Public sector borrowers face a raft of challenges in funding their programmes through difficult and volatile markets, OMFIF’s Public Sector Debt Outlook 2023 reveals. Featuring a survey from the Sovereign Debt Institute, the report finds that borrowers are concerned about the level of demand from investors, the size of new issuance premiums, the lack of liquidity and the ability of sovereign issuers to incentivise their primary dealer groups.
Aside from the usual rush to issuance at the very start of the year, and a typically busy January in the sovereign, supranational and agency primary markets, the survey results paint a clear picture of borrowers nervous about their ability to access the market. Typically, public sector issuers look to frontload their funding in the first half of the year, with as much as 70% of their borrowing completed by the end of the second quarter. This allows the issuers to strategically pick optimal funding windows in the latter part of the year.
But the survey results show that two-thirds of borrowers expect to have funded up to 50% or less of their annual requirement in the first six months of 2023. A substantial part of this group comes from emerging markets or issuers with smaller annual funding requirements. It hints that some expect market conditions will be extremely tough early in the year, due to a lack of clarity from central banks, with the hope that, as interest rate increases level off as inflation subsides in the second half of the year, issuance windows will become more frequent and benign.
But this might leave issuers hostage to the fortunes of the market if conditions fail to improve. More than half of respondents said the lack of clear issuance windows was one of their top three concerns for the year ahead.
Figure 1. Issuers worried about demand, pricing and liquidity
What are your biggest concerns in 2023?
Source: Public Sector Debt Outlook 2023
Around 60% of borrowers cite reduced demand from investors as one of their top two concerns for 2023, despite rising rates boosting returns for buyers (Figure 1). Coverage ratios for syndications are likely to fall, as the distortion of quantitative easing in some markets is withdrawn. Some 38% of borrowers expect syndications to only be one or two times covered, and 50% expect coverage of two or three times, suggesting that the era of inflated orderbooks may be well and truly over.
It is therefore no surprise that two-thirds of respondents say they will increase their investor relation efforts in 2023. The opening up of global travel post-Covid-19 is likely to see more borrowers get on the road for investor meetings, both deal and non-deal. Close to 40% of borrowers are planning to access new investors, and three-quarters want to deepen their relationships with existing investors. Just under half of respondents said that the return of traditional investors as rates rise has been the most significant change in the investor community over the past 12 months, while more than a quarter have seen a reduction in hedge fund participation in primary markets.
Tougher primary market conditions are also reflected in borrowers’ expectations of the cost of issuance. Around 60% of public sector borrowers say new issue premiums will be higher – most of them marginally so, but some substantially. Only 6% think premiums will be lower.
Liquidity – or the lack of it – is a major discussion topic between borrowers and their investors. Two-fifths of respondents to the survey rate liquidity as one of their top two concerns. In the sovereign debt space, a lot of this discussion is coalescing around the role of primary dealers and their willingness and ability to provide liquidity via auctions and in the secondary market. One-third of borrowers say they have had discussions in which primary dealers have expressed concerns about their obligations.
Figure 2. Primary dealers crucial to building trading volumes
How are you looking to boost liquidity?Source: Public Sector Debt Outlook 2023
In response, around 45% of issuers say they are looking at ways to provide primary dealers with new incentives, while 18% said they are considering how to ease obligations among their core bank intermediaries (Figure 2). Some 15% of sovereign issuers say they expect to increase their number of primary dealers in 2023, raising the importance of ensuring that banks have the right economic incentives to be active participants.
Public sector issuers are expected to continue to take the lead in the development of sustainable bond markets. Around one-fifth of respondents said they would issue more than 20% of this year’s borrowing programme in a sustainable format. The largest sector will remain green bonds – expected from close to 50% of borrowers – but other forms of sustainable bonds (27%) and social bonds (21%) will also be prevalent.
The sovereign sustainability-linked bond market is also expected to further develop, with 10% of borrowers looking to issue in this format in 2023, all from the emerging markets. A number of respondents commented that building new relationships with environmental, social and governance investors will be a core part of their investor relation programme over the next year.
The survey was completed by 33 sovereign, supranational and agency borrowers (two-thirds from developed markets, with the remainder from emerging markets) in December 2022 and January 2023. These survey results form the backbone of this report on the outlook for public sector debt issuance in 2023.
The report assesses the liquidity challenges for SSA borrowers and what they are doing in response, with comment from borrowers and banks. It analyses the current state of primary dealerships and what the future of this model will look like. Finally, it reviews the SSA ESG market in 2022 and how this can be recharged in 2023, with the introduction of new products such as SLBs and more debut ESG issuers, and looks into how ESG frameworks can better evolve, with comment from borrowers, banks and investors.
Clive Horwood is Managing Editor and Deputy Chief Executive Officer of OMFIF.