EU's Debt Crisis Boosts Allure of Region's Emerging Markets: Euro Credit

Western European government bonds are riskier than emerging-market debt for the first time as investors brace for $1.1 trillion of borrowing from euro-region nations this year.

The Markit iTraxx SovX Western Europe Index of credit- default swaps insuring the debt of 15 countries, including Germany, Greece and Portugal, climbed to 7 basis points more than the Markit iTraxx SovX CEEMEA Index linked to Romania, Turkey and Ukraine, according to data provider CMA. The developed nations were 160 basis points more creditworthy than their emerging-market peers as recently as February.

Portugal’s borrowing costs surged at a six-month bill sale this week, the first of Europe’s high-deficit nations to test investor demand in 2011 after the threat of default forced Greece and Ireland to seek bailouts last year. Spain and Italy together need to raise 317 billion euros ($413 billion) this year, according to BNP Paribas SA.

“Concerns about the periphery are dragging down western Europe,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “Emerging markets have solid growth stories and are not directly weighed down by peripheral issues.”

Europe’s developing nations will grow 3.1 percent this year, according to forecasts by the International Monetary Fund. That’s more than double the 1.5 percent euro-region expansion shown in a Bloomberg survey of economists.

Top Performers

Credit-default swaps on junk-rated Ukraine and Romania are among the world’s best-performing government-linked contracts in the last three months, while Greece, Ireland and Spain are the worst performing, CMA prices show. Investors are shunning the debt of countries including Spain and Portugal as austerity measures fail to reassure bondholders that they can meet their obligations.

Swaps on Ireland, which agreed to an 85 billion-euro rescue package last quarter, rose to a record 640 basis points yesterday, CMA prices show. That’s up from 448 basis points Oct. 7, and means it costs $640,000 annually to insure $10 million of debt for five years.

Swaps on Greece rose 273 basis points to 1,023 in the past three months and Spain increased 120 to 346. Ukraine fell 37.5 to 474.5, while Romania dropped 21.5 to 295.5, CMA prices show.

Ireland will this year post the widest deficit in the EU at 10.3 percent of gross domestic product, following 2010’s 32.3 percent, according to the European Commission. Some Irish banks’ bonds are no longer accepted as loan collateral by the Swiss National Bank after Moody’s Investors Service lowered the country’s credit rating by five levels to Baa1 on Dec. 17.

Unresolved Issues

“People are still wary that issues remain unresolved in the financial sector,” said Christian Weber, an analyst at UniCredit SpA in Munich. “That weighs on national budgets and poses a risk to the solvency of peripheral countries.”

Portugal’s debt rating was cut one level to A+ by Fitch Ratings on Dec. 23, which said the economy faces a “deteriorating” outlook. The nation’s consumer confidence dropped to a 21-month low in December, the National Statistics Institute said Jan. 5.

Portugal, which intends to sell as much as 20 billion euros in bonds to finance its budget and redemptions this year, sold 500 million euros of bills with a yield of 3.686 percent on Jan. 5, up from 2.045 percent at a sale of similar maturity securities in September. Swaps on Portugal cost 517.5 basis points, near the Nov. 30 record of 543.

‘Unholy Mess’

The credit-rating companies are also reviewing other countries. Moody’s said on Dec. 15 it may cut Spain’s Aa1 credit rating and on Dec. 16 placed Greece’s Ba1 rating on review for a possible downgrade. Greece may yet default on its debt even after a 110 billion-euro loan from the EU and IMF in May, Harvard University Professor Kenneth Rogoff said this week.

“It is an unholy mess,” said Suki Mann, a credit strategist at Societe Generale SA in London. “The pack will now be unleashed on other sovereigns until a solution is found.”

Countries such as Bulgaria, Lithuania and Kazakhstan are faring better than their advanced neighbors because they have less debt and avoided the plunge in real-estate prices that plagued the West.

Romania, which got a 20 billion-euro bailout from the International Monetary Fund and European Union in 2009, has pledged to cut its budget deficit of 7.2 percent of GDP to 4.4 percent next year. Greece’s deficit was 15.4 percent in 2009, Ireland’s 14.4 percent and Spain’s 11.1 percent, according to EU data.

Weathering the Storm

“Emerging markets as a group weathered the global recession better than advanced economies,” the IMF wrote in a report published on its website last month. “Many have seen growth bounce back during the past year, and they seem poised for high growth in coming years.”

The MSCI Emerging Markets Index of stocks gained 16 percent in 2010, beating the 8.6 percent increase for Europe’s Dow Jones Stoxx 600 Index and the 12.8 percent gain by the Standard & Poor’s 500 Index in the U.S.

Developing European governments were most affected by contagion from the sovereign debt crisis, the IMF said. Countries in the Middle East and Africa, which are also included in Markit Group Ltd.’s CEEMEA index, fared better.

That index has declined 11 basis points to 206 since it started trading on Jan. 20, 2010, CMA prices show. Markit’s Western Europe index rose 129 basis points to 213 in the same period.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net