Chapter

V International Bond and Note Markets and Other Flows

Author(s):
Donald Mathieson, Eliot Kalter, Maxwell Watson, and G. Kincaid
Published Date:
February 1986
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One of the most important recent changes in the structure of international financial markets has been the displacement of the syndicated bank loan as a principal instrument of international finance by a wide range of bonds and other marketable securities. Between 1981 and 1984, international bonds.30 net of redemptions and double counting due to bank purchases of bonds issues, rose from $30 billion to $60 billion. As a result, the proportion of the sum of net international bank loans and net bond issuance, accounted for by net bond issuance, rose from 7 percent to 24 percent.

This expansion of bond market activity stands in sharp contrast to the stagnant level of activity in the late 1970s and represents a response to lower inflation and improvements in other macroeconomic conditions, high real returns on bond holdings, the development of new types of financial instruments, and reductions in regulatory restrictions on bond issuance in certain major markets. This section first considers the general factors leading to the sharp growth of bond issuance during the past five years and then reviews specific developments in international bond markets in 1984 and the first half of 1985.

Bond Market Trends

The record level of bond issuance during 1981–84 represents a sharp recovery from an almost decade-long decline in bond market activity, especially during the late 1970s.31 Although the nominal level of net bond issuance remained at approximately $30 billion during 1976–80, the real value of these net issues fell to $20 billion in 1980 (a 31 percent decline from the real value in 1976). Moreover, net bond issues declined from the equivalent of 3.2 percent of world imports in 1976 to only 1.5 percent in 1980. At the same time, a growing level of international syndicated bank credits reduced the ratio of international net bond issuance to international bank lending from 42 percent in 1976 to only 18 percent in 1980.

A number of factors combined to reduce the attractiveness of long-term fixed-interest rate bonds as an instrument of international finance. These factors included high inflation, increased exchange rate and interest rate variability, and the substantial capital losses experienced on fixed interest rate securities, as interest rates rose (Table 13). Borrowers found that they could attract purchasers to the bond markets only by offering high real yields and by changing the maturities and risk-sharing characteristics of the instruments used in bond markets. In a number of major financial markets, real yields rose sharply during 1979–80 and remained at historically high levels throughout the early 1980s. In addition, bond maturities were shortened with the average maturity of Eurodollar bonds declining from a range of 12–15 years in the early 1970s to 7–10 years in the late 1970s.

The recovery of bond market activity began in late 1981 as short-term interest rates started to decline from post-World War II peaks in many industrial countries. As discussed in Section II, this recovery has encompassed record volumes of new issues, an extended period of high real returns on bonds, and a gradual lengthening of bond maturities. Declining interest rates and the slowing of inflation in a number of industrial countries created a situation where investors were able to obtain high real rates of return. Borrowers were willing to pay these high real rates in order to reduce their reliance on short-term debt and because of their ability to issue callable debt which helped ensure that they would not be locked into permanently high real borrowing costs, if future interest rates should decline.

The extent of the recovery in bond issuance activity during 1981–84 is indicated in Table 14. Net bond issues have risen from $28 billion in 1980 to $84 billion in 1984 (an average annual rate of growth of 32 percent), and the real value of net bond issues has risen from $20 billion (in 1975 prices) in 1980 to $47 billion in 1984. The recovery of bond market activity in the early 1980s has now more than offset the bond market decline of the late 1970s. This recovery has been based on an environment characterized by relatively low inflation in countries with major financial markets, declining nominal interest rates, high real bond yields, but considerable interest rate and exchange rate variability.

Issuance activity on international bond markets during 1984 and the first half of 1985 suggests a continuation of the recovery in bond market activity in 1985. The remainder of this section examines the nature of these developments?

Table 13.Real Return on Bond Holdings, 1976–831(In percent per annum)
Purchased in December of:19761977197819791980198119821983
U.S. Investor Holding a U.S. Dollar Eurobond
Sold in Dec. of:
19770.48
1978−2.00−5.18
1979−4.65−8.23−13.42
1980−4.97−7.22−9.91−8.55
1981−3.41−5.38−6.72−5.00−3.09
1982−1.05−2.13−2.281.226.2717.27
19830.40−0.200.283.958.5616.0514.00
19841.340.931.575.019.2914.8612.6710.51
U.S. Investor Holding a Deutsche Mark Eurobond
Sold in Dec. of:
197727.12
197820.3810.80
197911.942.68−5.95
19801.59−5.80−13.65−23.61
1981−1.42−7.54−11.82−16.10−11.30
1982−0.99−5.69−9.28−10.23−4.413.71
1983−1.80−5.46−8.07−9.24−5.44−2.29−7.72
1984−2.42−5.35−7.36−8.14−5.37−3.28−6.06−4.05
German Investor Holding a Deutsche Mark Eurobond
Sold in Dec. of:
197718.40
197811.003.10
19795.51−1.47−6.89
19802.66−2.59−6.38−7.40
19812.57−2.23−3.19−2.013.59
19823.60−0.15−1.561.466.6510.33
19834.261.200.442.276.488.326.03
19844.722.111.683.637.258.948.0910.41
German Investor Holding a U.S. Dollar Eurobond
Sold in Dec. of:
1977−6.42
1978−8.40−11.77
1979−8.72−11.5214.29
1980−4.17−4.17−1.8910.85
19810.150.593.9713.7113.18
19823.524.798.8818.7119.9224.76
19837.529.5914.7425.0926.4730.7430.98
198411.1513.6419.2829.8131.3334.4632.8727.17
Sources: Orion Royal Bank, Ltd., The Orion Royal Guide to the International Capital Markets (Euromoney Publications Limited, London, 1982); the Organization for Economic Cooperation and Development; and the International Monetary Fund. International Financial Statistics.

