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CMM RESEARCH NOTE
Corporate Debt in Emerging Markets
Where are the risks?
JUNE 1, 2015
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Since 2008, total corporate bonds outstanding have almost doubled, surpassing $6.8 trillion
in 2014. This increase has been more pronounced in the EM non-financial corporate bond
market, which now totals more than $2.6 trillion—almost triple its level in 2008.
Hung Tran
With the corporates shifting towards more bond financing, outstanding debt of the EM nonfinancial corporate sector is now over 80% of GDP (up from about 60% in 2008).
Sonja Gibbs
The share of bond issuance in USD has continued to rise—from 10-15% in 2008 to over
40% in the first five months of 2015.
In an environment of rising U.S. interest rates, Fed tightening, EM currency depreciation
and slowing economic growth and capital flows, USD-denominated debt may become
increasingly difficult for some EM non-financial corporate borrowers to service and
refinance.
The impact of a stronger U.S. dollar is likely to vary considerable across emerging market
sectors. Firms in the consumer and real estate sectors with local currency revenues and FX
liabilities are likely to be more exposed to currency risks.
A striking phenomenon in recent years has been the speed of
growth in EM corporate bond markets. This growth has been driven both by the hunt for yield as global investors look further
afield, and by the ongoing development of EM bond markets
more broadly. Since 2008, total corporate bonds outstanding
have almost doubled, surpassing $6.8 trillion at end-2014, significantly outpacing the growth of bank credit. While both financial
and non-financial corporate bonds have contributed to this sharp
increase, the rise has been more pronounced in the EM nonfinancial corporate bond market, which now totals more than $2.6
trillion—almost triple its level in 2008 (Chart 1).1 With hard currency (mainly USD) corporate issuance at or near record levels in
2013-14 (Charts 2 and 3), total EM international (hard currency)
debt securities outstanding now total over $1.8 trillion, i.e. one
fourth of the total. Of this, some $520 billion is non-financial corporate, $575 billion is financial corporate, and about $750 billion
is government bonds.
As a result of this rapid growth, outstanding debt of the emerging
market non-financial corporate sector is now over 80% of GDP on
average, up from about 60% in 2008; China, Singapore and Hungary now have corporate debt well over 80% of GDP. A significant
part of this debt has been denominated in foreign currencies,
about 25-30% in USD, prompting concerns about vulnerabilities in
many EM countries given recent dollar strength and widespread
anticipation of higher U.S. rates. Many EM firms have “natural
hedges,” i.e. dollar revenue streams, or may have hedged their
USD exposure in derivatives markets. However, those that have
limited or no protection against currency risk are likely to face a
Executive Managing Director
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Director,
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Zeynep Elif Aksoy
Senior Financial Economist
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[email protected]
Emre Tiftik
Financial Economist
1-202-857-3321
[email protected]
Khadija Mahmood
Research Analyst,
1-202-857-3309
[email protected]
Chart 1
EM Corporate and Sovereign Bond Markets
$ trillion
Sovereign LC
Sovereign HC
Non-fin. Corp. LC
2014
2007
Non-fin. Corp. HC
Fin. Corp. HC
Fin. Corp. LC
0
1
2
3
4
5
Chart 2
EM Corporates: Bond Issuance, by Currency
$ billion
Other foreign currency
EUR
800
USD
700
Local currency
600
500
400
300
200
100
0
1
The BIS statistics by residence of issuer underestimate the size of the EM non-financial
corporate sector, as they don’t include issuance via overseas and offshore
subsidiaries—this is particularly true for Brazilian, Chinese and Russian corporates.
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6
Source: BIS, IIF.
2007
2009
2011
2013
2015
Source: Thomson One, IIF. Data contain financial and non-financial
EM30 corporate bond issuances
50
45
40
35
30
25
20
15
10
5
0
page 2
CMM RESEARCH NOTE | June 1, 2015
higher degree of credit and refinancing risk over the next few
years.
