WHEN Hillary Clinton was US secretary of state she once paid a trip to China to deliver an important message to the country’s bondholders.

“We are truly going to rise or fall together,” she said in Beijing in 2009. “By continuing to support American Treasury instruments, the Chinese are recognising our interconnection.”

Foreign governments, companies and individuals own nearly half of US public debt, and China, with its $1.3tn stake, is the largest foreign owner of them all.

Not that this is a trend limited to the world’s biggest bond market.

Following the financial crisis, overseas investors increased their holdings of British government bonds to become the largest holders of UK gilts, allowing the country to keep funding costs down in spite of rising issuance.

Overseas demand can cut the cost of borrowing but leave a country more vulnerable

A few years ago bank analysts began sounding warning bells about the inflows of overseas money into Australian government bonds, which had pushed foreign ownership above 80pc of the outstanding debt.

Larger foreign participation in a government’s debt tends to be highly welcome during stable times, when the extra demand pushes up prices and pulls down yields - making it cheaper for the country to borrow money.

But in times of trouble the shift can leave a country more vulnerable. Overseas investor money is slippery and shifting inflows can affect borrowing costs and refinancing abilities.

In emerging markets, the development of local currency bond markets has helped cut external vulnerabilities and currency mismatches associated with borrowing in dollars, sterling or euros. But because so much of the debt is held overseas, the markets are just as exposed to changes in sentiment.

Research by the World Bank released this summer puts foreign ownership of Peruvian local bonds at about 60pc - up from 30pc in 2007. In Indonesia the share has risen from 16pc to a third, while in Hungary it has risen from 30pc to 36pc.

“The size of direct participation of foreign investors in local markets needs to be monitored,” the World Bank said.

Emerging market debt has been gobbled up by international investors as debt yields in their own countries remain at or near post-crisis lows.

International Monetary Fund economists Serkan Arslanalp and Takahiro Tsuda estimate $1tn was pumped into EM government bonds by global investors between 2004 and June 2013, with institutional investors making their presence felt particularly in Peru, Uruguay, Mexico, Lithuania and Hungary.

This can be a good thing, says James Barrineau, of emerging market debt at Schroders. Rising foreign bondholder levels indicate a country has a sufficiently sound and transparent system.

Changing investor bases can also have a positive impact on yields. The IMF estimated that when non-resident investors increase holdings of government debt 10 percentage points there is an associated fall in the yield on 10-year bonds (the benchmark used for government bonds) of up to 43 basis points.

On the other hand, countries with high levels of debt and a current account deficit that makes them reliant on capital inflows from overseas, plus a large non-domestic investor base, can face more pressure than those whose bonds are held by several domestic investors.

“In a stressed market the ownership dynamics of debt is something investors think about because it can induce more volatility. In September this year when emerging market debt experienced a bump in the road, the markets with higher levels of foreign ownership saw greater outflows,” says Mr Barrineau.

In some countries, such as Ukraine, a small number of foreign owners can hold a large stake in the country’s debt, meaning a shift in thinking by one overseas bondholder can affect the rest.

Whatever the concerns, the trend is not going away, says Pierre-Yves Bareau, EM debt head at JPMorgan Asset Management. “The world is interconnected to a far greater degree. There is global demand for every asset class in every country. That means more capacity for outflows but it’s also not something that is restricted just to emerging market debt.”

Published in Dawn, Economic & Business, October 13th, 2014