In calculating the real rates of return in this table, the following assumptions were made: (1) The bond is assumed to be purchased in December of the year at the lop of the table. (2) All interest on the bond is paid on December 31 of each year and the initial coupon rate of interest is taken as equal to the prevailing market interest rate. (3) Principal is repaid only at maturity. (4) Bonds are sold in December of the year given at the side of the table at a price which ensures that the bond yields a return to maturity equal to the prevailing (December) interest rate. (5) All coupon interest received is assumed to be continuously reinvested in three-month Eurocurrency deposits (at the prevailing Eurocurrency deposit rale) in the same currency as the interest rate payments and bonds are denominated. (6) In calculating the real return on bonds not denominated in the domestic currency, the accumulated interest income and bond sale proceeds are converted at the prevailing exchange rate, and any exchange gain or loss is included in the calculation of the real return. (7) The real return is calculated using the consumer price index in the investors’ home countries. (8) The bonds are those issued by private corporations.

Sources: Orion Royal Bank, Ltd., The Orion Royal Guide to the International Capital Markets (Euromoney Publications Limited, London, 1982); the Organization for Economic Cooperation and Development; and the International Monetary Fund. International Financial Statistics.

In calculating the real rates of return in this table, the following assumptions were made: (1) The bond is assumed to be purchased in December of the year at the lop of the table. (2) All interest on the bond is paid on December 31 of each year and the initial coupon rate of interest is taken as equal to the prevailing market interest rate. (3) Principal is repaid only at maturity. (4) Bonds are sold in December of the year given at the side of the table at a price which ensures that the bond yields a return to maturity equal to the prevailing (December) interest rate. (5) All coupon interest received is assumed to be continuously reinvested in three-month Eurocurrency deposits (at the prevailing Eurocurrency deposit rale) in the same currency as the interest rate payments and bonds are denominated. (6) In calculating the real return on bonds not denominated in the domestic currency, the accumulated interest income and bond sale proceeds are converted at the prevailing exchange rate, and any exchange gain or loss is included in the calculation of the real return. (7) The real return is calculated using the consumer price index in the investors’ home countries. (8) The bonds are those issued by private corporations.

Table 14.Measures of Real Size of Bond Market, 1976–84
197619771978197919801981198219831984
Billions of U.S. dollars
Bond issues (net)1303130322836585984
Billions of U.S. dollars at 1975 prices
Bond issues deflated by U.S. GNP deflator302825252023353447
Percent
Bond issues as ratio to world imports in U.S. dollars3.22.92.42.21.51.93.23.44.1
Bond issues as ratio to international bank lending (net)242.345.633.326.417.525.260.4105.4107.1
Sources: International Monetary Fund; Orion Royal Bank, Ltd. (London); and Bank for International Settlements.

New international bond issues less redemptions and repurchases, but including bank purchases of bonds.

International bank lending equals external lending by banks in the BIS reporting area, net of interbank redepositing.

Sources: International Monetary Fund; Orion Royal Bank, Ltd. (London); and Bank for International Settlements.

New international bond issues less redemptions and repurchases, but including bank purchases of bonds.

International bank lending equals external lending by banks in the BIS reporting area, net of interbank redepositing.

Table 15.Developments in International Bond Markets, 1980–First Half of 1985
1985
198019811982198319841st half1
Billions of U.S. dollars
Bond market lending (net of redemptions)22836585984119
Of which: purchases by banks926112442
By category of borrower
Industrial countries202646477098
Developing countries233247
Other (including international organizations)679111014
Percent
By currency of denomination
U.S. dollar436364576467
Deutsche mark2257966
Swiss franc20161518128
Japanese yen565566
Other10109111213
Share purchased by banks32610192935
Percent per annum
Interest rate developments
Eurodollar deposits314.616.813.29.710.88.6
Dollar Eurobonds412.614.415.012.612.711.7
Deutsche mark international bonds48.910.18.97.97.97.6
Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly; International Monetary Fund, International Financial Statistics; and Fund staff estimates.

On an annualized basis.

This series is net of redemptions but is not adjusted for double counting due to bank purchases of bonds.

Three-month deposits.

Bonds with remaining maturity of 7–5 years.

Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly; International Monetary Fund, International Financial Statistics; and Fund staff estimates.

On an annualized basis.

This series is net of redemptions but is not adjusted for double counting due to bank purchases of bonds.

Three-month deposits.

Bonds with remaining maturity of 7–5 years.

Developments in 1984 and 1985

Overview

After relatively slow growth in 1983, international bond issues rose to record levels in 1984 and the first half of 1985. While $77 billion of international bonds were issued in 1983, a total of $110 billion were sold in 1984. If the annualized rate of bond issuance during the first half of 1985 was sustained through the rest of the year, then about $160 billion of bonds will be issued in 1985. Much of this recent increase in bond issuance was accounted for by larger Eurobond sales, which increased from $50 billion in 1983 to $82 billion in 1984. During the first half of 1985, Eurobond issuance amounted to $66 billion. In contrast, foreign bond sales grew only slightly, from $27 billion in 1983 to $28 billion in 1984.

In part, this increase in bond issuance activity was stimulated by declining interest rates (especially in the second half of 1984 and early 1985), relatively stable inflation rates, the removal of withholding tax on bond holdings by foreigners in a number of countries, and a continued recovery in economic activity which helped stimulate corporate borrowing in the countries with major financial markets. Most of these bond issues were made by borrowers from industrial countries or international organizations, and only a quite limited number of developing countries have had access to these markets (Table 15). The U.S. dollar has continued to be the most widely used currency for the denomination of bond issues.

Interest Rate Developments

Charts 68 and Tables 44 and 45 show recent movements in interest rates. While there were extensive movements of short- and long-term interest rates during 1984, a number of countries began and ended the year with rates that were not very different from their initial levels. During the first half of 1985, however, interest rates fell in many major industrial countries. In the United States, for example, short-term interest rates rose from 9.5 percent in December 1983 to 11.6 percent in August 1984, but then declined to 8.4 percent at the end of the year. During the same period, U.S. long-term interest rates declined only marginally. Following some firming of short- and longterm U.S. interest rates in February and March of 1985, interest rates continued to fall during the remainder of the first half of 1985 (to 7.5 percent for the short-term rate and 10.6 percent for the long-term rate) and into the third quarter of the year.