SHIFT TOWARDS MORE BOND MARKET-BASED BORROWING
Strong growth in EM bond markets has contributed to a notable
shift towards non-financial corporate financing in most emerging
market countries. For example, the share of bond financing in
total non-financial corporate debt financing has increased more
than 20 percentage points in Korea and Mexico. Other countries,
including Hungary, South Africa, Indonesia, and Brazil have also
witnessed a marked shift towards bond financing (Chart 4).
While the majority of this bond financing has been in local currency (65-75%) over the past few years) , the share of the issuance
in foreign currency was over 50% in the first five months of
2015— a fresh record high (Chart 5). While a shift toward more
bond market financing is part of the structural development of
EM capital markets—as such a welcome development—the
speed of the increase in non-financial corporate debt in some
emerging markets is a cause for concern.
CROSS-BORDER BANK LENDING ALSO ROSE SHARPLY IN
2008-13
Chart 3
Emerging Markets: USD Bond Issuance
$ billion
125
Non-financial corporates
Financial corporates
100
75
50
25
0
2007
2011
2015ytd
Source: Thomson One, IIF.
Chart 4
Share of Bond Financing for EM Non-financial Corporates
percentage of total debt financing
Mexico
Korea
While the focus has been on the rise in bonded debt, growth in
cross-border bank lending to the corporate sector has also been
strong in recent years. Indeed, data on BIS-reporting banks’ international claims on the EM non-bank private sector suggest a sustained pickup in cross-border bank lending in the aftermath of
the 2008 crisis to nearly $3 trillion in 2014 (Chart 6), driven mainly
by non-EU banks—notably, U.S., Japan, and China. While almost
all countries in our sample have increased reliance on crossborder bank credit, firms in EM Asia and in oil-exporting countries have recorded the largest buildup in cross-border banking
liabilities.
Although some 8-9% of the outstanding stock of international EM
loans is denominated in euro (and would thus be less exposed to
a strengthening USD), most of the remainder—nearly $3 trillion—
is USD-denominated.2 While the share of EUR-denominated
bank lending has been broadly stable—and Japanese and Chinese banks are becoming increasingly important as a source of
cross-border credit, primarily in yen and RMB—over 45% of new
cross-border lending to EM borrowers was denominated in USD
in 2013-14.
A CLOSER LOOK AT THE USD EXPOSURE OF EM NONFINANCIAL FIRMS
To identify specific countries and sectors that would be particularly vulnerable to a stronger USD and higher U.S. rates, it is
worth looking more closely at both the stock of EM non-financial
South Africa
Thailand
The series on the currency decomposition of the cross-border bank lending is based
on Bloomberg data.
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2014
Russia
2008
Indonesia
China
Hungary
Turkey
0
10
20
30
40
50
Source: BIS, IIF.
Chart 5
Non-Fin. Corporate Bond Issuance in Foreign Currency
percent
50
40
Share of USD
30
20
10
0
2
Brazil
Share of EUR
2007
Source: Thomson One, IIF.
2011
2015
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CMM RESEARCH NOTE | June 1, 2015
corporate debt relative to GDP, and at its breakdown by currency and sector. China is the clearly the elephant in the room—
non-financial corporate debt has grown by more than 50 percentage points since 2008 to around 150% of GDP. However,
other EM countries have also seen a notable increase in nonfinancial corporate sector indebtedness, including Turkey, Brazil,
and Russia (Charts 7). While a number of countries, notably Korea, China and Russia, now have less USD exposure relative to
GDP than in 2008 (in some cases due to deliberate efforts to
reduce such exposure), for many EM countries USD exposure
continues to be a significant proportion of overall debt (except
in a number of Central and East European countries, where euro-denominated borrowing has been more prevalent). Across
the emerging market countries in our sample, USD borrowing
exposure of the non-financial corporate sector stands at over
10% of GDP on average (Chart 8).3
Chart 6
International Claims of BIS reporting Banks in EM30
$ trillion
3.2
Government
Banks
Nonbank Private Sector
2.4
1.6
0.8
0.0
1996
1999
2002
2005
2008
2011
2014
Source: BIS-CBS, IIF.
