Setting a sovereign borrowing strategy
Sudip Chatterjee, Deputy Head of Global Rach, Euroclear
Stability in government funding plays an important role in building business confidence, encouraging investment and, in many instances, going a long way towards fulfilling certain Uited Nations Sustainable Development Goals.
A recent interesting study by the World Bank shows a marked shift in borrowing patterns by a number of sovereign issuers. In my view however, its focus is not comprehensive enough.
The study shows that, since 2013, there has been an increasing trend towards borrowing in euros. This is especially apparent in Latin America, a region that has traditionally borrowed in dollars.
The study notes a number of reasons – most obviously the divergence in US and European monetary policy, which has led to expectations that euro rates will remain ‘lower for longer’.
There is also the desire from borrowers to diversify the investor base. When Peru launched its first euro-denominated bond in 2016, it brought in mainly ‘new’ investors who had no previous exposure to the country.
The ability to issue debt in multiple currencies is doubtless a plus. But, what is more important from the issuer point of view is getting to the point where all options – including attracting the international investors to the local currency debt market– are on the table.
A step-by-step process
For most emerging markets the process of accessing international investors goes through four phases.
The sovereign borrower generally starts with a traditional international bond issue, in a hard currency like dollars or euros. This has to be marketed to investors that are unfamiliar with the issuer. They assume the country risk, while the sovereign issuer takes on the foreign exchange (FX) risk.
Once international investors are comfortable with the sovereign risk, the smart move for many issuers is to denominate an international bond issuance in their local currency. This effectively moves the FX risk to the investors.
If international investors are happy to buy a local currency denominated international bond, the third phase is for investors dealing in the local currency (e.g. for balance of trade payments), to be allowed to settle in the local currency, as well.
The logical conclusion of this process – phase four – is to create the right conditions in the domestic market to attract these international investors to invest in the domestic market securities, which will create a single pool of liquidity for local and international investors.
Strategy should come first
The World Bank study stresses that strategy should come first in dictating where and in what currency a country should borrow.
Nevertheless, when a market is at the first or second phase, the options available for designing a comprehensive strategy is limited.
However, when the market attains the ability to operate in all the four phases, they can design a comprehensive borrowing strategy in line with their macro-economic objectives like monetary policy and fiscal discipline.
Euroclearability is key
Having the right conditions in the market to achieve the phase 4, has been coined by the international investor community as being ‘Euroclearable’. At Euroclear, we have helped a number of Latin American markets – Peru, Chile, Argentina and Mexico among them – travel this path. Making their markets ‘Euroclearable’ has been a material factor in helping them reach the final stage of the process when they can attract international investors into their domestic market securities.
The drive for Euroclearability often comes not from the sovereign issuer but from the international investors, since they see Euroclearability as a necessary precondition for their participation in any domestic issue.
Making the domestic market Euroclearable can set off a virtuous circle in increasing liquidity, creating stability and reducing borrowing costs – which are recognised by major local currency indices in increasing their weightage in local bonds. This is something that both Chile and Peru have experienced.
Each of the phases contribute cumulatively to making funding more accessible and providing the right levers to the sovereign issuers to manage their strategies to create long-term social and economic development for their markets.
Sudip Chatterjee is Deputy Head of Global Reach at Euroclear. He is responsible for defining and designing the vision and strategy, along with aligning all business initiatives across the global capital markets business line of Euroclear. In this capacity, Sudip leads the discussions with market authorities and regulators in local and international markets across the world, with the objective of implementing solutions that help market liquidity resulting in a stronger macroeconomic climate.