Chart 6.Domestic Money Market Rates, January 1983 to June 1985

(In percent per annum)

Source: International Monetary Fund, International Financial Statistics.

Chart 7.Domestic Long-Term Interest Rates, January 1983 to June 1985

(In percent per annum)

Source: International Monetary Fund, International Financial Statistics.

Chart 8.Interest Rate Developments, January 1981 to June 1985

(In percent per annum)

Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly; and International Monetary Fund, International Financial Statistics.

1 Bonds with remaining maturity of 7 to 15 years.

2 Three-month deposits.

In contrast, short-term interest rates in the Federal Republic of Germany fell from 6.5 percent in December 1983 to 5.8 percent in December 1984, and German long-term rates declined from 8.2 percent to 7 percent in the same period. During the first half of 1985, German short- and long-term interest rates were relatively stable. Because interest rates in Canada and the United States have tended to decline more rapidly than in the European countries and Japan, there was a narrowing of interest rate spreads between U.S. and Canadian interest rates and those in other major markets throughout the last half of 1984 and first half of 1985.

Interest rate movements in 1984 did not bring about a sharp reduction in real interest rates in the major industrial countries, as inflation has been declining or remaining stable in most major industrial countries (Table 16). The level of real interest rates in the major industrial countries in the 1980s generally has been higher than at any time during the 1960s or the 1970s. Moreover, the dispersion of real yields across the major industrial countries has been lower than in many earlier periods, particularly during 1980–81.

Table 16.Nominal and Real Interest Rates, 1979–84(In percent)
197919801981198219831984
United States
Three-month Eurodollar deposit rate12.114.116.813.29.610.8
GNP deflator8.69.29.46.03.83.8
Real interest rate3.24.66.86.85.66.7
Germany, Federal Republic of
Three-month money market rate6.79.512.18.95.86.0
GNP deflator4.04.54.24.73.21.9
Real interest rate2.64.87.64.02.54.0
Japan
Three-month gensaki rate5.910.77.46.86.56.3
GNP deflator2.62.82.71.70.70.7
Real interest rate3.27.74.65.05.85.6
Sources: International Monetary Fund, International Financial Statistics; Deutsche Bundesbank, Monthly Report; and Bank of Japan, Economic Statistics Monthly.
Sources: International Monetary Fund, International Financial Statistics; Deutsche Bundesbank, Monthly Report; and Bank of Japan, Economic Statistics Monthly.
Table 17.Gross International Bond Issues and Placements, 1979–June 19851(In millions of U.S. dollars)
197919801981198219831984January to June 1985
Foreign bonds20,30817,92420,51425,19927,05027,80113,068
Industrial countries13,42111,33914,12916,85418,69318,2997,745
Developing countries1,4317461,2127268931,618840
Centrally planned economies243
International organizations5,2595,7145,0307,4617,2697,5804,430
Other15412514315819530453
Eurobonds18,69120,39431,32450,32950,09881,71766,038
Industrial countries14,21217,20625,21042,81641,01573,14556,989
Developing countries1,8851,4033,2153,9702,3823,6464,095
Centrally planned economies23055
International organizations2,2201,7102,4863,2806,0744,2184,598
Other34475358263627708356
International bonds38,99938,31851,83875,52877,148109,51879,106
Industrial countries27,63328,54539,33959,67059,70891,44464,734
Developing countries3,3162,1494,4274,6963,2755,2644,935
Centrally planned economies27355
International organizations7,4797,4247,51610,74113,34311,7989,028
Other4982005014218221,012409
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Excludes special issues by development institutions placed directly with governments or central banks and, from October 1984, issues targeted specifically to foreigners.

Excluding Fund member countries.

Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Excludes special issues by development institutions placed directly with governments or central banks and, from October 1984, issues targeted specifically to foreigners.

Excluding Fund member countries.

The persistence of high real interest rates has been attributed to the following factors: expectations of higher inflation in the future; the existence of risk premiums required to compensate asset holders for uncertainty about future inflation rates; the impact of large current and prospective budget deficits on the balance between the supply and demand for loanable funds; the impact of financial deregulation; and the stance of monetary policy. During the first half of 1985, the continuing decline in interest rates helped to lower real interest in most major industrial countries and reduced the spread of real yields between the United States and other major financial markets.

International Bond Issuance

After growing at an annual rate of 26 percent during 1980–83, the total issuance of foreign and Eurobonds expanded by 42 percent in 1984 and continued to increase at that rate during the first half of 1985 (Table 17). This expansion has primarily reflected growth in the issuance of Eurobonds rather than foreign bonds. While foreign bonds grew from $27.1 billion in 1983 to only $27.8 billion in 1984, Eurobonds increased by 63 percent (from $50.1 billion in 1983 to $81.7 billion in 1984).

The volume of international bonds issued by industrial country entities grew from $59.7 billion in 1983 to $91.4 billion in 1984, with their issuance of Eurobonds expanding sharply and foreign bond issues declining. U.S. residents borrowed $25 billion on the international bond markets in 1984, three times more than in 1983. Most of this borrowing ($19.5 billion) involved the issuance of Eurobonds, but the subsidiaries of U.S. corporations raised substantial funds on the bond markets in the Federal Republic of Germany, Switzerland, and the United Kingdom. The second largest group of borrowers were Japanese corporations and banks, which raised $17 billion and $3.8 billion, respectively, on international bond markets. French entities obtained $8.5 billion from these markets, with French banks accounting for $4.3 billion of these issues. Swedish borrowers raised $6.4 billion, with government borrowing accounting for $4.6 billion of the total increase. This rapid growth of bond issuance raised the share of industrial countries in total international bond issues from 77 percent in 1983, to 83 percent in 1984, and 82 percent in the first half of 1985.

