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Understanding the drivers of record EM debt issuance

The massive Spring 2020 selloff of emerging market assets called the medium-term viability of the asset class into question. However, flows had reversed by the summer, and January 2021 saw EM debt issuances set records. To the sovereigns, increased borrowing volumes are necessary to plug budget gaps from the pandemic-induced hits to core economic drivers like energy commodities, tourism, trade, and remittances. However, the declining fiscal positions of countries from Argentina to Angola that would have otherwise created higher borrowing costs have created the conditions for a record $115bn borrowing binge.

Investors are moving into such risky fixed-income assets than more as a response to several secular trends that are shaping the world beyond finance. Quantitative easing amid the century-long decline in real interest rates means that capital markets struggle to find necessary returns. This creates a hunt for yield where investors are driven into riskier assets that have higher returns, like junk, emerging market government, and corporate bonds. With demand boosted, many EM's in difficult budgetary positions, like oil dependant Saudi Arabia, have been allowed to favorably tap capital markets at historically low rates.

However, even with this convalescence of abnormal supply and demand, idiosyncracies in monetary dynamics are creating a new phenomenon. In countries like Nigerian and Indonesia, the monetization of debt is creating distortions amid weak currency dynamics and concerns about the ultimate stability of the sovereign.

While sovereign borrowing is still favored, investors have increasingly been willing to buy emerging corporate debt, an asset class once seen as too risky. Such flows are lifelines for companies and countries in dire fiscal straits; however, the historically low-interest rates could easily give rise to debt sustainability problems given the rise of private lenders and the status of many EM equities as implicit fiscal obligations.

Bottom Line: The drastic increase in funding may be a lifeline now, but increasing signs of inflationary pressures may force rising rates, which turn such debt into a noose.

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