After a rapid and severe flight of capital from Latin American markets earlier in the year, some countries are seeing renewed interest by way of sovereign bond issuances, despite a worsening economic outlook for the region.
Heading into 2020, sovereign issuances across Latin America were widely expected to grow over the course of the year amid stronger growth projections and easing central bank policies. S&P Global Ratings forecast a 3.8% rise in bond issuances for the region, and Ecuador started the year with a $400 million social bond, the first Latin American country to issue such an instrument.
Those expectations flipped on their head, however, with the coronavirus pandemic. Investment capital fled emerging markets at a record pace, and credit default swaps — a key measurement of credit risk — skyrocketed.
Despite the turmoil, a handful Latin American countries have been able to raise capital through bond issuances, and more could soon follow suit. Panama was one of the first to break through, with an oversubscribed $2.5 billion offering in late March, spurring others to push forward. In the weeks that followed, five more LatAm sovereigns — Chile, Peru, Guatemala, Mexico and Paraguay — launched bond offerings for an aggregate $14 billion. More recently, Brazil, Colombia and Uruguay also have launched offerings, while Honduras and El Salvador are planning to do the same.
Experts point to several factors that supported the issuances, which were oftentimes oversubscribed. Among them is the intervention by global economic powers during the pandemic.
"The intervention, particularly of the U.S. Federal Reserve, has been so massive that it had stopped the collapse of the financial markets," said José Antonio Ocampo, a professor at Columbia University who once served as Colombia's finance minister. Emerging economies, he said, were bound to benefit from such a large capital infusion.
But the sovereign issuances also underscore that investors are not moving back into Latin America across the board, but rather selectively into the highest rated countries in the space. All of the Latin American countries that have issued sovereign bonds since the onset of the crisis have ratings of BB- or better from S&P Global Ratings; at least five have investment grade ratings.
The renewed demand for "new, primarily investment grade EM issues" is driven by the expectation of "a gradual global growth recovery, coupled with highly accommodative monetary and fiscal policies which provide a supportive risk environment," Patrick Wacker, portfolio manager at NN Investment Partners, said.
"Despite uncertainties, there is some search for yield from investors," Livia Honsel, an analyst for S&P Global Ratings, said, noting that developed countries are offering fixed income segments very low or even negative interest rates.
The majority of recent bonds from Latin American sovereigns with maturities above 10 years carry coupons between 4% and 6%, though some of the highest-rated sovereigns have completed long-term bond offerings with coupons below 4%, and Peru managed an offering with a 2.8% coupon.
"While each country is different, investors will look for those that give confidence in terms of fiscal policy and prospects of growth recovery following COVID-19," Honsel said. Peru, one of the highest rated sovereigns in the region, has garnered considerable support for its issuance at a "very low interest rate."
Diego Macera, general manager for Instituto Peruano de Economía, called the response to Peru's offering "mildly surprising," but also noted that the country is "widely regarded as one of the strongest emerging economies" fiscally speaking.
"If investors wanted any exposure to LatAm sovereign debt," he added, "Peru was an obvious choice."
A social bond to fight COVID-19
Among the more interesting offerings of late was Guatemala's $1.2 billion issuance. It included a $500 million social bond tranche, with proceeds earmarked specifically to support measures against the spread of COVID-19. It was just the second sovereign social bond in Latin America following Ecuador's pre-crisis issuance.
The region could see more social bond issuances, experts said, particularly from countries like Chile and Colombia that already have shown a willingness to develop and issue socially responsible bonds.
"While it's too early to tell if we will see more social bonds, it is clear we are seeing more sovereign ESG bonds, which we welcome from a responsible investment perspective," Wacker, the NN Investment Partners portfolio manager, said. Development bank support could be key, he noted, pointing to partial guarantee that the Inter-American Development Bank provided for Ecuador's issuance.
"If development banks are willing to play similar roles as guarantors of these issuances, we could see an increase over time," he said.
But there are other hurdles. Social bonds, like many ESG instruments, come with both limitations on what the funds can be used for, as well as expectations for continued monitoring. Other bonds don't often carry the same sorts of restrictions, offering more flexibility to sovereigns facing widening fiscal deficits alongside their growing COVID-19 case counts.
"We will probably see a development of these bonds given demand from investors," S&P Global Ratings' Honsel said. "But in the short term, the urgent needs of ... governments is to finance their deficits."
Across Latin America, fiscal deficits are rising rapidly as government's launch stimulus and other support measures to help combat the economic fallout from the COVID-19 pandemic. While most experts see the expenditures as necessary, they also have flagged the potential longer-term impact rising debt loads could have on some countries.
"The longer term effects of higher indebtedness post COVID-19 depend on a host of factors and with significant variation by country," Wacker said.
Chile and Peru, for example, could absorb higher debt ratios without having to resort to tighter austerity measures. However, Wacker noted, "places like Brazil, Mexico, South Africa and India, where fiscal positions were weaker coming into the crisis, will have more problems."