Buttonwood
Can't pay? Won't payJan 25th 2007
From The Economist print edition
SourceIn emerging markets, the bond-market dogs lose their bite“WHEN I come back, I want to come back as the bond market, because then you can intimidate everybody,” said James Carville, Bill Clinton's political adviser, in the 1990s. But the “bond-market vigilantes” are not always as menacing as they once were.
Emerging-market governments now seem able to thumb their noses at investors. The latest is Ecuador, where the economy ministry has described some parts of its debt as “illegitimate” and hinted at repaying just 40% of the outstanding total.
It is not that Ecuador lacks resources. Investors generally agree that any default would be the result of unwillingness, rather than inability, to pay. Standard & Poor's, a rating agency, said Ecuador had “one of the weakest payment cultures” of the 113 countries it monitors.
Along with Bolivia and Venezuela, Ecuador is part of an “axis of Marxists” that seems to take a delight in aggravating the international financial community and America in particular. The surge in oil prices this decade has financed this defiance. And while Ecuador is no Saudi Arabia, it may feel it is able to rely on its near neighbour, “Uncle Hugo” Chávez, to provide it with some excess cash.
The commodity boom has allowed others to strike a tougher attitude towards international capital than before, most notably Russia, which has mistreated foreign investors in its oil sector. It has also helped that yield-hungry investors have been pouring money into emerging markets. With returns on American Treasury bonds and high-grade debt too low to meet the needs of pension funds and endowments, they have to take more risks.
According to the Institute of International Finance (IIF), an international banking club, some $502 billion of private capital flowed into emerging markets last year, only slightly down on the $509 billion in 2005. The IIF predicts $469 billion of capital flows this year, which would be the third-highest level on record. Those flows reflect the general perception that emerging-market economies have improved substantially since the Asian crisis of 1997-98. Many developing countries are running current-account surpluses, in order to be less dependent on foreign capital than they were a decade ago. By doing so, they have proved the old rule that bankers are willing to lend money only to people who do not need it.
An element of moral hazard may have entered the equation. Argentina imposed a substantial default on its creditors five years ago. Its debt now yields a little above two percentage points more than American Treasury bonds; hardly a sign that it is a financial pariah. Investors have been happy to buy its inflation-linked bonds, on the expectation that consumer prices will rise sharply.
This may reflect a change among investors. When the Latin American debt crisis broke in the 1980s, much of the debt was in the hands of Western banks. Given the importance of these banks to the financial system, there was a lot of political interest in ensuring that the loans were restructured. Now that debt is widely dispersed among hedge funds, pension funds and the rest, it may be harder for creditors to join ranks. And while one hedge fund may give up on Ecuador, another may see the crisis as a buying opportunity.
It would be wrong to say that Ecuador has not been punished for its defiance. Its cost of finance has definitely increased. Ecuador's bonds were trading close to their face value in the spring of last year, according to PIMCO, a fund-management group; now the benchmark 2030 bond trades at only 70 cents to the dollar. Its credit-default swaps, which insure the buyer against non-payment, traded as low as 270 basis points (hundredths of a percentage point) in August; they are now at 1,350 basis points.
Emerging-market investors also point out that Ecuador is a small country, in terms of both population and importance to financial markets. They argue it would be wrong to see it as a harbinger. So far there has been little sign of a “contagion effect” in other markets.
However, Richard Bernstein of Merrill Lynch likens risk to popcorn in a microwave. One kernel pops, but it seems to be an isolated event. Then another goes and another, until the entire bag is active. Ecuador is only the latest pop, following Thailand's botched capital controls, Venezuela's proposed nationalisations and sharp falls in commodity prices.
At some point, the credit cycle will turn and some emerging markets may regret “dissing” international investors when the going was good. As Gene Frieda, head of emerging-markets research at Royal Bank of Scotland, says: “The bargaining power of some countries is diminishing with every tick lower of the oil price.” The vigilantes may yet have their revenge.