By Carolyn Cohn / Reuters
LONDON: With refinancing becoming a giant headache for sovereign debtors across the globe, some struggling emerging economies are securing guarantees from richer nations or multilateral development banks to bolster their chances of selling bonds to wary investors.
The guarantee provides the emerging country borrower with access to otherwise-closed international capital markets, while the guarantor is extending financial support to a friendly trading partner at relatively low cost.
It’s already being used in one Arab Spring country — Tunisia — and analysts say it could extend to others in the region, like Egypt.
Tunisia, which suffered several ratings downgrades in the past year following its Arab Spring uprising, last week said it was planning a U.S.-guaranteed dollar bond in the next few months.
And the tiny indebted nation of St Kitts & Nevis last week completed a debt exchange with new debt carrying a small guarantee from the Caribbean Development Bank.
The guarantees are particularly helpful in countries in the Middle East that have been through political and financial turmoil in the past year.
Setting a precedent for this type of guarantee, the United States underwrote a borrowing program for Israel 10 years ago to help the country out of economic difficulties.
“Over the medium term, we are going to see a series of funding gaps in the Middle East region — the guaranteeing of sovereign debt is going to be one way of resolving this,” said Florence Eid, chief executive of research and advisory firm Arabia Monitor.
“It’s a very good idea for countries in the region to get guarantees on their debt, from international economies like the United States that can afford it.”
Plugging gaps
Tunisia’s finance ministry said last week the country could issue a US-guaranteed bond totaling $400-500 million, its first international bond since 2007.
Plans for a conventional Eurobond last year were put on hold after the ousting of President Zine Al-Abidine Ben Ali.
Tunisia’s still boasts an investment grade rating, helped by a relatively contained budget deficit.
But at the lowest possible investment grade rating with negative outlook from all three major ratings agencies, the country is at risk of tipping into junk territory.
The guarantee, from the AAA/AA+ rated United States, is likely to boost the rating of the bond, investors say.
“Clearly, having debt issued with the sovereign risk of the United States is superior to having it issued with the sovereign risk of a country that has just undergone a revolution,” said Daniel Broby, chief investment officer of fund manager Silk Invest.
“The guarantee will allow the issue to be priced more tightly.”
A precedent was set in 2002 when Israel received a package of US loan guarantees to help the economy deal with a recession caused by a global downturn and wave of Palestinian bombings.
Israel has issued $4.1 billion under the program and still has billions left to use. But it hasn’t issued anything under the program for a number of years, since its own credit ratings have risen.
Investors speculate that countries such as Egypt, which has gone back to the drawing board to negotiate a loan from the International Monetary Fund, may follow suit in getting a US guarantee on their debt.
“If Tunisia gets it, I suspect others will ask — Greece could do with such a guarantee right now as well,” said Broby.
Greece successfully completed a debt exchange earlier this month after months of market anguish, but its new debt continues to trade at very weak levels.
Long way
The beauty for the guarantor is that a little money can go a long way.
The US State Department announced last month that it was making $30 million available for loan and bond guarantees to Tunisia.
Such a sum can go much further, analysts say, as the guarantee only needs to represent the probability of default.
So if investors place a 5 percent probability of Tunisia going into default, the country can easily borrow $600 million with only a $30 million guarantee.
In the case of St Kitt’s, a small $12 million guarantee from the Caribbean Development Bank will ensure the country can pay interest payments on its debt, according to David Nagoski, director at White Oak Advisory, advisers on the deal.
“Creditors can take comfort from the fact that a multilateral institution other than the IMF has reviewed the overall program and feels sufficiently confident about future debt sustainability to provide support through a guarantee,” Nagoski said.
The African Development Bank provided a similar guarantee when Seychelles restructured its debt in 2010.
The World Bank has also guaranteed emerging debt in the past, most notably Argentina.
Argentina defaulted on a World Bank-guaranteed $250 million bond in 2002 and has not yet been able to re-enter international capital markets, but investors in that bond were able to recoup their money via the guarantor.
But the danger for borrowers is that investors no longer trust their credit without the crutch of the high-grade guarantee. Too large a guarantee can reduce investor confidence in a borrower’s ability to issue alone in future, analysts say.
Meanwhile, the danger for the guarantors is that they are increasingly forced to open their wallets, once such a precedent has been set.
“Giving such guarantees creates moral hazard. It may be seen as a cheap source of aid in the short run but it debases the sovereign status of the guarantor in the long run,” said Broby.
“Imagine a world 10 years down the line, where the U.S. has guaranteed every restructured nation’s bond.” –Additional reporting by Steven Scheer in Jerusalem
