The boom in foreign-currency corporate bonds after 2008: why emerging markets are gaining momentum
Charles Calomiris, Mauricio Larrain, Sergio Schmukler, Tomás Williams February 28, 2022
After the 2008 global crisis, emerging market companies dramatically increased their issuance of US dollar-denominated bonds. Focusing on the rise of foreign currency bond issuance and overall corporate debt, several authors discuss the drivers and implications of high dollar debt for financial stability (Acharya et al. 2015, Acharya and Vij 2021, Forni and Turner 2021).
All-time lows in U.S. interest rates and the “search for yield” of institutional investors in developed economies are seen as key drivers of the post-2008 boom in dollar-denominated emerging debt (Becker and Ivashina 2013). In this regard, this latest episode can be seen as a repeat of the booms that occurred in the 1970s (when petrodollars were recycled through bank loans to sovereign states and corporations in developing countries) and in the early of the 1990s (when the decline in dollar interest rates led to a major expansion of developing country sovereign and corporate bonds).
The preponderance of large bonds
This time there is an added wrinkle, which has prompted emerging market borrowers to focus on a particular segment of the market. As we show in this column and document in detail in a recent study (Calomiris et al. 2022), the growth of US dollar-denominated issuance after 2008 by emerging market companies was driven by large bonds.
In particular, the market has focused since 2008 on bonds with a principal amount greater than or equal to $500 million (Figure 1). These bonds had lower yields than lower denomination bonds issued by otherwise identical issuers (Chart 2).
Figure 1 Total value of emerging market corporate bond issues
Remarks: This figure shows the total value of US dollar-denominated international bonds issued by emerging market companies over the period 2000-2016. The figure shows the total value of bonds in billions of 2011 US dollars, dividing bonds with face value less than $300 million (0:300), between $300 and $500 million[300:500]and equal to or greater than $500 million[500:1000)respectively[300:500)andequaltoorabove0million[500:1000)respectively[500 :1000)respectivement[300:500)andequaltoorabove0million[500:1000)respectively
Figure 2 Yield to maturity of corporate bond issues, before and after 2008
Remarks: This chart shows the average yield to maturity of US dollar-denominated international bonds of various sizes issued by emerging market companies in the pre-2008 (2000-2008) and post-2008 (2009-2016) time periods. The issue size is in millions of US dollars.
The role of institutional investors
The boom in large bonds and their lower yields since 2008 reflect a shift in demand for bonds from institutional investors. Newly created emerging market corporate debt benchmarks, such as the narrow JP Morgan CEMBI index, as well as increased interest from institutional investors in developed economies in expanding into emerging markets since 2008, are the key factors driving the markets to issue large bonds. . Issuers are automatically included in the narrow CEMBI if they issue a standard type of bond with a principal of $500 million or more. Many companies that would previously have issued smaller bonds began issuing $500 million principal bonds because these bonds became eligible for inclusion in the index (Figure 3).
picture 3 Cumulative distribution of the size of corporate bond issues, before and after 2008
Remarks: This chart shows the cumulative distribution of US dollar-denominated international bonds of various sizes issued by emerging market companies over the periods before 2008 (2000-2008) and after 2008 (2009-2016). The issue size is in millions of US dollars.
There is a clear link between institutional investor involvement in emerging market debt and the premium on large bonds. As international investors generated increased capital inflows into emerging economies, corporations responded by issuing proportionally more bonds of exactly $500 million (Figure 4).
Figure 4 Investments in mutual funds in emerging markets
Remarks: This figure shows the cumulative flows into emerging market sovereign and corporate debt mutual funds in billions of US dollars and the fraction of international bonds denominated in US dollars with a face value equal to $500 million at the during the period 2003-2016. The fraction is calculated as the number of US-dollar-denominated international bonds issued with a face value equal to $500 million relative to all US-dollar-denominated international bonds issued by emerging market companies.
What is driving institutional investors’ preference for large index-eligible bonds? We show that it is mainly non-specialized funds (those that do not replicate the CEMBI index) that have a preference for large bonds. We argue that this reflects the liquidity advantages of index-eligible bonds, which are particularly valuable to non-specialists who are relatively inexperienced in the asset class. From a corporate perspective, the greater liquidity premium attached to large bonds provides them with a significant cost advantage (Kashyap et al. 2019).
Borrowers – including those who may not need significant funding – have had a strong incentive to borrow high-value bonds as yields on such bonds have turned particularly low. This means that some companies have taken on unprecedentedly large debts.
Companies that issued more than they needed to finance their investments kept the unused proceeds in the form of increased cash. This additional liquidity (if held in risk-free dollar-denominated form, such as in treasury bills) could buffer future crises for these dollar-borrowing firms (Joseph et al. 2020a, 2020b), or alternatively, cash could be an additional source of risk if firms invest it in local currency-denominated assets, thereby creating currency mismatch (Bruno and Shin 2017). We find that the latter is a distinct possibility. In fact, companies are more likely, ceteris paribus, to commit to large bond issues in countries where carry is advantageous (where local interest rates are high relative to interest rates in dollars).
The surge in dollar-denominated borrowing during past periods of low US interest rates has been a source of instability for emerging markets when monetary policy has tightened, causing the US dollar to appreciate. Rising inflation in the United States and the prospect of a tightening of monetary policy by the Fed today should therefore be a source of current concern.
Acharya, V, S Cecchetti, J De Gregorio, S Kalemli-Ozcan, P Lane and U Panizza (2015), “Emerging Economy Corporate Debt: The Threat to Financial Stability”, VoxEU.org, 5 October.
Acharya, V and S Vij (2021), “Corporate Foreign Currency Borrowing: Risks and Policy Responses”, VoxEU.org, 29 April.
Becker, B and V Ivashina (2013), “Reaching for Yield in Hot Credit Markets”, VoxEU.org, 3 May.
Bruno, V and HS Shin (2017), “Global Dollar Credit and Carry Trades: A Firm-level Analysis”, Review of financial studies 30(3): 703-749.
Calomiris, C, M Larrain, S Schmukler and T Williams (2022), “Large International Corporate Bonds: Investor Behavior and Firm Responses”, Journal of International Economicsforthcoming Also available as NBER Working Paper 25979).
Forni, L and P Turner (2021), “Global Liquidity and Dollar Debts of Emerging Market Corporates”, VoxEU.org, 15 January.
Joseph, A, C Kneer, N Van Horen and J Saleheen (2020a), “All You Need Is Cash: Business Cash and Investments After the Financial Crisis”, CEPR Working Paper 14199.
Joseph, A, C Kneer, N van Horen and J Saleheen (2020b), “Cash in the time of corona”, VoxEU.org, 26 April.
Kashyap, A, N Kovrijnykh, J Li and A Pavlova (2019), “Why Asset Managers Create Subsidies for Certain Firms”, VoxEU.org, 18 February.