GAI Director Alejandro Werner’s Views on Sovereign Yields in Emerging Markets
On September 29, the Georgetown Americas Institute’s (GAI) director Alejandro Werner published a journal article “The long-run impact of sovereign yields on corporate yields in emerging markets” for the Journal of International Money and Finance.
The article was co-authored with Delong Li, adjunct professor at the Department of Economics and Finance of the University of Guelph and with Nicolas E. Magud, senior economist at the International Monetary Fund. The paper analyzes the long-run impact of sovereign yields on corporate yields in emerging markets and finds a connection between high sovereign risk and increasing private sector borrowing costs.
The relation between corporate and sovereign bonds
Utilizing data from IHS Markit, Bloomberg, and Datastream, the authors analyzed the relation between corporate and sovereign bonds focusing on long-term impacts. The authors proved that there is significant heterogeneity across countries and bonds. This goes in line with theoretical assertions that governments can transfer credit risk to domestic firms, and that sovereign bonds can affect corporate bond pricing by influencing liquidity. They also found that the sensitivity of corporate yields to sovereign yields also relies on corporate bonds’ credit ratings and maturities. Sensitivity is stronger, for example, for corporate bonds with maturities between one and five years.
If there is a positive, strong, and persistent pass-through from sovereign yields to corporate yields, weaker fiscal positions could slowdown growth by increasing borrowing costs, thus persistently reducing private sector investment.
High Sovereign Risk and Growth Slowdowns
The paper found that in emerging markets, corporate and sovereign yields are directly linked together in the long-run, specifically in credit risk and liquidity premiums. Because of this, high sovereign risk levels can lead to a slowdown of growth by increasing private sector borrowing costs.
This is particularly significant for the emerging markets of Latin America and the Caribbean where sovereign debt defaults and high risk environments negatively impact the private sector’s development. This in turn affects the country’s growth trajectory, which will further disrupt debt payments and consequently increase sovereign risk.
You can find the full article here.