WEEKAHEAD-Emerging debt seen rising despite war risks

Reuters, 03.30.03, 5:05 PM ET By Hugh Bronstein NEW YORK, March 30 (Reuters) - Investors are expected to buy high-yielding emerging market bonds this week in a bid to ride out the war in Iraq, which has weakened other markets. "Emerging markets will be bullish while people hunt for yield and while the stock markets realign themselves with the reality that this war is going to be longer than people thought it would be," said Walter Molano, head of research at BCP Securities. U.S. aircraft kept up relentless pressure on Iraqi positions in and around Baghdad on Sunday as U.S. military leaders fended off growing criticism of their war plans and insisted the campaign was still on course. While stock markets have trembled in fear that the war will kick off a global economic downturn, emerging bonds have rewarded holders with total returns of 7 percent since Jan. 1. Brazil, which makes up more than 22 percent of the benchmark JP Morgan Emerging Markets Bond Index Plus, has shot 20.16 percent higher following a weak 2002. At 1,032 basis points over Treasuries, Molano said, Brazil was still "one of the cheapest assets out there." If Brazilian spreads narrow beneath 1,000 basis points, indicating a reduction in risk, analysts said they expect the country may want to issue new bonds. "The question for Brazil is the timing of reentry to the capital markets," said Siobhan Manning, Latin American debt strategist at Caboto, the Italian investment bank. "The market is held hostage to events in Iraq but resilient as investors look for a safe haven that offers yield," she added. Brazil C bonds <BRAZILC=RR> ended last week at a bid of 79, having recouped last year's losses. "We're days away from the C bond hitting 80," Molano said. "It could be this week." Brazilian spreads started 2002 trading at 830 basis points over U.S. Treasuries before blowing out to a high of 2,436 in late September, just before leftist candidate Luiz Inacio Lula da Silva won the October presidential election. Wider spreads reflect the perception of increased risk as measured against U.S. Treasury bonds. Since winning the presidency, Lula has pleasantly surprised investors by appointing a market-friendly cabinet and embracing fiscal austerity, seen by Wall Street as necessary for Brazil to shoulder its mountainous debt load. MARKET HOLDS UP DESPITE WAR Faced with much stronger-than-expected opposition from forces loyal to Iraqi President Saddam Hussein, U.S. troops dug in south of Baghdad on Sunday, apparently in no rush to assault the Iraqi capital until air strikes and artillery had ground down its defenders. "I've been impressed by the relative stability of emerging markets in a wartime situation," said Daniel Tillotson, an emerging markets analyst at Prudential Securities. One potential trouble spot, analysts agreed, is Venezuela, whose government last week said it planned to offer a voluntary debt swap during the second quarter of this year in a bid to lengthen bond maturities. Venezuela is facing a severe fiscal crunch after a two-month strike staged by opponents of leftist President Hugo Chavez who accuse him of trying to set up a Cuban-style authoritarian state. Investors are left to balance the longer-term economic risks against evidence that Venezuela is increasing its post-strike oil production. Oil exports account for around half of government revenues. "Chavez is trying to exert more control within a nominally democratic framework," said Mark Dow, a portfolio manager at MFS Investment in Boston. "I don't see how he can continue to regulate the economy without an eventual collapse." Venezuelan total returns are down nearly 6 percent so far this year.