Emerging markets ready to absorb next year's new supply, says IMF

By Reshmi Basu

New York, Nov. 30 - Emerging markets are ready to absorb next year's new supply of debt, thanks to improving fundamentals and technicals, even with issuance at historic highs in 2004, according to the November financial market update from the International Monetary Fund.

But the IMF cautioned that, of course, risk looms.

The search for yield and improved credit fundamentals have resulted in lower volatility within emerging markets, the IMF study said. Spreads have compressed to historical low levels, reflecting abundant global liquidity and a benign external environment.

As bond valuations stretch, the market still faces risks if factors such as continued expectations of low short-term rates, limited inflationary pressure, unwinding of carry trades and market volatility are disturbed.

Nonetheless, emerging market debt has performed well as part of global credit spread compression, the IMF noted. For instance, spreads for higher yielding emerging markets, particularly oil exporters, have narrowed more than on investment-grade countries.

While emerging market credit spreads are tight in a historical context, they remain above those of comparably rated U.S corporate bonds. The spread differential between emerging markets and investment-grade corporates remains stable. But the difference between B and BB rated credits has widened. The question then arises whether credit spreads are artificially low.

Meanwhile, strong fundamentals such as improving fiscal balances, strong trade surpluses and technical factors such as third quarter pickup in overall inflows support emerging markets debt, the IMF noted. Long-term "strategic" inflows are expected to reach $10 billion this year.

One of biggest years for new deals

Gross issuance for 2004 is set to be one of the strongest years on record. Besides the high volume of new paper, the market witnessed two key developments: the increase in new euro-denominated bonds and issuers, such as Colombia, tapping the international market with bonds denominated in local currencies.

This supportive environment has allowed for the completion of 2004 bond financing requirements as well as early pre-funding for 2005.

Latin America hit the ground running for its 2005 funding requirements. The region has issued $4.78 billion of its $14.75 billion 2005 financing needs, the IMF said. Thus far, Brazil has issued $1.2 billion of its $6 billion funding requirements for 2005. That leaves $4.8 billion left to issue.

Colombia has issued $500 million bonds, with $1 billion remaining in 2005. Venezuela has issued $790 million of its $3 billion funding requirement for next year.

And the market seems ready and able to absorb next year's expected issuance of $40 billion. Asia is expected to issue 5.8 billion. Emerging Europe is anticipated to come in with $18.36 billion of issuances.

Since January, the market has been hit with $52 billion of sovereign bonds.

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