This paper analyses the determimants of emerging market sovereign bond spreads by examining the short and long-run effects of fundamental (macroeconomic) and temporary (financial market) factors on these spreads. During the current global financial and economic crisis, sovereign bond spreads widened dramatically for both developed and emerging market economies. This deterioration has widely been attributed to rapidly growing public debts and balance sheet risks. Our results indicate that in the long run, fundamentals are significant determinants of emerging market sovereign bond spreads, while in the short run, financial volatility is a more important determinant of sperads than fundamentals indicators.

Abstract: "The authors offer evidence that U.S. interest rate policy has an important influence in the determination of credit spreads on emerging market bonds over U.S. benchmark treasuries and therefore on their cost of capital. Their analysis improves on the existing literature and understanding by addressing the dynamics of market expectations in shaping views on interest rate and monetary policy changes and by recognizing nonlinearities in the link between U.S. interest rates and emerging market bond spreads, as the level of interest rates affect the market's perceived probability of default and the solvency of emerging market borrowers. For a country with a moderate level of debt, repayment prospects would remain good in the face of an increase in U.S. interest rates, so there would be little increase in spreads. A country close to the borderline of solvency would face a steeper increase in spreads. Simulations of a 200 basis points (bps) increase in U.S. interest rates show an increase in emerging market spreads ranging from 6 bps to 65 bps, depending on debt/GDP ratios. This would be in addition to the increase in the benchmark U.S. 10 year Treasury rate."--World Bank web site.

Corporate debt in emerging markets has risen significantly in recent years amid accommodative global financial conditions. This paper studies the relationship of leverage growth in emerging market (EM) firms to U.S. monetary conditions, and more broadly, to global financial conditions. We find that accommodative U.S. monetary conditions are reliably associated with faster EM leverage growth during the past decade. Specifically, a 1 percentage point decline in the U.S. policy rate corresponds to an appreciable increase in EM leverage growth of 9 basis points, on average (relative to the sample average leverage growth of 35 basis points per year). This impact is more pronounced for sectors dependent on external financing, for SMEs, and for firms in more financially open EMs with less flexible exchange rates. The findings suggest that global financial conditions affect EM firms’ leverage growth in part by influencing domestic interest rates and by relaxing corporate borrowing constraints.

The authors offer evidence that U.S. interest rate policy has an important influence in the determination of credit spreads on emerging market bonds over U.S. benchmark treasuries and therefore on their cost of capital. Their analysis improves on the existing literature and understanding by addressing the dynamics of market expectations in shaping views on interest rate and monetary policy changes and by recognizing nonlinearities in the link between U.S. interest rates and emerging market bond spreads, as the level of interest rates affect the market's perceived probability of default and the solvency of emerging market borrowers. For a country with a moderate level of debt, repayment prospects would remain good in the face of an increase in U.S. interest rates, so there would be little increase in spreads. A country close to the borderline of solvency would face a steeper increase in spreads. Simulations of a 200 basis points (bps) increase in U.S. interest rates show an increase in emerging market spreads ranging from 6 bps to 65 bps, depending on debt/GDP ratios. This would be in addition to the increase in the benchmark U.S. 10 year Treasury rate.

The global economy has experienced four waves of rapid debt accumulation over the past 50 years. The first three debt waves ended with financial crises in many emerging market and developing economies. During the current wave, which started in 2010, the increase in debt in these economies has already been larger, faster, and broader-based than in the previous three waves. Current low interest rates mitigate some of the risks associated with high debt. However, emerging market and developing economies are also confronted by weak growth prospects, mounting vulnerabilities, and elevated global risks. A menu of policy options is available to reduce the likelihood that the current debt wave will end in crisis and, if crises do take place, will alleviate their impact.

Accommodative monetary policies in advanced economies have spurred increased capital inflows into emerging markets since the global financial crisis. Starting in May 2013, when the Federal Reserve publicly discussed its plans for tapering unconventional monetary policies, these emerging markets have experienced financial turbulence at the same that their domestic economic activity has slowed. This paper examines their experiences and policy responses and draws broad policy lessons. For emerging markets, good macroeconomic fundamentals matter, and early and decisive measures to strengthen macroeconomic policies and reduce vulnerabilities help dampen market reactions to external shocks. For advanced economies, clear and effective communication about the exit from unconventional monetary policy can and did help later to reduce the risk of excessive market volatility. And for the global community, enhanced global cooperation, including a strong global financial safety net, offers emerging markets effective protection against excessive volatility.

The Global Financial Stability Report examines current risks facing the global financial system and policy actions that may mitigate these. It analyzes the key challenges facing financial and nonfinancial firms as they continue to repair their balance sheets. Chapter 2 takes a closer look at whether sovereign credit default swaps markets are good indicators of sovereign credit risk. Chapter 3 examines unconventional monetary policy in some depth, including the policies pursued by the Federal Reserve, the Bank of England, the Bank of Japan, the European Central Bank, and the U.S. Federal Reserve.