Although the bond issues of developing countries rose from 4 percent to 5 percent of international bond issues between 1983 and 1984, the issuance of such bonds was highly concentrated. Korea, Malaysia, and South Africa issued about $1 billion each, together representing more than 60 percent of the developing country issues. Moreover, some bond issues by developing countries appear to have substituted for medium-term bank credits, because few of these bonds were placed outside the banking system. In the first half of 1985, bond issues by developing countries represented 6 percent of total issues.

Table 18.International Bond Issues and Placements by Currency of Denomination, 1979–June 1985(In millions of U.S. dollars; and in percent)
197919801981198219831984Jan.–June 1985
AmountShare of totalAmountShare of totalAmountShare of totalAmountShare of totalAmountShare of totalAmountShare of totalAmountShare of total
U.S. dollar14,72437.816,35842.732,61763.048,25363.943,94057.069,62863.552,99267.0
Eurobonds10,36013,64925,76142,22839,20565,33450,837
Foreign bonds4,3642,7096,8566,0254,7354,2942,155
Deutsche mark8,57122.08,40821.92,5925.05,3627.16,6608.66,7436.24,4775.7
Eurobonds5,8813,4571,3963,2534,0424,3243,675
Foreign bonds2,6904,9511,1962,1092,6182,419802
Swiss franc9,71824.97,47019.58,11815.711,32515.013,50017.513,12012.05,9867.6
Eurobonds
Foreign bonds9,7187,4708,11811,32513,50013,1205,986
Japanese yen2,8557.31,8444.93,1326.03,9155.24,0845.36,0635.54,8566.1
Eurobonds1843014105982331,1901,866
Foreign bonds2,6711,5432,7223,3173,8514,8732,990
Netherlands guilder4701.28742.39291.81,4742.01,6812.21,8461.77691.0
Eurobonds308549490618748986387
Foreign bonds162325439854933860382
Pound sterling2910.71,1523.01,4462.81,9752.63,0123.95,6145.12,6233.3
Eurobonds2919745358462,1533,9652,466
Foreign bonds1779111,1298591,649157
French franc5711.51,1423.06021.22210.31880.2216460.8
Eurobonds374882513343
Foreign bonds1972608922118821303
Other currencies1,7994.61,0702.72,3734.63,0054.04,0835.36,5836.06,7778.5
Eurobonds1,2945822,2192,7863,7176,0186,464
Foreign bonds505488184219366565293
——————————————————————————————————————————
Total38,999100.038,318100.051,838100.075,528100.077,148100.0109,618100.079,106100.0
Eurobonds18,69120,39431,32450,32950,09881,81766,038
Foreign bonds20,30817,92420,51425,19927,05027,80113,068
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

The bond issues of international organizations declined from $13.3 billion in 1983 to $11.8 billion in 1984. While the issuance of international bonds by the World Bank expanded from $4.3 billion in 1983 to $5.2 billion in 1984, other regional institutions significantly reduced their issuance. For example, the European Community (EC) issued only $300 million of international bonds in 1984, compared with $3 billion in 1983. As a result of the decline in their issuance activity, international organizations accounted for only 11 percent of total international bonds in 1984 and in the first half of 1985, as opposed to 17 percent in 1983.

In 1984, international bond issues, net of redemptions, amounted to $84 billion or 42 percent above net issues in 1983. These net flows went mainly to the industrial countries and international organizations. The net flows to developing countries have remained relatively unchanged during the past five years.

Currency Composition and Market Share

Because the U.S. dollar is the primary currency of denomination in the Eurobond markets, the sharp surge in Eurobond issues relative to those in foreign bond markets had a pronounced effect on the currency composition of international bonds in 1984 and in early 1985. Although the share of international bonds denominated in the U.S. dollar had declined to 57 percent in 1983 (Table 18), the share rose to 64 percent in 1984, matching the previous peak share established in 1982. This higher share reflected the fact that Eurobonds denominated in U.S. dollars have increased by 67 percent between 1983 and 1984, and that they represented 80 percent of all Eurobonds issued in 1984. In the first half of 1985, moreover, the share of U.S. dollar-denominated bonds rose to 67 percent of all international bonds. In contrast, the shares of international bonds denominated in deutsche marks, Swiss francs, and Netherlands guilders all declined in 1984 and the first half of 1985.

Types of Bonds

The implications of recent bond market developments for the types of instruments used in international bond markets is illustrated in Chart 9 and Table 42. While straight debt issues represented 76 percent of all international bond issues in 1982, this proportion declined to 52 percent in 1984. In contrast, the share of floating rate notes has expanded from 20 percent to 34 percent in the same period. At the same time, use of convertible international bonds rose from 3 percent to 10 percent of total bond issues.

Chart 9.Developments in International Bond Markets, 1981–84

(In billions of U.S. dollars)

Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly: and International Monetary Fund, international Financial Statistics.

In addition to a growing volume of floating rate notes, the average size of individual issues and average maturity has increased noticeably in recent years; and the secondary market for floating rate notes has gained both in terms of volume and participants. As discussed in Section II, floating rate notes have served as an attractive alternative to fixed rate bonds during periods when volatile interest rate movements discouraged lenders from committing their funds long term at fixed interest rates. Moreover, holders of floating rate notes have generally earned high returns in the period since the late 1970s. For example, investors in Eurodollar floating rate notes earned an annual average rate of return of 13.6 percent during 1979–84, which compares favorably with 12.8 percent on three-month Eurodollar deposits or 10.9 percent on three-month U.S. Treasury bills.

Commercial banks also became major purchasers of floating rate notes, especially those issued by the best credit risk, in order to improve the quality of their balance sheets. They have been willing to accept a lower spread on floating rate notes than on loans in order to obtain what they regard as a more liquid and safer security and to maintain business ties with prime borrowers. In addition, U.S. savings and loan associations acquired floating rate notes to offset their money market deposits: and Japanese banks, until recently, may have purchased Eurodollar floating rate notes because these securities fell outside certain domestic regulatory guidelines applied to mediumterm loans.

