EMD expansion: from BRICs to Philippines, Ukraine, Kazakhstan & Egypt
In our first blog, we looked at the impact of India entering the J.P. Morgan GBI-EM Global Diversified Bond Index, with the country now on ‘index watch’.
But it is not alone in becoming eligible for addition. This week, index provider J.P. Morgan confirmed that Egyptian local-currency government bonds would join the relevant benchmark in two phases beginning on 31 January 2022 and that Ukrainian hryvnia-denominated sovereign debt would be eligible from 31 March 2022. We also believe the Philippines onshore market and Kazakhstan could join them.
Let’s take a look at each in turn.
The average annual growth rate in Egyptian-issued government debt for the five years ending 2020 was +82%, with 2021 year-to-date issuance already well above the total 2020 level. Onshore bond market participation by foreign investors is growing too, largely attributable to developments with Euroclear that will enhance market efficiency and widen access for foreign investors. The government has also recently approved amendments to the Central Depository and Registration Law, allowing for a single entity to provide clearing and settlement for both government bonds and bills.
Holding all else constant, we calculate the inclusion of Egypt into the J.P. Morgan GBI-EM Global Diversified Bond Index would equate to a circa 1.85% allocation to the country. 14 bonds are on the watch list with a total market value of $24 billion, yielding approximately 14% with a modified duration of around three years.
Adding Egypt to the benchmark would have a strong impact on its overall yield, with that 14% well above the median yield of the index and higher than all but one country (Turkey). Egypt would also shorten the overall duration of the benchmark, from 5.23 to 5.15 years.
There is currently a temporary capital gains tax (CGT) exemption on government-issued debt in place until 31 December 2021, which is expected to be made permanent, and a withholding tax on interest from government bonds ranging from 10-20% depending on jurisdiction. Egypt’s FX market is also among the most restrictive to trade, as FX must be linked to an underlying bond trade, but temporary overdrafts are permitted.
Egypt’s government debt currently has a J.P. Morgan ESG (JESG) score of 28.95; if included in the J.P. Morgan ESG GBI-EM Global Diversified Index, we estimate that the ESG tilting would reduce Egypt’s allocation by circa 57 basis points.
Ukraine is working hard to improve its international debt offering, making a concerted effort at market liquidity enhancements with a focus on adding to the benchmark yield curve by focusing issuance towards benchmark-tenor bonds. Previously, only banks could act as primary dealers in Ukraine, but this too is moving in the right direction with a decree passed locally to evolve this limiting factor.
The average annual market growth rate for the five years ending 2020 was +35%, with consistent positive issuance since 2013, further emphasising the country’s development. Government debt issuance for 2021 year-to-date is at almost 80% of the total 2020 level.
Holding all else constant, we calculate the inclusion of Ukraine into the J.P Morgan GBI-EM Global Diversified Bond Index would equate to a circa 0.12% allocation to the country. The single government bond eligible for inclusion (based upon the parameters of >$1bn in size and >2.5 years to maturity) has a market value of $1.5 billion, and contributes a yield of 13.3% and a modified duration of 2.5 years.
Currently, there is effectively no withholding tax on debt instruments between non-residents and Ukraine’s FX market is relatively unrestrictive.
Ukraine government debt currently has a JESG score of 43.10. If included in the J.P. Morgan ESG GBI-EM Global Diversified Index, we calculate that the country’s allocation would remain unchanged (largely due to the relatively small weighting to the country).
Kazakhstan is another country we feel is highly likely to be included in the index. This is a country that benefits from Eurasian investment opportunities, and one might argue it’s the only real opportunity among the region’s former Soviet republics.
The Kazakh capital’s Astana International Financial Centre is looking to attract foreign direct investment, diversify the economy and ultimately develop capital markets from within. The country has made clear that it aims for inclusion in the larger benchmarks.
The growth of both the government and corporate debt markets has been significant in Kazakhstan over the past 10 years, with the real acceleration coming over the past five years with the average annual government debt growth rate at +90%. Notably, the 2021 year-to-date growth is already greater than each of the previous five years.
Holding all else constant, we calculate the inclusion of Kazakhstan into the J.P Morgan GBI-EM Global Diversified Bond Index would equate to a circa 0.25% weighting allocation to the country. Three bonds are on the index watch list, with a total market value of $3.9 billion, yielding approximately 10% with a modified duration of around 6.5 years. The credit quality is BBB, with a stable outlook.
As it stands, there is currently no CGT impact for foreign investors. Additionally, there is no withholding tax applicable to bond interest; there will, however, be an interest and dividend withholding tax of 15% unless the security is listed on the Kazakhstan exchange. Kazakhstan’s FX market is one of the more restrictive, as FX must be linked to an underlying bond trade and no overdrafts are permitted.
Kazakhstan government debt currently has a JESG score of 47.16. If included in the J.P. Morgan ESG GBI-EM Global Diversified Index, we calculate that the Kazakhstan allocation would remain unchanged (largely due to the relatively small weighting to the country).
In line with many other bond markets, the Philippines continues to issue debt apace, with the current 2021 issuance already 135% of 2020’s full-year issuance.
One notable aspect of the Philippines is the benchmark already contains three “offshore” global bonds that trade and settle via Euroclear in USD terms. The bonds currently on watch for inclusion are the “onshore” bonds.
We calculate the inclusion of Philippines onshore government debt into the J.P. Morgan GBI-EM Global Diversified Bond Index would equate to a circa 2.3% increase in the current weight to the country. 10 bonds are on the watch list with a total market value of $33 billion, yielding 3.2% with a modified duration of 5.01 years and a credit quality of BBB.
Government bond interest is subject to a 20% withholding tax (Philippine government bonds are in theory subject to a 30% non-resident WHT rate, but in practice the 20% domestic rate applies).
Philippines government debt currently has a JESG score of 46.75. If included in the J.P. Morgan ESG GBI-EM Global Diversified Index, we estimate that the ESG tilting would reduce the Philippines allocation by around 0.10%.
The change in index risk characteristics due to the potential inclusion of the countries mentioned here and in our previous blog will primarily be driven by India, given its potential allocation of around 8%. The benchmark yield, though, will be more shaped by the potential inclusion of Ukraine, Kazakhstan and Egypt, which each separately contribute yield levels of greater than 10% (albeit with relatively small weights).
Overall, we consider all five of these potential inclusions to be positive developments for EMD as they enhance the capacity and diversification of the local emerging-bond universe. Given the yields available in developed markets, we believe that EMD’s higher yield and duration – which will be spread across the curve – will be well received by investors if and when these country inclusions materialise.