Determinants of emerging market bond spread : do economic fundamentals matter?

In the 1990s international bond issues from developing countries surged dramatically, becoming one of the fastest-growing devices for financing external development. Their terms have improved as institutional investors have become more interested in emerging market securities and better economic prospects in a number of developing countries. But little is known about what determines the pricing and thus the yield spreads of new emerging market bond issues. The author investigates what determines bond spreads in emerging markets in the 1990s. He finds that strong macroeconomic fundamentals in a country -- such as low domestic inflation rates, improved terms of trade, and increased foreign assets -- are associated with lower yield spreads. By contrast, higher yield spreads are associated with weak liquidity variables in a country, such as a high debt-to-GDP (Gross Domestic Product) ratio, a low ratio of foreign reserves to GDP, a low (high) export (import) growth rate, and a high debt-service ratio. At the same time, external shocks -- as measured by the international interest rate -- matter little in the determination of bond spreads. In the aggregate, Latin America countries have a negative yield curve.