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2016-03-08 12:20:00
Why borrowing in dollars is central to the business cycle in developing
countries
Mar 5th 2016
OIL PRICES have perked up a bit, but producers are still reeling from the slump
in crude prices last year. The boss of Pemex, Mexico s state-owned oil firm,
said this week that the company faced a liquidity crunch . Malaysia s state
oil firm is laying off workers. Petrobras, Brazil s troubled oil giant,
recently secured a $10 billion loan from the China Development Bank to help it
to pay off maturing bonds. The trouble at these firms underlines broader
concerns about the burden of corporate debt in emerging markets. A particular
worry for resources firms is the rising cost of servicing dollar debts taken
out when the greenback was much weaker than it is now. Short-term dollar loans
to be repaid with earnings in falling currencies featured prominently in past
emerging-market crises. But the concern about the role of dollar lending in the
current cycle is different.
The numbers are startling. Corporate debt in 12 biggish emerging markets rose
from around 60% of GDP in 2008 to more than 100% in 2015, according to the Bank
for International Settlements (BIS). Places that experience a rapid run-up in
debt often subsequently endure a sharp slowdown in GDP (see article). An extra
twist is that big emerging-market firms were for a while able to borrow freely
in dollars. By the middle of last year, the stock of dollar loans to non-bank
borrowers in emerging markets, including companies and government, had reached
$3.3 trillion. Indeed until recently, dollar credit to borrowers outside
America was growing much more quickly than to borrowers within it. The fastest
increase of all was in corporate bonds issued by emerging-market firms.
Jaime Caruana, the head of the BIS, argues that a global liquidity cycle the
waxing and waning of dollar borrowing outside America helps to explain the
slowdown in emerging-market economies, the rise in the dollar s value, and the
sudden oil glut. When the dollar was weak and global liquidity was ample thanks
to the purchase of Treasuries by the Federal Reserve (so-called quantitative
easing , or QE), companies outside America were happy to borrow in dollars,
because that was cheaper than borrowing in local currency. Capital inflows
pushed up local asset prices, including currencies, making dollar debt seem
even more affordable.
As long as the dollar remained weak, the feedback loop of cheap credit, rising
asset prices and strong GDP growth could continue. But when the dollar started
to strengthen, the loop reversed. The dollar s ascent is tied to a change in
America s monetary policy which began in May 2013, when the Fed first hinted
that it would phase out QE. When the Fed s bond-buying ended in October 2014,
it paved the way for an interest-rate increase 14 months later. The tightening
of monetary policy in America has reduced the appetite for financial
risk-taking beyond its shores.
The impact of this minor shift on the value of the dollar has been remarkable,
particularly against emerging-market currencies (see chart 1). Wherever there
has been lots of borrowing in foreign currency, the exchange rate becomes a
financial amplifier, notes Mr Caruana. As companies scramble to pay down their
dollar debts, asset prices in emerging markets fall. Firms cut back on
investment and shed employees. GDP falters. This drives emerging-market
currencies down even further in a vicious cycle that mirrors the virtuous cycle
during the boom. Since much of the credit went to oil firms, the result has
been a supply glut, as producers pump crude at full tilt to earn dollars to pay
down their debts.
Mr Caruana s reading of events has dollar borrowing at its centre. Yet the
sell-off in emerging-market currencies has more to it. Rich countries that
export raw materials, including Australia, Canada and Norway, have also seen
their currencies plummet against the dollar. Falling export income as a
consequence of much lower oil and commodity prices is likely to have played a
similar role in the slump in other currencies.
Some analysts think the problem of dollar debt is blown out of proportion.
There are countries, such as Chile and Turkey, where dollar debts loom large
(see chart 2). But the average dollar share of corporate debt in emerging
markets is just 10%. Chinese firms account for more than a quarter of the $3.3
trillion of dollar loans to emerging markets and since August, when fears
surged that the yuan would be devalued, they have been swapping dollar loans
into yuan, notes Jan Dehn of Ashmore Group, a fund manager.
Much of the foreign-currency debt taken out by companies elsewhere was
long-term: the average maturity of bonds issued last year was more than ten
years, for instance. That pushes refinancing, and the associated risk of
default, far into the future. In many cases, dollar debt is matched by dollar
income even if, as in the case of oil exporters, it is much diminished by low
prices. And there are pots of dollars in emerging-market banks to which
indebted companies may have recourse.
In any event, the dollar s ascent has stalled because of concerns about America
s faltering economy and doubts that the Fed can raise interest rates again.
Yet the cycle of dollar lending nevertheless has implications that may not be
fully appreciated. A recent study of firm-level finances by Valentino Bruno and
Hyun Song Shin of the BIS found that emerging-market firms with strong cash
balances are more likely to issue dollar bonds. That goes against a tenet of
corporate finance, that firms only borrow to invest once they have exhausted
internal sources of funds. It suggests that financial risk-taking was the
motivation for borrowing. On average, 17-22 cents of every dollar borrowed by
an emerging-market company ends up as cash on the firm s balance-sheet. Such
liquid funds could go into bank deposits, or be used to buy other firms
commercial paper or even to lend to them directly. In other words, the authors
say, companies seem to be acting as surrogate financial firms. As a result,
dollar borrowing spills over into easier credit conditions in domestic markets.
This is one of the ways the dollar-credit cycle exerts a strong influence over
overall lending in emerging markets. The credit cycle took an apparently
decisive turn last year. The stock of dollar credit to emerging markets stopped
rising in the third quarter, says the BIS, the first stalling since 2009.
Dollar credit is much harder to come by than it was. So are local-currency
loans. Bank-lending conditions in emerging markets tightened further in the
fourth quarter, according to the Institute for International Finance. The
dollar may have peaked but, for emerging markets, tight financial conditions
are likely to endure.