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The mighty dollar

2015-03-24 05:55:08

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