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Feeling green
Debt-ridden emerging markets are heading for a nasty dollar hangover
Mar 21st 2015 | From the print edition
IN THE world of economics, one policymaker towers above all others. The head of
America s central bank, Janet Yellen, presides over a $17 trillion economy. The
empire of her nearest competitor, Mario Draghi, amounts to a relatively puny
$10 trillion. On top of this, the dollar s global role means Ms Yellen has a
huge impact abroad, influencing more than $9 trillion in borrowing in dollars
by non-financial companies outside America more than enough to buy all the
firms listed on the stock exchanges of Shanghai and Tokyo (see chart 1). As the
dollar strengthens both in response to healthier growth in America and in the
expectation that the Federal Reserve is getting ready to raise rates, this
burden is becoming harder to bear.
Dollar borrowing is everywhere, but the biggest growth has been in emerging
markets. Between 2009 and 2014 the dollar-denominated debts of the developing
world, in the form of both bank loans and bonds, more than doubled, from around
$2 trillion to some $4.5 trillion, according to the Bank for International
Settlements (BIS). Places like Brazil, South Africa and Turkey, whose exports
fall far short of imports, finance their current-account gaps by building up
debts to foreigners.
Even countries without trade gaps have been borrowing heavily. With interest
rates on American assets so meagre a five-year Treasury bond pays just 1.5%
those with dollars to invest have sought out more rewarding opportunities.
Firms based in emerging markets seemed to fit the bill. Some are big names:
state-owned energy giants like Russia s Gazprom and Brazil s Petrobras have
been issuing dollar bonds via subsidiaries based in Luxembourg and the Cayman
Islands. Others are smaller. Recent months have seen Lodha group, an Indian
property developer, Eskom, a South African power generator, and Yasar, a
Turkish firm that makes TV dinners, sell dollar-denominated bonds. By borrowing
dollars at several percentage points below the prevailing interest rate in
their domestic currency, CEOs have pepped up profits in the short term.
But finance rarely offers a free lunch. The worry is that tumbling energy
prices mean firms like Gazprom and Petrobras now have much lower dollar income
than expected when they took on debts. Others, such as Lodha, Eskom and Yasar,
have few dollar earnings. Taking on debt just before a shift in exchange rates
can be painful. In 2010 a Turkish firm borrowing $10m via a ten-year bond with
a 5% coupon could expect to pay 22.5m lira ($15m) over the life of the bond.
But the lira is down 43% against the dollar since then (see chart 2); the
payments are now over 39m lira.
Where foreign debts and earnings line up there is little reason to worry. Asian
firms foreign-currency debts tripled from $700 billion to $2.1 trillion
between 2008 and 2014, going from 7.9% of regional GDP to 12.3%, according to
economists at Morgan Stanley, a bank. To see whether the surge was bearable,
the economists looked at the accounts of 762 firms across Asia. The findings
were reassuring: on average 22% of their debt is dollar-denominated, but so are
21% of earnings. Although Asian firms are a big part of the emerging-markets
borrowing binge, on the whole they seem well placed to cope with a rising
dollar.
Yet there are still two reasons to worry. First, the outlook for China is a
puzzle. The country holds $1.2 trillion in Treasury bills, many of which are
sitting in its sovereign-wealth fund. When the dollar rises, the fund gets
richer. But even in a dollar-rich country, there can be pockets of pain. China
s firms have built up a nasty currency mismatch. Almost 25% of corporate debt
is dollar-denominated, but only 8.5% of corporate earnings are. Worse, this
debt is concentrated, according to Morgan Stanley, with 5% of firms holding 50%
of it.
Chinese property developers are the most obviously vulnerable. Companies like
Evergrande, China Vanke and Wanda build and sell offices and houses, so most of
their earnings are in yuan. Banned from borrowing directly from banks, they
have been active issuers of dollar bonds. They have also borrowed from trust
companies, according to Fitch, a rating agency. The trusts are themselves
highly leveraged and have borrowed dollars via subsidiaries in Hong Kong. This
arrangement will amplify the economic pain if property prices in China continue
to decline, as they have been doing for several months.
The second problem is that whole economies, rather than just the corporate
sector, look short of dollars. In Brazil and Russia, for instance, bail-outs of
firms lacking greenbacks are blurring the lines between the state, banks and
big companies. The general scramble for dollars has contributed to the plunge
of the real and the rouble. Others could follow this path. Turkey s dollar
borrowing has grown rapidly since 2009: in addition to the debts Turkish firms
have taken on, the state s external debt has grown to almost 50% of GDP, far
above the average for middle-income countries (23%). South Africa looks
worrying too: its current-account deficit is the widest of any big emerging
market, and the government s external debt is 40% of GDP.
A wave of defaults would be unlikely to cause problems as widespread as the
subprime crisis of 2008. Most bonds are owned by deep-pocketed institutional
investors such as pension funds and insurers. The banks that have made loans
face far tougher regulation than they did eight years ago and are generally far
better capitalised. An emerging-market rout would not cause another Lehman
moment. But it would mean big job losses at stricken firms. As investors
reprice risk it would probably also lead to a sudden tightening of credit. In
countries like South Africa or Turkey, where growth is evaporating fast, that
could still be very painful.
From the print edition: Finance and economics