Sovereign borrowers and commercial banks have been the major issuers of floating rate notes. Concerns about the quality of banks’ portfolios raised their funding costs in the 1980s, enabling those sovereign borrowers regarded as good credit risks to obtain funds from international bond markets at a lower cost and with longer maturity than were available by borrowing from banks. Bank issuance of floating rate notes has reflected attempts to secure longer-term funding, especially with regard to U.S. dollar funding from non-U.S. banks. In addition, where allowed by the supervisory authorities (e.g., in the United Kingdom and the United States), banks have also made extensive use of subordinated debentures as a means of raising capital funds.

Bond market activity has also been affected by the growing use of swaps. In 1984, interest rate and exchange rates swaps have been estimated to have reached $65 billion and $12–15 billion, respectively, amounting to a total volume three times greater than in 1983. Such transactions are a part of a continuing arbitrage of financial market conditions in different national and international financial markets, and they reflect the differing ability of borrowers to access the various markets.

Foreign Bond Markets

Although the Eurodollar bond market has expanded at a rapid rate in recent years, sales of foreign bonds denominated in U.S. dollars (colloquially known as “Yankee bonds” continued the decline first evident in 1981. In part, this reflected the efforts of international organizations, such as the World Bank, to lower their borrowing costs by relying less heavily on U.S. capital markets. Canadian entities, in particular public agencies, also reduced their issuance of U.S. dollar bonds from $2.5 billion in 1983 to $700 million in 1984. As a result, the share of “Yankee bonds” in total foreign bonds fell from 18 percent in 1983 to between 15 and 16 percent in 1984 and the first half of 1985.

While the value of Swiss franc foreign bonds rose in 1984, an approximately 19 percent depreciation of the Swiss franc relative to the U.S. dollar resulted in a small decline in the U.S. dollar value of these issues (from $13.5 billion in 1983 to $13.1 billion in 1984). Swiss franc issues, nonetheless, continue to represent the largest share of total foreign bonds (15 percent in 1984). As in 1983, Japanese firms were the most important issuers in this market, accounting for 44 percent of all issues. The activities of Japanese corporations were particularly evident in the convertible bond market where their issues of Swiss franc convertibles increased to nearly $3.8 billion in 1984 from $3.5 billion in 1983. Swiss franc issues by U.S. banks and corporations declined slightly from $1.3 billion in 1983 to $1.2 billion in 1984. Moreover, Swiss franc bond issues have often been associated with currency or interest rate swaps, especially as they relate to the Japanese yen. In the first half of 1985, the Swiss franc value of foreign bond issues was about 47 percent below that for the corresponding period in 1984.

Foreign bonds denominated in deutsche marks declined slightly from $2.6 billion in 1983 to $2.4 billion in 1984. Despite a rise in the deutsche mark value of foreign bonds (from DM 6.6 billion in 1983 to DM 7 billion in 1984), the U.S. dollar value of these issues declined in 1984 as the deutsche mark depreciated relative to the U.S. dollar. International organizations accounted for a significant share of foreign bonds issued in the Federal Republic of Germany. Japanese corporations were also particularly active in the public issuance market for convertibles and warrant attached bonds. Issue activity was especially heavy in the latter part of 1984 when secondary market yields on foreign deutsche mark bonds fell from 8.2 percent in July to 7.2 percent in January 1985. During late January and early February 1985, however, yields began to rise sharply when the deutsche mark came under pressure in the foreign exchange market. The capital markets subcommittee, therefore, closed the foreign deutsche mark market to new borrowing for three weeks ending in early March.

In May 1985, the authorities implemented a number of changes in regulations pertaining to the issuance of foreign bonds (and Eurobonds) in the Federal Republic of Germany. Since May 1, foreign bonds can take the form of floating rate notes and zero coupon issues. In addition, such bonds can be used as part of a swap transaction. Moreover, the capital markets subcommittee had its last regular meeting on April 12. Banks that are lead managers now inform the Bundesbank at the beginning of the month of the size and form of the new issues which they plan to bring to the market. Foreign deutsche mark-denominated bond issues may now be lead-managed by foreign banks incorporated in the Federal Republic of Germany.

Total issue volume in the deutsche mark market during the first half of 1985 nearly doubled the volume during the first half of 1984. Two floating rate notes were sold in early May, including a DM 1.5 billion issue by Sweden. In addition, there was a floating rate note issue of DM 500 million for Ireland and a swap-related floating rate note of DM 250 million by a French bank. Two zero coupon bond issues with a nominal value of DM 1.1 billion were also marketed, Malaysia sold a DM 100 million bond issue with a coupon of 7½ percent on a ten-year maturity; and The Bank of China raised DM 150 million through a bond issue with a coupon of 7 percent and a seven-year maturity.

Foreign bond issues in the Japanese yen rose from $3.9 billion in 1983 to $4.9 billion in 1984 (a 27 percent increase). In the period since 1980, the volume of these issues has more than tripled. Borrowers from all major industrial countries, some East European countries, international organizations, and developing countries obtained funds by the issuing of either public (Samurai) bonds or by private placements.

While industrial country borrowers tend to dominate in most other markets, international institutions accounted for approximately 30 and 38 percent of foreign bond issues in the Japanese market in 1984 and early 1985, respectively, and developing countries represented approximately 25 percent of issues. China was the largest developing country borrower in early 1985, but Malaysia and Korea also raised substantial amounts.

Low and stable interest rates on Japanese markets have helped to attract borrowers, while the yen’s relative stability against the U.S. dollar helped to make these bonds attractive for investors. During 1984 and 1985, the Japanese authorities also undertook a series of measures designed to liberalize the foreign bond market, including a reduction in the required credit rating for foreign governments and official agencies borrowing on the Japanese market from AAA to AA, and further to A.

Activity in other foreign bond markets in 1984 was generally little changed from that in 1983, although foreign bond issues denominated in the pound sterling rose from $0.9 billion in 1983 to $1.6 billion in 1984.

