In February this year, Poland sold a five year bond in euros offering investors minus 0.102%, in what was the first ever negatively yielding bond in euros from an emerging markets issuer. When it returned to euros in July, during the Covid-19 era, it paid minus 0.11% for a three year deal.
Poland had already become the first EM borrower to issue with a negative yield in any currency, when it sold a three year Swiss franc bond in 2015.
These deals beg an obvious question: if you can borrow money at a rate below zero, can you really be considered an emerging market?
Tadeusz Kościński, Poland’s finance minister, does not seem overly concerned either way.
“Whether Poland is a developed or emerging market is debatable,” Kościński tells GlobalMarkets. “Investors look more now at the economic fundamentals, rather than which box you are in.”
Minister Kościński may be right to suggest that the difference is “mostly academic”. But what is not debatable is that Poland’s bond issues have few characteristics of a traditional EM issuer.
“Poland currently has negative yields up to the 10 year part of the euro curve; at those levels, it is clearly a rates trade and not a credit story,” says Marzena Fick, head of CEE DCM at Citi.
Fick says that no CEE sovereign is 100% EM or 100% SSA in terms of its investor base.
“But there are some that are mainly held by European rates buyers, and those are not just the eurozone countries,” she adds.
Funding the fightback
In the immediate aftermath of the last global financial crisis, non-eurozone CEE sovereigns such as Poland would have still been seen as useful relative value comps for other EM credits — including certain Latin American sovereigns, such as Brazil, which are today deep in sub-investment grade territory.
With CEE economies outperforming and the issuers gaining followers, Covid-19 was the ideal opportunity for the region’s sovereigns to demonstrate how resilient their bond market prowess was.
When 2020 began, CEE debt bankers had largely been gearing up for a busy year of corporate and financial institution issuance. The pandemic immediately changed that, with sovereigns suddenly under pressure to raise funding, corporates retreating from volatility and bank regulation pushed down the list of priorities.
Sovereigns stormed bond markets in unprecedented fashion. In 2019, CEE governments — excluding Russia and those to the east of the Caspian Sea — raised $20.8bn-equivalent in international bond markets, according to Dealogic. As of September 25, they had raised more than $51bn-equivalent in 2020.
With the EU creating its Pandemic Emergency Purchase Programme (Pepp), it was the eurozone issuers who led the way as CEE bond markets emerged from the Covid-19 market shutdown in March. Slovenia was the first from the region to test the waters. Latvia soon followed.
“Slovenia has built a broad and diversified investor base and ensured a permanent and steady access to the sources of financing in the past years,” Marjan Divjak, director general of the treasury at Slovenia’s ministry of finance, tells GlobalMarkets. “We have not seen any deterioration in that respect during the Covid-19 crisis.”
SSA yield-hunters
ECB buying of CEE sovereigns in the eurozone was clearly a big factor in driving yields tighter; by July, Slovakia, Slovenia, Lithuania and Latvia were all trading inside where they began the year, notes Scope Ratings.
“Several CEE sovereigns have moved into a different spectrum of investor base, and rates buyers are bidding aggressively for CEE sovereigns with strong metrics,” says Maryam Khosrowshahi, head of CEEMEA sovereign DCM at Deutsche Bank.
Furthermore, EU countries outside the eurozone also benefit, note both Khosrowshahi and Fick.
“These sovereigns are among the very few assets that a rates buyer can find without competing with the central bank,” says Fick. “Even at a negative yield, Poland is offering investors a pick-up to western European countries.”
When Hungary — rated Baa3/BBB/BBB versus Poland’s A2/A-/A- — tapped euro markets for the first time in two years in April, and then returned in September with a green bond, it was therefore an issuer to watch.
The April deal — the first from a non-eurozone European sovereign in the Covid-19 era —did not receive the inflated orders “on the back of perspective central bank buying” that eurozone credits enjoyed, notes Zoltán Kurali, CEO at AKK, Hungary’s debt management office.
“Nonetheless, in our euro deals — and more so with interest rates so low — we see continental asset managers and pension funds, as we are trying to attract more developed markets and rates buyers,” says Kurali.
Well prepared
If vast liquidity from central banks has played a serious helping hand in squeezing CEE sovereign yields, the region’s outstanding economic growth in recent years has also been a big factor. Most major economies were therefore very well prepared for the Covid-19 crisis.
Hungary quadrupled its external issuance requirements overnight from €1bn to €4bn when Covid-19 set in. It was not an issue for markets.
