Ben Aris in Moscow -
Every cloud has a silver lining, but for sovereign bond issuers in Central and Eastern Europe the recent crisis has done more than drive down interest rates as investors snap up each new issue - it has promoted the entire region and turned it into an attractive asset class in its own right.
"The CEE market has enjoyed a re-rating that is for the first time based purely on their macroeconomic fundamentals," says Clemens Popp, head of sovereign bond issues at UniCredit Group. "CEE issuers have been a clear beneficiary of the crisis, as they now offer decent value and decent credit quality compared to many of their peers in Western Europe, and offer a real alternative to the more traditional issuers."
Not much has changed with the issuers. Most of the countries in the region are still sporting the same relatively healthy macroeconomic fundamentals they had pre-crisis and they continue to put in strong growth as the game of catch-up with the West matures.
What has changed is western investors are finally waking up to the realities of bond investing in the region and are basing investment decisions on a country's fundamental state of health. But this is still a work in progress. "Many global investors are still in denial, assessing that default risks in many of the big emerging markets are much greater than in the West. At best this is nonsense, and at worst it is deluded prejudice - particularly when you consider that the governments of the 'advanced' countries are tacitly reliant on debasing and depreciating their currencies in order to lower their liabilities, so imposing on their creditors anyway a slow-burn 'soft default'," argues Liam Halligan, chief economist at Prosperity Capital Management.
This change of heart strikes to the core of the problems that the Eurozone is currently facing. Prior to the crisis, interest rates across the Eurozone were rapidly converging as despite the fact that members of the euro skipped over the hard fiscal union that many believe is necessary to make the whole euro project work, investors widely assumed that if a country like Greece got into trouble, the other members states would bail it out; a hope that was largely proved correct when a new debt deal was thrashed out by EU leaders in Brussels on July 22. The upshot was Greece borrowed at the same rate as Germany - and they did so, in spades.
The post-crisis change is dramatic. Now Greece (and the other members of the so-called PIIGS) are being charged at a rate that reflects the health of their economies, not that of Germany, and the cost of borrowing has soared. On the other side of the fence in CEE, despite the robust fiscal health and GDP growth, they're still being charged a premium for simply being an emerging market. "Prior to the crisis, the convergence story was driving spreads, but investors seemed to have forgotten to look at the underlying fundamentals," says Marcus Svedberg, chief economist at East Capital. "The assumption was that if you were in the [EU] club, then your bonds were as creditworthy as those of Germany. People had forgotten about the underlying credit quality."
CDS spreads have remained contained in spite of the rise in Eurozone spreads
The premium that CEE has had to pay was not entirely unfair. Debt rates are calculated as a function of a country's financial health, but like any borrower your credit history is also a factor and the newness of the CEE issuers on the international debt markets warranted a premium for investors. At least that was the theory until the crisis broke. Everyone's time horizon has telescoped down significantly. The question most investors are asking now is: "can pay, will pay?" In Europe's periphery, the answer to this question is largely "no", while in CEE it is a big fat "yes." Popps says: "The crisis has proven to be a leveller. Portugal and Greece enjoyed tighter spreads before the crisis, but now even Italy is trading far above Slovenia."
Not spoilt for choice
Since Lehamn Brothers collapsed in September 2008, there has been little activity on the sovereign bond market in CEE, as most bond traders were fully occupied with sorting out the mess on their books caused by the meltdown. But as we emerge from the crisis, international investors are starting to look for places to put their money to work. The trouble is that CEE countries have been reluctant to tap international markets.
For example, Russia wrote in $17bn of international borrowing each year over the next three years, but after oil prices recovered it issued just one Eurobond for $5.5bn - its first in over a decade - and has since cancelled plans for more issues, instead ramping up domestic borrowing. All across the region, demand for new paper is running far ahead of supply. "Russia's economy is looking strong and its low level of debt means that if the Russian government were to go to the credit markets, it could collect as much money as it wants," reckons Popps.
The reason why investors are starting to talk about CEE as a new asset class in its own right (as opposed to a bolt-on to the generic emerging market story) is that most of the countries in the region are running much more prudent fiscal policies than their profligate peers in the west. Russia is working hard to bring its deficit down to zero and will probably get there by next year. Bulgaria has written into the constitution that deficits can be no more than 2% of GDP and was upgraded by Fitch Ratings in the middle of July as this policy starts to bear fruit. And Poland has made a similar hardwired commitment to prudence. "Italy used to enjoy tight spreads that were converging to the Western European average, but 160% debt/GDP ratios are unhealthy full stop. In contrast, Poland has a constitutionally fixed maximum debt ratio of 55% of GDP - less than the Maastricht recommended level - and if debt breaches this level, then spending cuts automatically come into effect."
Moreover, Popps says that the low level of leverage has insulated the CEE region from any possible double-dip or second wave of the financial crisis. "If Hungary issues $3bn of bonds and America gets into trouble, it can easily replace a dollar issue with another currency. Poland, Slovenia and other countries can also work in euros. CEE won't be a safe haven, but they are not as at risk as more developed economies."
Still, not everything is perfect in CEE. You can't compare Poland, which is the only country in Europe not to go into recession during the crisis, with the likes of say Albania. Size still matters, so Poland, Turkey and Russia still dominate the story. But turning the issue on its head, countries like Greece would be better off classed as emerging markets. And the reality of this change can be seen on the trading desks in London; according to bne sources, in some banks Greek bond trading has been moved off the European bond desk and passed to the distressed debt desks that are used to dealing with emerging market issues, while CEE bond trading is making the migration in the other direction.
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