- Several high-risk countries continue to struggle with elevated costs for issuing foreign-currency-denominated debt amid rising interest rates by major central banks.
Capital flows to emerging markets and developing economies have historically experienced cycles of boom and bust, often influenced by monetary policy shifts in advanced economies. Despite recent global monetary tightening, many emerging market nations demonstrated resilience, supported by solid policy frameworks and healthy international reserves. However, the most vulnerable countries faced significant challenges due to higher external borrowing costs, evidenced by a substantial decline in Eurobond issuance.
Eurobonds, which are international debt instruments issued in currencies other than the issuer’s domestic currency—commonly the US dollar or euro—are frequently utilized by high-risk emerging market countries. These bonds circumvent the limitations of underdeveloped domestic capital markets, allowing borrowers access to foreign capital and diversified funding sources. However, unlike local currency bonds, Eurobonds expose borrowers to exchange rate risk, with interest rates acutely sensitive to the monetary policy of the currency in which they are issued.
Recent data shows a stark reduction in net Eurobond issuance from emerging markets and developing countries, plummeting to an annual total of $40 billion in 2022-23—a 70% decrease compared to the previous two years. Throughout this period, 26 out of 75 countries reported net Eurobond outflows totaling $58 billion, driven by maturing Eurobonds outpacing new issuance rather than outright sales by global investors.
This decline in Eurobond flows can be attributed to tightening financial conditions abroad as well as pre-existing vulnerabilities within the affected economies, including fiscal and external sustainability issues. Countries with stronger fundamentals and policy frameworks managed to offset foreign currency issuance with local currency debt, partially funded by domestic investors. In reaction, numerous nations reduced investments to curtail imports, negatively impacting economic growth. Many countries also utilized their reserve buffers, potentially compromising their capacity to weather future shocks.
Net Eurobond issuance has shown a strong inverse correlation with advanced economy interest rates, as measured by the 10-year US Treasury yield. During the pandemic, when bond yields in advanced economies fell, emerging market borrowers capitalized on lower borrowing costs to issue debt.
However, with the Federal Reserve and other major central banks tightening monetary policy, Eurobond inflows diminished significantly as borrowing costs soared to unsustainable levels. Eurobond issuance contracted even as the interest rate differential widened favorably for emerging market economies, highlighting the critical impact of external interest rates on these capital flows.
Currently, global interest rate conditions are trending more positively for borrowers as central banks in advanced economies begin to ease monetary policy. This shift is contributing to a revival in Eurobond issuance, reaching $40 billion in the first quarter of 2024, with countries like Benin and Côte d’Ivoire re-entering the market. The potential onset of a Federal Reserve easing cycle may further bolster Eurobond issuance and stimulate a more extensive resurgence of capital flows to emerging market and developing economies.