“Hungary did not have much hard currency debt outstanding when the crisis began, meaning the FX depreciation did not hurt us too much,” says Kurali. “We are very conscious that this low FX exposure helps, which is why our hard currency debt cannot exceed 20% of total central government debt.”
This meant Hungary had no need to reassure international investors about the sudden increase in euro issuance.
“In fact, the international issues were a way to reassure domestic investors that we were not going to overly rely on them,” says Kurali.
So impressed was Moody’s with Hungary’s ability to deal with the crisis that, on September 25, the rating agency placed a lesser-spotted Covid-era positive outlook on the sovereign’s rating. Moody’s believes the country’s reduction in external vulnerabilities since 2012 will be sustained, it said.
Trickier credit stories were no match for the weight of demand either, however. Romania, with weakening fiscal metrics even before Covid-19 and a Baa3/BBB-/BBB- rating (on negative outlook from all three agencies), was the biggest contributor to supply, with more than $10bn-equivalent by September this year.
Crossover name Croatia took investors down the credit curve in May, and in the next two months high yield sovereigns Serbia, North Macedonia, Albania and Belarus followed.
Ukraine was even able to issue immediately after having to pull an initial deal when the central bank governor resigned.
For the SSA buyers looking for high grade countries or the EM investors looking away from the eurozone countries, the rarity of certain issuers meant CEE’s bond party offered something different.
“I don’t believe this many CEE sovereigns have ever issued in the same year before, and as many of these countries are not frequent issuers, they offer investors a great opportunity for diversification, which adds to the attraction of these deals,” says Fick.
Bulgaria’s euro deal in September was its first since March 2016, while eurozone member Estonia had not issued since 2002 until its €1.5bn 10 year in June.
Generating more deals
The ease with which CEE sovereigns across the credit spectrum have tapped markets provides comfort as, by mid-September, fears of a second wave of coronavirus cases in Europe were gaining traction.
Analysts say that this risks derailing what they had assumed to be a smooth economic rebound for CEE, raising the very real possibility that primary activity from the region’s sovereigns will remain elevated.
“If Covid-19 were over and everything were back to normal, then this year would have been a one-off,” says Fick. “However, Covid-19 is not done and sovereigns will have to continue to fund themselves and their stimulus packages.”
Much of this might depend on conditions in domestic markets. Khosrowshahi at Deutsche Bank notes that many non-eurozone countries raise “the lion’s share” of their funding in local currencies, having focused on developing domestic markets in recent years.
“This allows them to reduce their reliance on the international markets,” she says.
Yet bankers and issuers say there is an important unknown in the form of the EU’s Next Generation recovery fund. Comprising €750bn of grants and loans, the fund has the potential to provide important funding to government investments — and CEE countries are likely to be some of the largest beneficiaries.
Florin Cîțu, Romania’s minister of finance, notes that the country wants to shift a lot of its investment towards EU funding.
“This could release some of the financing pressure for Romania, and potentially mean a lower budget deficit,” Cîțu tells GlobalMarkets.
Divjak in Slovenia says it is “still early” and that questions remain before he can elaborate on the impact of the Next Gen fund on the country’s funding needs. Hungary’s debt office, AKK, echoes this.
“Whether the EU funding will affect Hungary’s bond market funding needs depends very much on the details, such as the use of proceeds and conditionalities,” says AKK’s Kurali. “We have low redemptions of FX debt in the next three years, so — provided that the EU funding is cheaper — there is certainly a possibility that it could reduce our willingness to tap markets.”
Fick of Citi believes there could be a reduction in issuance volumes from individual countries as a result of the EU’s support programmes — but only in the medium term.
“CEE sovereigns are still cautious about when and how EU funding might be distributed, so the impact is still to be determined and will not, most likely, be immediate,” she says.
Liquid outlook
When chaos hit financial markets in March, few could have predicted that bond markets of all kinds would be showing record levels of supply and all-time low yields just six months later.
“There are reasons to expect volatility, especially when the fear factor about another wave of the virus is high,” says Khosrowshahi of Deutsche Bank. “Markets have shown that they can recover very strongly from panic, because of the significant prevailing liquidity.”
However, CEE issuers are unlikely to become complacent.
Having carried out pre-financing, a decision which “proved to be the right one”, Slovenia this year “decided to scatter new funding throughout time due to uncertainties brought to financial markets by Covid-19”, says Divjak at Slovenia’s finance ministry. Indeed, Slovenia has visited the markets on eight occasions in 2020, according to Dealogic.
“Therefore, a strategy of frontloading and pre-financing combined with scattering the issuance dynamics using different maturities in certain time horizon shall remain our guidance,” says Divjak.