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Bond-Market Veteran Braces for More Emerging-Market Defaults

(Bloomberg) -- Veteran fixed-income investor Abdul Kadir Hussain sees unsettling similarities between the 1997 Asian crisis and the present that spell trouble for emerging markets.

Default rates on emerging-market debt will climb next year as the ending of a decade of easy money by central banks hits weaker companies the most, said Hussain, the head of fixed income at Arqaam Capital, a Dubai-based investment bank.

Flush with cash and hungry for yield, many investors were eager to buy emerging-market bonds they might well have been averse to in normal market conditions, fueling a record borrowing binge. But the reverse is now happening and investors have become more selective.

Bond-Market Veteran Braces for More Emerging-Market Defaults

“Given the relatively loose liquidity in the market over the last five years, you’ve had a lot of deals financed that maybe in more disciplined markets would not have been financed,” said Hussain. “In 2019 and probably into 2020, you’re going to see default rates pick up in emerging markets, particularly in the weaker part of the spectrum.”

That stirred memories of the Asian debt crisis, when companies defaulted on billions of dollars of liabilities as the region’s currencies collapsed following the devaluation of the Thai baht. Companies had loaded up on dollar debt to take advantage of lower interest rates, even when their revenues were in local currencies.

Short Memories

Hussain witnessed it all firsthand. He moved to Singapore from the U.S. to join Peregrine Investments Holdings Ltd. in 1997 as the head of credit research for Southeast Asia, only to spend most of his time attempting to restructure the investment bank’s largest credit exposure: a $269 million loan to Jakarta-based taxi company PT Steady Safe. The Indonesian company couldn’t repay the money to Peregrine as the rupiah collapsed, pushing the investment bank into liquidation in 1998.

“People have forgotten,” said Hussain, who was managing director at Credit Suisse Group AG in London before moving to Dubai in 2006. “Money has been cheap.”

Governments and companies in developing nations sold $1.1 trillion of bonds so far this year, after raising a record of almost $2 trillion in all of 2017, according to data compiled by Bloomberg. As the U.S., Japan and Europe kept interest rates close to, or below, zero to help their stagnant economies recover from the 2008 financial crisis, investors had flocked to emerging markets to seek higher returns.

Credit Spectrum

Companies in China and Latin America will probably lead defaults as they fall in the “weaker part of the credit spectrum,” Hussain said. Those that have defaulted on dollar bonds this year include Chinese high-yield borrowers China Energy Reserve & Chemicals Group Co. and Hsin Chong Group Holdings Ltd.

Sovereign crises in Indonesia, Russia and Argentina led to record default rates in developing nations between 1999 and 2003, according to Moody’s Investors Service. The average emerging-market default rate was 8.9 percent during that period, the rating company said in a report in March.

Some companies have sought to reduce their debt burden recently and there’s “potential state support,” according to BMO Global Asset Management.

Default Rate

“Inevitably conditions will probably lead to a higher default rate going forward,” said Jonathan Mann, London-based head of emerging-market debt at BMO Global Asset Management, which oversees $260 billion. “But it doesn’t mean the asset class can’t produce good returns.”

Currency volatility is often one of the triggers for defaults in emerging markets, according to Moody’s. The recent slump in developing nations’ currencies have increased the cost of servicing foreign debt. The MSCI Emerging Markets Currency Index has declined 3.3 percent this year as the prospect of higher U.S. interest rates reinvigorates the dollar and the specter of a global trade war dents demand for riskier assets.

“As liquidity gets withdrawn from the market and as capital gets more of a price to it, you’re going to see continued credit differentiation,” Hussain said. “You’re going to see the weak get weaker and the strong get stronger.”

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