Although the Swiss market has continued to account for the largest portion of total foreign bond issues, its share declined from 50 percent in 1983 to 47 percent in 1984, and 46 percent in the first half of 1985. The rapid increase in issuance activity in the Japanese foreign bond markets gave that market the second largest share (18 percent in 1984 and 23 percent in the first half of 1985). Activity in the foreign bond markets in the United States had the third largest share (15 percent in 1984 and 16 percent in the first half of 1985). Foreign bonds issued in the Federal Republic of Germany represented 9 percent of total foreign bonds in 1984 and 6 percent in the first half of 1985.

Eurobond Markets

During the past five years, Eurobond issues have expanded at an average annual rate of 34 percent, and the growth was even more rapid in 1984, at 63 percent, In the first half of 1985, Eurobond issues expanded at a rate which would imply a 61 percent growth for 1985. The issuance of Eurobonds denominated in all currencies expanded, but bonds denominated in the U.S. dollar continue to account for 80 percent of all Eurobond issues and approximately two thirds of all international bond issues.

For the second successive year, the volume of U.S. dollar Eurobonds issued in 1984—floating rate notes, straight bonds, and convertible bonds—exceeded by over $10 billion the total issues of U.S. domestic corporate bonds. Throughout this period, interest rate and exchange rate developments strongly affected the level of activity in the Eurodollar markets. As Eurobond yields rose from 12 percent in January and February 1984 to nearly 14 percent in July, issue volume fell from an annual rate of $65 billion to $50 billion. When U.S. money market rates began to decline in the early fall and the U.S. dollar showed strength on foreign exchange markets, however, there was a sharp increase in issuance activity (to an annual rate of $90 billion in the August-December period). This increase in Eurodollar bond market activity was also stimulated by the repeal by the United States of its 30 percent withholding tax on interest payments to foreign holders of U.S. bonds and by legal changes which made it possible for U.S. corporations to issue directly debt obligations on the Eurodollar market in bearer form.

One important aspect of the rapid expansion in Eurodollar issues has been the growing importance of floating rate notes relative to straight debt issues. Although straight debt issues expanded from $17.2 billion in 1983 to $25.4 billion in 1984, their share of Eurodollar bond issues fell from 44 percent in 1983 to 39 percent in 1984. In contrast, floating rate notes accounted for 50 percent of all Eurodollar bond issues in 1984; their issuance increased from $17.9 billion in 1983 to $32.8 billion.

The deutsche mark represented the second most heavily used currency of denomination in the Eurobond markets. Issues of Euro-deutsche mark bonds rose from $4 billion in 1983 to $4.3 billion in 1984. However, the share of Euro-deutsche mark bonds in total Eurobonds fell to 5,3 percent, the lowest share since 1981. The share of deutsche mark-denominated bonds in the first half of 1985 amounted to 5.6 percent of total Eurobonds. As noted earlier, however, the liberalization of German bond markets that occurred in May 1985 has had a significant impact on the recent volume of international bonds denominated in deutsche marks.

The third most heavily used currency of denomination in 1984 in the Eurobond markets was the pound sterling, which was used for 4.8 percent of Eurobond issues. Euro-sterling bond issues increased from $2.2 billion in 1983 to $4 billion in 1984. Nearly a quarter of these issues were made by borrowers from the United Kingdom, although entities from the United States, France, and Canada were also active. Despite the issuance of $2.5 billion Euro-sterling bonds in the first half of 1985, the share of sterling issues in total Eurobond issues fell to 4 percent.

Although Eurobonds denominated in ECUs were first issued in 1981, these issues reached $2.9 billion in 1984 and constituted 3.6 percent of all Eurobond issues. In the first half of 1985, moreover, there were $3.2 billion of ECU issues, which made the ECU the third most heavily used currency of denomination. The ECU bond has been used by a variety of borrowers, including EEC official institutions, sovereign borrowers in the European monetary system (such as France, Italy, and Ireland), international organizations (such as the World Bank), and European, Japanese, and (to a more limited extent) U.S. banks. Banks have often increased their issuance of ECU bonds to fund their growing holdings of ECU-denominated assets. Investors have been attracted to the ECU in part by a relatively high nominal yield and by the fact that the ECU underlying basket of currencies does not include the U.S. dollar. In addition, some European investors have been affected by the more favorable treatment that ECU-denominated bonds have received under exchange regulations and capital controls in some European countries.

Table 19.Developing Country Gross Issues and Placements in International Markets, 1979–First Half of 19851(In millions of U.S. dollars)
1979198019811982198319841985 1st half
Algeria182.8500.0
Argentina416.6163.9195.3
Bahrain30.0100.0150.0
Bermuda60.0
Brazil735.6316.260.8100.9
Chile83.582.230.0
China44.520.581.7246.5
Colombia55.020.035.015.0
Costa Rica109.3
Côte d’lvoire14.3
Egypt65.040.050.0
Gabon33.2
Greece30.050.041.6200.8464.1
Haiti8.0
Hong Kong123.871.762.8185.6
Hungary50.020.040.5195.5
India30.0281.7185.060.0297.6180.0
Indonesia62.745.896.5363.1365.750.0
Israel200.0130.0117.0110.0135.0
Korea43.647.8322.8141.7546.81,056.0758.6
Kuwait25.0110.050.0
Malaysia152.4816.8884.61,141.2893.1
Mexico363.0353.52,344.11,602.5
Morocco21.823.2
Panama110.725.021.020.0
Papua New Guinea20.6
Peru25.0
Philippines176.266.868.530.0
Portugal30.020.0183.376.2389.4177.0
Saudi Arabia14.7200.0
Singapore25.055.6125.070.0
South Africa243.636.592.0314.1532.51,013.9691.6
Sri Lanka11.3
Thailand176.245.998.762.5253.5283.3540.6
Trinidad and Tobago50.0107.428.6
Tunisia60.020.3
United Arab Emirates25.0
Venezuela173.6131.5290.835.0
Yugoslavia96.337.2
Other29.754.979.4145.639.821.019.1
—————————————————————
Total3,316.02,149.04,427.04,696.03,275.05,264.04,935.0
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Foreign bonds and Eurobonds.

Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Foreign bonds and Eurobonds.

The liberalization of the Euro-yen bond market in 1984–85 was discussed in Section II of this paper. Notably, it included easing of the guidelines on eligible resident and nonresident issuers, permission to make swap-related issues, and abolition of the withholding tax for nonresident purchasers of Japanese corporate issues.

There was a sharp distinction between the issuance activity in the Euro-yen bond market before and after the financial market liberalization which took place in late 1984. The pace of Euro-yen issues has accelerated sharply in the wake of these liberalization measures. Euro-yen bond issues rose from only $0.2 billion in 1983 to $1.2 billion in 1984, with $464 million of these issues in December 1984 alone. This market continued to expand to $1.9 billion in the first half of 1985. Recently, foreign borrowers have also issued ECU-and U.S. dollar-denominated instruments on the Japanese market.

Maturities

There has been considerable diversity of maturities across the international bond markets on the basis of currency of denomination in the period since 1981. In the U.S. dollar market, there has been a general decline in the proportions of short-term (0–5 years) and medium-term (6–10 years) maturities and an increase in the proportion of long-term (over 10 years) bonds. In part, this reflects the growing importance of floating rate note issues, whose maturities are currently much longer than those typically available through the fixed interest rate markets. In contrast, in the markets for borrowings in Japanese yen, pound sterling, and Netherlands guilder, there has been a shift from longer-term bonds to medium-term issues (Table 43).

Developing Country Access

Most developing countries currently have very limited access to international bond markets. Although bond issues by developing countries rose from $3.3 billion in 1983 to $5.3 billion in 1984, the share of developing country bonds in total bonds fell from 9 percent in 1981 to 5 percent in 1984 (Table 19). Only those developing countries regarded as the best credit risks have been able to access these markets. The four largest developing country issuers typically accounted for 67 percent to 80 percent of all developing country issues in each of the years between 1982 and 1984. In the first half of 1985, six developing countries (Algeria, China, Greece, Korea, Malaysia, and Thailand) accounted for approximately 70 percent of all developing country issues.

These limitations on entry into international bond markets have persisted despite the continued servicing of principal and interest on outstanding bonds by almost all developing countries. This servicing record has, nonetheless, had a strong impact on the differentials between yields on developed and developing country bonds in the secondary markets for bonds denominated in deutsche marks (Chart 10). Although the differentials between the yields on developed and developing country bonds had reached levels ranging from 6 to 10 percentage points in the period following the emergence of the external payment difficulties for many developing countries, they declined to less than 2 percentage points by the beginning of 1985. A similar pattern of yield differentials has also been found for U.S. dollar-denominated bonds.32

Chart 10.Yield Differentials on Deutsche Mark-Denominated Public Bonds Issued by Nonresidents, 1982–851

(In percent)

Source: Deutsche Bundesbank.

1 These differentials equal the yield on the bonds of the individual developing countries or the average for all developing countries and minus the average yield on bonds for industrial country entities other than bonds issued by German residents.

2 As defined by the Deutsche Bundesbank.

3 Since 1983, excluding southern European countries, particularly Spain.

International Issuance Facilities

The rapid increase in the volume of international issuance facilities is one of the key changes that have taken place recently in international markets. Long-term international bank facility commitments (excluding those that were merger-related) amounted to almost $29 billion in 1984, in comparison with less than $10 billion in 1983 and $5.5 billion in 1982. In the first half of 1985, these commitments proceeded at an annual rate of $40 billion (Table 20). The central feature of these arrangements is the rapid development of an international market in short-term securities. Back-up facilities for Euronotes and commercial paper rose from less than $4 billion in 1983 to $12 billion in 1984 and $22 billion in the first half of 1985 (at an annual rate).

The market for such facilities is in a phase of rapid evolution. Increasingly complex financial packages are being created, as reflected in the increase in the volume of “multiple component facilities” from $7.7 billion in 1984 to $11.3 billion, at an annual rate, in the first half of 1985. These facilities allowed the issuance of Euronotes or use of short-term bank advances by competitive bidding, against a range of funding bases and currencies. In contrast, the volume of other facilities of a more traditional nature (e.g., bankers’ acceptances) has not increased substantially during the period.

Table 20.International Facility by Type of Use, 1982–85(In billions of U.S. dollars)
19821983198419851
Euronotes2.20.88.815.8
Commercial paper0.23.13.55.9
Certificates of deposit0.72.81.11.8
Bankers’ acceptance2.01.85.82.4
Multiple component facilities7.711.3
Other instruments0.31.01.92.7
Merger-related standbys4.026.5
————————
Total5.513.555.339.8
Source: Organization for Economic Cooperation and Development, Financial Market Trends.

January-June at annual rates.

Source: Organization for Economic Cooperation and Development, Financial Market Trends.

January-June at annual rates.

Table 21.International Facility by Borrower, 1982–851(In billions of U.S. dollars)
19821983198419852
OECD countries3.38.622.036.8
Eastern European countries0.10.10.3
OPEC countries0.50.30.51.2
Other developing countries1.30.45.71.8
Other0.20.10.3
————————
Total5.59.528.839.8
Source: Organization for Economic Cooperation and Development, Financial Market Trends.

Excluding merger-related standbys.

January-June at annual rates.

Source: Organization for Economic Cooperation and Development, Financial Market Trends.

Excluding merger-related standbys.

January-June at annual rates.

As indicated in Table 21, most borrowers using these facilities have come from within the OECD area. Highly regarded U.S. corporations used such facilities to back up commercial paper programs or the issuance of Euronotes. In addition, there was a strong demand for such facilities by corporations which had not previously borrowed extensively in international markets. Official borrowers using these facilities have included Indonesia, Oman, Portugal, and Sweden. The users of international facilities have thus been governments and governmental agencies, corporations, bank holding companies, and banks of countries with a generally high credit standing. Although financial institutions were the principal users of note issuance facilities (to obtain stand-by funds) during 1983, non-bank corporations and governments were the most active participants in these markets during 1984 and the first eight months of 1985. During 1984, corporations and governments each accounted for roughly 40 percent of announced note issuance facilities, while during January to August 1985, corporations became the most active users of these facilities, arranging nearly 70 percent of new facilities.

