AI Debt Binge Risks Crowding Out EM Nations From Global Markets

The debt binge to finance artificial intelligence infrastructure is pitting governments against technology giants in a competition for capital.

That’s driving up borrowing costs for developing nations, with yields already under pressure due to geopolitical concerns, elevated oil prices and higher policy rates, according to Bank of America Corp. strategists.

The average yield on emerging-market dollar bonds has soared almost a percentage point this half to the highest since April last year. Governments seeking to refinance maturing debt may find that a challenge, according to Merveille Paja, a sovereign credit strategist for Eastern Europe, Middle East and Africa at BofA.

Just two tech giants — Amazon.com Inc. and Alphabet Inc. — have already issued the equivalent of about $70 billion of debt so far this half, according to data compiled by Bloomberg. By contrast, eurobond issuance by emerging-market sovereign borrowers is down by half to $45 billion since July 1, compared with $91 billion in the same period last year.

Among investment-grade emerging-market countries, issuance has declined 56% to $29 billion. There haven’t been any sales so far in October.

“The risk that hyperscalers actually are crowding out emerging markets really is a risk for our asset class,” Paja said in an interview. With global financial conditions tightening, the rise in yields could hurt borrowers waiting for a better opportunity to refinance, she said.

Developing-nation borrowers have about $27.7 billion of dollar- and euro-denominated external debt coming due by year-end, according to data compiled by Bloomberg. Saudi Arabia with $5.2 billion and Turkey with $3 billion have the largest refinancing needs.

Globally, AI-driven debt issuance has already exceeded $445 billion this year, according to Bloomberg calculations. The trend is expected to intensify, with hyperscaler borrowing seen rising to as high as $500 billion next year, according to Bloomberg Intelligence. Elon Musk’s SpaceX is in talks with banks and investors to raise $40 billion to buy chips from Nvidia Corp., Bloomberg reported. That could include $30 billion in investment-grade bonds debt.

Read more: AI Is Driving Up Treasury Yields: ‘It Just Touches Everything’

Bond investors are having to pick between higher-yielding debt from the immensely profitable AI-linked companies or emerging-market sovereigns which have been hard hit by the ongoing US-Iran war and rising US Treasury yields. EM sovereign debt offered as little as 1.5 percentage points on top of US debt in June, roughly half of its five-year average premium, according to a Bloomberg index.

Still, the impact has been nuanced between countries with the tightest spreads versus those with a wider risk premium. Investment-grade emerging markets are most at risk of higher borrowing costs as they compete against similarly rated hyperscalers.

“Some pressure has materialized among the tightest-trading investment-grade sovereign issuers,” said Micah James, global head of emerging-markets research at Vanguard. “Investors can more easily substitute between highly-rated EM sovereign debt and investment-grade technology issuers.”

Read more: Emerging Markets Better Armed for Renewed Europe Debt Fears

The competition for capital and ever larger public deficits in the US and Europe as well as increased financing needs of the developing world push investors to be more selective as the era of low rates comes to an end. That could even work in favor of high-quality emerging-market issuers, according to Eoghan McDonagh, lead portfolio manager for EM debt at Allianz SE.

“For us, it is not an either/or situation of picking an EM or a hyperscaler bond,” McDonagh said. “We monitor the spread between the two, to help judge when valuations are attractive. There has been good demand from US accounts who have been using EM sovereign investment-grade names as a diversifier from some of their hyperscaler exposure.”

But governments struggling with weak growth and high debt may have to pay up to borrow more, said Edouard Carmignac, chairman and chief investment officer of Carmignac, which has backed Mistral, SpaceX and Revolut in fundraising.

“When money becomes expensive again, choosing becomes essential,” he said. “Scarcer money favors the most promising companies, particularly those harnessing augmented intelligence, while crowding out governments suffering from fiscal incontinence.”