Dramatic rise in local currency sovereign debt issuance reduces emerging market countries’ vulnerability to shocks

 NEW YORK, USA, Capital Markets in Africa — The average local currency share of emerging market sovereign debt rose from about half in 2000 to almost three quarters in 2014, reducing for many countries the vulnerability to economic shocks and increasing the effectiveness of monetary and fiscal policies, Moody’s Investors Service said in the report “The Evolution of Emerging Market Sovereign Debt: Dramatic Growth in Local Currency Sovereign Debt Is Reducing Emerging Market Financial Vulnerabilities today.

Moody’s research shows that local currency sovereign debt outstanding grew on average by 14.4% each year between 2000 and 2014, well above the annual average 2.3% growth rate of foreign currency sovereign debt, and going against the traditional view that emerging economies can sometimes struggle to borrow in their own currency. At the same time, the rapid growth of local currency debt was not accompanied by an increase in total sovereign indebtedness as the average debt-to-GDP ratio for these emerging markets was 48.3% in 2014, only slightly above the 47.9% of 2000.

“The deepening of local sovereign bond markets has allowed governments to shift a growing portion of their funding to local currency instruments,” said Elena Duggar, Senior Vice President, Credit Policy, and a co-author of the report. “This suggests they will be less susceptible to shocks and it should also contribute to the development of domestic financial markets for use by other borrowers, not only sovereigns.”

Further, the average share of resident debt holdings has increased as well, from 57.6% in 2000 to 67.8% in 2014. The increase in resident holdings is less than the increase in the share of local currency debt, reflecting increased participation of foreign investors in local currency sovereign bond markets.

An improved inflation record, stronger institutional enforcement, improved protection for creditors and a strong macroeconomic performance have supported the development of domestic markets in recent years.

The growth of local institutional investors, such as pension funds and insurance companies, has further supported domestic demand, while the backdrop of high liquidity and low interest rates in advanced economies after the financial crisis contributed to foreign investors moving into emerging market asset classes.

The fastest growth in emerging market sovereign debt was seen in Asia, where it has expanded six-fold since 2000 to $5.7 trillion, with an average annual growth rate of 14.5%.

Debt in Latin America has grown at an annual average of 9.3%, followed by the Middle East and Africa at 8.4% and Central and Eastern Europe at 7.6%.

At the end of 2014, Asia accounted for 58.2% of total emerging market sovereign debt, Latin America 22.2%, Central and Eastern Europe 10.0% and the Middle East and Africa 9.7%.

Overall, the deepening of local sovereign bond markets has reduced currency and maturity mismatches on government balance sheets and means these countries are less vulnerable to economic and financial shocks.