Borrowers using such facilities have paid relatively low fees and have generally obtained funds at a lower cost than that associated with either syndicated loans or floating rate notes. The size of the potential differential in borrowing costs can be illustrated by the spread between the yields on U.S. commercial paper and LIBOR (Chart 11). Despite relatively low fees, many banks have been active participants in the underwriting of note issuance facilities. As in the case of floating rate notes, a high proportion of the short-term notes is held by bank portfolios. Nonetheless, leading arrangers of these facilities report an increasing market for notes outside the banking system. Holders reportedly include insurance companies, investment trusts, corporations, and central banks.

Chart 11.Eurodollar and U.S. Commercial Paper Interest Rates, January 1983–September 19851

(In percent)

Sources: Board of Governors of the Federal Reserve, Statistical Release H. 15 (for commercial paper); and Bank of America (for LIBOR).

1 Six-month maturities.

2 London interbank offered rate.

While the market for back-up facilities is in a phase of rapid growth, the use of these facilities is believed to have been below that of other forms of financial commitments. For many borrowers, back-up facilities may not actually involve any drawdown of funds. Data are not available concerning the issuance of notes under these facilities, but it is estimated that private sector borrowers have, by mid-1985, made issues amounting to 10–20 percent of facilities. In contrast, sovereign borrowers have tended to use these facilities as a substitute for syndicated loans, and have issued notes equivalent to a substantial proportion of their facilities.

Table 22.Capital-Importing Developing Countries: Financing of Current Account Deficit and Reserve Accumulation, 1977–84(In billions of U.S. dollars)
19771978197919801981198219831984
Market borrowers
Current account deficit19.532.830.336.572.774.729.47.2
Reserve accumulation6.110.618.217.4−2.7−25.14.018.5
Financing25.643.448.553.970.049.633.425.7
Direct investment4.56.47.87.411.310.67.47.7
Official transfers0.81.01.21.31.81.92.22.1
Long-term borrowing from official creditors, net5.46.55.17.58.48.014.412.3
Other net external borrowing22.236.141.656.979.250.110.39.0
Other sources1−7.3−6.6−7.2−19.2−30.7−21.0−0.9−5.4
Official borrowers
Current account deficit8.411.012.116.019.017.615.716.3
Reserve accumulation1.90.70.80.5−0.2−1.00.8−0.9
Financing10.311.712.916.518.816.616.515.4
Direct investment0.70.60.60.20.90.50.40.4
Official transfers4.23.96.17.07.47.26.56.2
Long-term borrowing from official creditors, net2.83.86.38.59.79.07.47.3
Other net external borrowing2.92.50.90.5−1.4−2.11.71.9
Other sources1−0.30.9−1.00.32.22.00.50.6
Source: International Monetary Fund, World Economic Outlook, October 1985: Revised Projections by the Staff of the International Monetary Fund.

Includes errors and omissions.

Source: International Monetary Fund, World Economic Outlook, October 1985: Revised Projections by the Staff of the International Monetary Fund.

Includes errors and omissions.

Foreign Direct Investment and Official Flows

As a result of the sharp slowdown in the growth of international bank lending to developing countries and this group’s limited access to international bond markets, foreign direct investment and official flows have come to play an increasing role in financing of current account deficits and reserve accumulation of developing countries. This trend is shown in Table 22 along with the financing requirements of two major groups of capital-importing countries, the market borrowers, and the official borrowers.

For the market borrowers, the sum of their current account deficits and reserve accumulations during 1973–84 reached a peak of $70 billion in 1981, but has declined to $26 billion in 1984 despite extensive reserve accumulation. While other net external borrowing accounted for 113 percent of the financing requirement of 1981, this type of borrowing accounted for only 31 and 35 percent of the borrowing requirements in 1983 and 1984, respectively. In contrast, direct foreign investment flows represented only 14 percent of the borrowing requirement in 1980, but subsequently increased to 30 percent in 1984. Nonetheless, such investment flows have fallen in absolute amount from $11 billion in 1981 to less than $8 billion in 1984.

The position of the official borrowers has been significantly different from that of the market borrowers. Other net external borrowings accounted for the largest proportion of the sum of current account deficits and reserve accumulations when they represented 28 percent in 1977. However, there has been a net repayment of these borrowings in 1981 and 1982. Foreign direct investment flows have also represented only a small proportion of the financing requirement for this group of countries. In contrast, official transfers and lending have represented at least 84 percent of their financing requirement since 1979.

While the World Economic Outlook, October 1985, projects a recovery of foreign direct investment in 1985–86 (from $10 billion in 1984 to $12 billion in 1986 for all capital-importing countries), official lending and transfers to this group are anticipated to fall from $40 billion in 1984 to $38 billion by 1986. This will encompass an increase in official transfers from $14 billion in 1984 to $17 billion in 1986 but a decline in official lending from $26 billion to $22 billion in the same period.

International bonds consist of foreign and Eurocurrency bonds. Foreign bonds arc issued by a borrower who is of a nationality different from the country in which the bonds are issued. Such issues are underwritten and sold by a group of banks of the market country and are denominated in that country’s currency. In contrast, Eurocurrency bonds are those underwritten and sold in various national markets simultaneously usually through international syndicates of banks.

The earlier stages of this recovery were discussed extensively in International Capital Markets: Developments and Prospects. 1983, Occasional Paper No. 23 (Washington: International Monetary Fund, July 1983), pp. 40–44 and International Capital Markets: Developments and Prospects, 1984, Occasional Paper No. 31 (Washington: International Monetary Fund, August 1984), pp, 45–49.

See D. Folkerts-Landau, “The Changing Role of International Bank Lending in Development Finance,” Staff Papers, International Monetary Fund (Washington, March 1985), Vol. 32, No. 2, pp. 317–363.

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