Issuing International Sovereign Bonds

This African Department Paper examines the rise in international sovereign bonds issued by African frontier economies and recommends policies for potential first-time issuers.

What determines the ability of low-income developing countries to issue bonds in international capital and what explains the spreads on these bonds? This paper examines these questions using a dataset that includes emerging markets and developing economies (EMDEs) that issued sovereign bonds at least once during the period 1995-2013 as well as those that did not. We find that an EMDE is more likely to issue a bond when, in comparison with non-issuing peers, it is larger in economic size, has higher per capita GDP, and has stronger macroeconomic fundamentals and government. Spreads on sovereign bonds are lower for countries with strong external and fiscal positions, as well as robust economic growth and government effectiveness. With regard to global factors, the results show that sovereign bond spreads are reduced in periods of lower market volatility.

In recent years, the number of countries which have borrowed in international capital markets by issuing sovereign bonds has increased substantially. For these countries, capital market access meant a de facto acknowledgement of their policy successes and improvements in their creditworthiness that enabled them to graduate from the group of official financing recipients into a more advanced group of emerging market economies. The paper looks at the determinants of sovereign bond issuances and derives the relationship between internal and external factors and market access using a simple macro model. The market access condition is then translated into a simple rule that requires an excess demand for the sovereign bonds in question. Regression results based on this model offer some insights into peculiarities of first-time sovereign bond issues that could be used in policy deliberations.

This paper examines the rise in international sovereign bonds issued by African frontier economies and recommends policies for potential first-time issuers. Maintaining prudent fiscal frameworks consistent with debt sustainability is crucial for deriving lasting benefits from additional financing. Beyond that, first-time international sovereign bond issuers should focus on improving the composition and profile of their public debt under an appropriate debt management framework, adhering to best operational practices for first time issuance, and locking in low interest rates while smoothing the maturity profile of the entire public debt portfolio. International sovereign bonds may not be the best option for financing infrastructure investment, and other funding options may need careful consideration.

As part of the Fund’s ongoing work on sovereign debt restructuring, in October 2014 the Executive Board endorsed the inclusion of key features of enhanced pari passu provisions and collective action clauses (CACs) in new international sovereign bonds.1 Specifically, the Executive Board endorsed the use of: (i) a modified pari passu clause that explicitly excludes the obligation to effect ratable payments and (ii) an enhanced CAC with a menu of voting procedures, including a “single-limb” voting procedure that enables bonds to be restructured on the basis of a single vote across all affected instruments, a two-limb aggregated voting procedure and a series-by-series voting procedure.

International bond issuance by debut issuers has risen in recent years. The uptick was a result of both demand and supply factors. The search for yield and demand for portfolio diversification have resulted in demand-driven easy financing conditions. At the same time, rising financing needs for many debut issuers, coupled with reduced access to concessional financing, relatively undeveloped domestic markets, and a favorable interest rate environment have made international bonds an attractive financing alternative for many countries. As bonds issued in the international markets are typically denominated in hard currencies, have large volumes and a bullet structure, exposure to exchange rate and refinancing risk has increased. Therefore, risk-mitigating policy actions are needed to prepare for redemption, support debt sustainability, and secure adequate debt management capacity.

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The recent round of debt relief has restored debt sustainability in many low-income countries (LICs). This, along with a continued search for yield and desire for portfolio diversification by investors, has increased the range of viable financing options, including international bonds, for many emerging market (EM) economies and LICs. This paper presents some of the advantages and disadvantages of international debut bonds, within a debt sustainability framework. It outlines key preconditions and discusses strategic considerations that countries need to take into account when contemplating bond issuance in international markets for the first time. In this context, the paper also discusses some typical pitfalls in accessing international capital markets, including excessive issue size relative to the intended use of bond proceeds, issuance of bullet bonds, and inadequate preparation for accessing the markets.