IMF unveils true picture of debt

BIG institutional investors account for 80% of the half a trillion dollars foreigners have plowed into emerging market sovereign debt in the past few years, according to an analysis by International Monetary Fund economists.

Investors such as hedge funds and sovereign wealth funds held $768billion (R8.1-trillion) in emerging market government bonds by June 2013, the paper showed. Foreign central banks held at least $40-billion more.

The makeup of a country’s investor base is important in gauging whether investors will stick around when times get tough or run for the exit, pushing bond yields up and currencies down.

Central banks and pension funds are seen as stable investors, whereas hedge funds can be changeable.

The paper found that about half the foreign holdings of emerging market debt, worth nearly $500-billion, were accumulated during the three years from 2010 as emerging markets rebounded from the financial crisis more quickly than developed countries. Many, such as Colombia, also regained investment-grade credit ratings, which burnished their appeal in the eyes of yield-hungry investors flush with cheap cash.

“Rising foreign participation in government debt markets can help to reduce borrowing costs and spread risks more broadly among investors, but it can also raise external funding risks for countries,” authors Serkan Arslanalp and Takahiro Tsuda write in a blog post. “The more you know your investors, the better you understand the potential risks and how to deal with them.”

Data prepared for the paper show that institutional investors held relatively steady during the second quarter of 2013, when jitters about the US Federal Reserve starting to unwind stimulus hit financial markets worldwide. Holdings of institutional investors fell less during the second quarter of 2013 than foreign debt holdings overall, a turnaround from earlier periods of outflows.

Tests of how sensitive countries would be to a cold shoulder from foreign investors showed that Egypt, Lithuania and Poland would likely be among the first to feel the pinch, followed by Argentina, Hungary, Mexico and Ukraine.

But countries such as Poland and Mexico, which had lower debt, lower financing needs, strong local banking systems and good liquidity buffers, had a better chance of withstanding a reversal in investor sentiment. The paper showed institutional investors were a significant presence in Peru, Uruguay, Mexico, Lithuania and Hungary. Foreign central bank investments were concentrated in Brazil, China, Indonesia, Poland, Malaysia, Mexico and South Africa. —