Bond Issue May Crowd Out Other Borrowers

LONDON — The government's long-awaited and much sought-after global bond, expected this month and estimated to be $3 billion to $5 billion, will intensify the worldwide scramble for government funding and could crowd out other borrowers.

The global bond will be Russia's first in more than a decade and is seen as a trophy credit by many dedicated emerging markets funds, which analysts think have set aside plentiful cash to snap up the paper when it goes on sale.

But the timing of the launch, when even U.S. Treasury debt prices are coming under some pressure, may well leave more troubled sovereign borrowers such as Greece struggling to raise cash.

What's more, strategists say, it also may draw a line under the boom in emerging market bond issuance, which hit a record $74 billion in the first quarter of this year.

The government has drawn up plans for $17.8 billion in external financing for 2010, although some experts think that it could now require less thanks to resurgent energy prices.

The scarcity of Russian foreign debt has prompted investors to set aside some of the record $18.8 billion that flowed into emerging debt funds in the first quarter for the new bond.

"Cash balances have increased and exposures have declined despite record inflows into emerging debt," said Rashique Rahman, Morgan Stanley's emerging markets macro strategy chief.

"Plenty of accounts are still sitting on cash — in part because investors are waiting for this quarter's issuance, which includes not just the Russian sovereign deal but corporate issuance from Russia," he added.

Joining Russia on the markets could be investment-grade Brazil, which has mooted a possible issue in the coming weeks.

The appeal of external debt sold by the two countries, set to benefit from higher commodity prices this year, will spill outside the traditional emerging-markets-focused investor base.

"They could even crowd out appetite for euro-zone countries such as Greece," said Morgan Stanley's Rahman.

Greece is reported to be seeking the sale of $5 billion to $10 billion in bonds to mainly U.S. investors, but the debt-stricken euro-zone economy stands in stark contrast to Brazil and Russia, which have low public debt levels.

With yields in excess of 400 basis points over benchmark German Bunds, Greek bonds are already offering returns comparable to weaker emerging sovereign names.

"We have the trend of upward credit rating trends in emerging markets and the trend of deteriorating ratings in G7 countries and those on the periphery of the euro zone," said Michael Ganske, head of emerging markets research at Commerzbank.

The cost of insuring Greek bonds against default already rates the country's sovereign debt as the ninth-riskiest in the world, just above Egypt's.

While buyers of euro-zone and emerging market debt remain largely two distinct groups, previously predictable returns associated with the two asset classes are now unmoored.

This could force emerging borrowers at the weaker end of the credit-rating spectrum to offer higher returns on their debt to entice buyers, making it costlier for countries such as Belarus, Montenegro and Kenya when they come to the market this year.

At the same time, the spike in Treasury yields to nine-month highs is also eroding the premiums that investors earn on dollar-denominated emerging debt over benchmark U.S. bonds.

With U.S. Treasuries offering a "risk-free" return of 4 percent yields for 10 years, emerging borrowers will need to offer wider spreads to issue hard-currency debt.

Trading at about 230 basis points, emerging sovereign dollar bonds are already at their tightest over Treasuries since late 2007.

Raphael Marechal, a debt fund manager at Fortis Investments, thinks that the narrowing premiums could impel emerging market investors to go beyond sovereign dollar debt.

"It could make investors more aggressive — not necessarily on sovereign external debt, but to take on local or corporate debt offering higher yields," he said.