After six years, key emerging bond index sliding back to junk

LONDON, March 10 (Reuters) - A steady deterioration in emerging market credit quality is pushing the collective rating on the sector's most widely used debt benchmark back towards junk, six years after it rose out of that category.

JPMorgan (LSE: JPIU.L - news) , which runs the EMBI Global Diversified index of sovereign dollar bonds from developing countries, said that based on the ratings from two of the three main ratings agencies the index would already be considered junk, or sub-investment grade.

Fitch and Standard (Other OTC: SNDH - news) and Poor's rate the EMBIG at BB-plus but Moody's still has it on the lowest investment grade category, Baa3.

"The EMBIG Diversified is at risk of losing its last remaining investment grade rating if Moody's were to downgrade approximately 7 percent of the index by one notch," JPM told clients in a note sent sent late on Wednesday.

While many conservative funds are barred from investing in junk-rated securities, a slideback to junk for the index as a whole is largely symbolic.

But it would deal a fresh blow to emerging markets' already battered image, with huge capital outflows, rising debt ratios and a rise in borrowing costs all pressuring the asset class.

All this has led to dozens of ratings cuts, with 34 sovereign downgrades in 2015 compared with 18 upgrades. The most significant were Brazil, Russia, South Africa and Kazakhstan, all of which comprise a sizeable chunk of the index.

This year has already seen 10 downgrades and only one upgrade in emerging markets.

Moreover, 27 of the 65 countries in the EMBIG index are on the negative rating outlook of one or more rating agencies, indicating a downgrade is likely, JPM added.

South Africa's rating, for instance, is expected to fall to junk later this year.

The average yield spread on the EMBIG Diversified index - the premium over U.S (Other OTC: UBGXF - news) . Treasuries that investors demand to hold emerging debt - is around 420 basis points (bps) compared to just under 300 bps in January 2010, when JPMorgan announced the index had shed junk status.

It (Other OTC: ITGL - news) had 39 constituents at the time, but since then a host of issuers have debuted, including lowly-rated sub-Saharan African and Central American countries.

"We have seen credit erosion in emerging debt indexes and this has happened along with a big boom in issuance," said David Spegel, head of global EM strategy at ICBC Standard Bank.

"The over-reliance on debt capital relative to equity eroded issuers' underlying credit quality and the commodity price collapse accelerated the process." (Reporting by Sujata Rao; Editing by Ruth Pitchford)