international security-level data on new issues of sovereign bonds. The data set covers bonds issued by emerging market sovereigns in the period from 1 January 2015 to 15 December 2021 and includes both short-term and long-term debt. Short-term debt (“bills”) is defined as any security with a maturity less than or equal to 365 days but no less than 30 days, as bill issuances with maturity less than 30 days are considered to be done for cash management purposes and excluded from calculations. The database provides a detailed set of information for each bond issue, including the proceeds, maturity date, interest rate and interest rate structure.
The definition of emerging markets used in this report is consistent with the IMF’s classification of Emerging and Developing Economies used in its World Economic Outlook. The regional definitions are also those used by the IMF, while the income categories used (high income, low income, lower middle income, upper middle income) are defined by the World Bank according to GNI per capita levels.
A number of bonds have been subject to reopening. For these bonds the initial data only provide the total amount (original issuance plus reopening). To retrieve the issuance amount for such reopened bonds, specific data on the outstanding amount on each reopening date for the concerned bonds have been downloaded separately from Refinitiv. As the reopening data only provide amounts outstanding in order to obtain the issuance amount on each relevant date, the outstanding amount on the previous date is subtracted from the outstanding amount on that given date. These calculated issuance amounts are converted on the transaction date using USD foreign exchange data from Refinitiv. To ensure consistency and comparability, the same method is used for all bonds, including those which have not been subject to reopening.
Exchange offers and certain bonds in the dataset have been manually excluded when they did not have any identifier (ISIN, RIC or CUSIP) and when they have not been able to be manually confirmed by comparing with official government data.
The issuance amounts are presented in 2021 USD and adjusted by US CPI.
Refinitiv provides rating information from three leading rating agencies: S&P, Fitch and Moody’s. For each country that has rating information in the dataset, a value of 1 to the lowest credit quality rating (C) and 21 to the highest credit quality rating (AAA for S&P and Fitch and Aaa for Moody’s) is assigned. There are 11 non-investment grade categories: five from C (C to CCC+); and six from B (B- to BB+). The ratings data are observed on a monthly basis. If a country has received several ratings in one month, the lowest one is used, except when that is a default rating (SD or D for S&P; RD or DDD for Fitch and C or / for Moody’s).
The rating in question is then assigned to each relevant bond issued by that country (as at issuance or transaction date). In the case that there are ratings available from several agencies, their average is used. When differentiating between investment and non-investment grade bonds, if the final rating is higher than or equal to 12 it is classified as investment grade. If the final rating is below 12 but higher than or equal to 11 and at least two agencies have given a rating higher than or equal to 12, it is also classified as investment grade. All other bonds are considered non-investment grade.
The weighted debt quality analysis uses the rating information from three rating agencies (S&P, Fitch and Moody’s). Every gross debt issuance is then assigned a rating by each rating agency based on the date of transaction and the last rating the sovereign was given by that agency. Overall the average of these assigned ratings is used and weighted by their corresponding issuance amounts to calculate weighted monthly debt quality of each region.
Average term-to-maturity (ATM) figures presented in Figure 3.9 are calculated for each region by taking the maturity of each bond issuance within the region weighted by their issue amount.
Yield-to-Maturity calculations presented in Figure 3.8 are calculated using fixed-rate USD-denominated securities with maturity longer than 365 days. Comparison between EMDE yields between 2020 and 2021 is based on the same 35 EMDE sovereigns who issued fixed-rate USD denominated bonds in 2021 and their corresponding yields in 2020.
Notes
← 1. The data used in Figure 3.1 includes debt security issuances in the financial markets by the EMDE sovereigns up to 15 December 2021.
← 2. From May 2020 to December 2021, the DSSI initiative suspended USD 12.9 billion in debt-service payments owed by participating countries to their creditors, according to the Word Bank.
← 3. IMF Commodity Price Index.
← 4. Prior to the adoption of inflation targeting, emerging-market economy central banks occasionally monetised government debt (World Bank, 2021[20]). Several recent studies elaborate the latest objectives of central bank asset purchases in EMEs and discuss their announcement effects on government bond yields (Arslan, Drehmann and Hofmann, 2020[17]; IMF, 2020[9]; Fratto et al., 2021[8]).
← 5. Up to date as of 9 March 2022 based on https://www.imf.org/en/Topics/imf-and-COVID-19/COVID-Lending-Tracker.
← 6. OECD Revenue Statistics in Africa highlights that African governments have both increased their level of external government debt and seen an increase in borrowing costs. Between 2010 and 2019, among 26 Revenue Statistics in Africa countries, 19 registered an increase in their external government debt as a percentage of GDP as well as in the ratio of interest payments paid to debt stock. Over this period, the average ratio of debt interest payments to debt stock for these countries rose from 1.6% to 3.1% (OECD/AUC/ATAF, 2021[22]).
← 7. For example, the share of fixed-rate USD denominated bond issuance with yield more than 5% picked up from 31% in 2020 to 69% in 2021.
← 8. The Executive Board of the International Monetary Fund (IMF) approved on 25 March 2022, a 30-month extended arrangement for Argentina (equivalent to USD 44 billion) under the Extended Fund Facility (EFF).
← 9. Fixed rate government bonds constituted nearly 90% of bonds issued in 2021.
← 10. Securities that need to be repaid in 365 days or less but no less than 30 days are categorised as T-Bills.
← 11. Investment grade category is considered having a grade higher than or equal to BBB- for Fitch and S&P, Baa3 for Moody’s which is equivalent to 12 in Figure 3.13.
← 12. OECD simulations suggests that the war in Ukraine will be a 1% negative shock to world in 2022 (OECD, 2022[2]).