Emerging market companies are increasingly choosing to borrow in euros rather than dollars as the spread between the yield on 10-year US Treasuries and German Bunds has widened to its highest level since the fall of the Berlin Wall.
In the first eight months of 2016, EM non-financial corporates issued $38.1bn of euro-denominated bonds and syndicated loans, surpassing the highest ever full-year total of $33.4bn in 2013, according to FT analysis of data from the Institute of International Finance encompassing 20 major emerging market countries, as the first chart below shows.
While companies are still borrowing much more in dollars than euros in absolute terms, the gap between the two has fallen to its lowest level since the creation of the single currency.
“We have seen that bit less issuance in dollars and that bit more in euros. If you have a currency that you expect to strengthen and you want to borrow in foreign currency, it makes sense for you to borrow in a currency that you think will depreciate,” said Sonja Gibbs, senior director of global capital markets at the IIF.
Luis Costa, an emerging market currency and credit strategist at Citi, said she saw the shift as the start of a long-term trend and added: “The spreads between US and European fixed income will remain very wide and may widen further. The perception is that dollar funding has a more expensive bias in the near to medium term relative to euro funding.”
Between 2001 and 2014, emerging market companies issued at least seven times as much dollar-denominated debt as that denominated in euros each year, with the ratio topping 13 times as recently as 2012.
However, last year EM corporates issued just 5.11 times more debt in dollars than euros, and the ratio fell to a new low of 4.68 in the first eight months of 2016, analysis of the IIF data shows, illustrated in the second chart:
While the outstanding stock of dollar-denominated debt fell by $60bn in the first two-thirds of 2016, the stock of euro-denominated debt rose by $15bn.
Ms Gibbs traces the jump in euro borrowing to the taper tantrum in 2013, when US Treasury yields rose as the Federal Reserve said it would scale down its programme of quantitative easing.
With the European Central Bank still engaging in QE in an attempt to reinvigorate the still sluggish eurozone economy as the Fed has started to raise policy rates, albeit slowly, the spread between 10-year US and German yields has widened sharply to 2.27 percentage points, as the third chart shows.
This widening spread can make it cheaper to borrow in euros, as well as increasing yield-starved European institutions and retail investors’ appetite for higher-yielding EM corporate bonds.
Mr Costa also pointed to the ECB’s move to start buying investment-grade corporate debt as part of its €80bn-a-month QE programme, as of June, as providing additional impetus to the trend, given that the ECB’s move compressed the risk premium for corporate bonds.
EM non-financial companies issued $14.5bn of euro-denominated bonds and syndicated loans in June, comfortably above the previous monthly record of $10.2bn in August 2013, a month after the start of the taper tantrum, although issuance was light in July and August of this year.
Neil Shearing, chief emerging markets economist at Capital Economics, suggested that expectations of a still stronger dollar under US president-elect Donald Trump, who has vowed to implement an expansionary fiscal policy, could encourage further euro borrowing.
“Over a two-year horizon, which currency is more likely to strengthen? It would be the dollar, which increases the attractiveness of issuing in euros,” he said.
One factor that has traditionally bolstered the attractiveness of the greenback as a funding currency has been the “much more established and liquid market” for dollar instruments, compared to the “niche” euro market, Ms Gibbs said.
However, Mr Costa said there were “massive pockets” of demand for investment-grade debt in the eurozone, thanks to the presence of large insurance companies and pension funds.
Unsurprisingly, the growth of euro-denominated corporate debt has been strongest in countries closest to the eurozone.
Turkish non-financial companies at present have $84.1bn of euro-denominated debt outstanding, compared with just $10.9bn in 2005, when the IIF’s records began. Likewise, Russia has seen a rise from $11.5bn to $36.9bn over the same period, Poland a jump from $22.4bn to $44.4bn and the Czech Republic an increase from $13.5bn to $28.5bn.
Hungary has seen a smaller increase but has the highest level of outstanding euro-denominated non-financial corporate debt as a share of gross domestic product, at 34 per cent.
However, some non-European countries have also seen large increases in such euro debt, with China going from $16.5bn to $59.9bn, Mexico from $7.4bn to $31.9bn and Brazil from $4.9bn to $18.8bn.
The euro is a larger source of funding than the dollar in countries such as Hungary, the Czech Republic and Poland.
But despite the recent jump in euro-denominated debt issuance, the single currency remains a smaller source of funding in all 20 countries than the respective local currency, with the smallest gap being in Hungary, where forint-denominated borrowing by non-financial corporates is equivalent to 34.3 per cent of GDP, a sliver above the euro’s share.
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