WHICH EMERGING MARKETS—AND SECTORS—ARE MOST
AT RISK FROM USD LIABILITIES?
In an environment of rising global interest rates, Fed tightening,
EM currency depreciation (Chart 9) and slowing economic
growth and capital flows, USD-denominated debt may become
increasingly difficult for EM non-financial corporate borrowers to
repay. Some of these firms also suffer from significant reduction
in oil and commodity prices as well as a general slowdown in
growth of global trade. Indeed, for EM-30 countries, maturing
USD non-financial corporate bonds and cross-border loans total
around $375 billion for the 2016-18 period (Chart 10)—a period
when U.S. rates are likely to be higher, making roll-over of credits more difficult. Against this backdrop, a key question is how
well EM corporates are hedged against potential currency mismatches during stress episodes.
Chart 7
Change in EM Non-Financial Corporrate Debt-to-GDP Ratio
percentage point change since 2008
China
Turkey
Brazil
Russia
Indonesia
Czech Rep.
Hungary
Poland
Mexico
Thailand
India
Saudi Arabia
Korea
South Africa
-10
To identify vulnerabilities for specific countries and sectors, it is
helpful to look both at the stock of EM non-financial corporate
debt relative to GDP, and at its breakdown by currency and
sector. Looking at specific sectors, a key question is to what
extent currency risk may be hedged—either via a natural hedge
such as export revenues, or via derivatives markets. Some corporate borrowers may also maintain significant foreign currency
assets on their balance sheets to offer a degree of protection for
FX liabilities.
Looking across the diverse range of EM countries and taking
into account both the level of corporate external debt and the
structure of the economy, the impact of a stronger U.S. dollar is
likely to vary considerably:
■
More protected: commodity producers and exporters of
manufactured goods typically have a natural hedge as their
0
Underlying data in Chart 8 cover international and domestic debt securities as well as
domestic and cross-border bank credit provided by the BIS. Data on currency
breakdown is based on IIF estimates.
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20
30
40
50
60
Chart 8
EM Non-Financial Corporate Debt
percent of GDP
China
Korea
Hungary
Russia
Thailand
LC
Turkey
USD
Brazil
Others
South Africa
Mexico
Indonesia
0
3
10
Source: BIS, IIF.
20
Source: BIS, IIF estimates.
40
60
80
100 120 140 160
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CMM RESEARCH NOTE | June 1, 2015
revenues are primarily USD-denominated. Within the internationally tradable EM corporate bond universe, these sectors (energy and basic metals) account for around 30% of
total outstanding bonds (Chart 11). However, it is important
to note that many such “hedged” EM corporates—oil and
commodity producers in particular—have seen prices of
their exports fall substantially over the past year, reducing
the value of their natural hedges.
■
■
■
Indirect exposure: Financial corporates are typically adequately hedged against currency risk via derivatives markets, mainly due to regulatory requirements that limit the
extent to which banks can have currency mismatches. However, as some non-financial corporates are not hedged
against this risk, their FX risk may translate into credit risk
for banks at times of market stress. For example, Turkish
banks have relatively small net open foreign currency positions (around 3% of bank capital). However, the Turkish
non-financial corporate sector has FX liabilities of over $250
billion, and over $140 billion of this accounts for domestic
FX loans.
Little direct impact: For others, a rising U.S. dollar may have
little impact. Countries with managed and pegged currencies, like China, Hong Kong and GCC, would be better protected from higher debt service costs due to currency depreciation (Chart 12), though rising global rates would affect their refinancing costs. The flip side, however, is that
where a currency peg proves to be unsustainable, corporates may be exposed to a sharp and unexpected rise in
their foreign currency liabilities in local currency terms when
its peg breaks down.
Limited vulnerability: Some countries/sectors face fewer
risks, either because corporate USD exposure is modest,
and/or because there is some degree of hedging in place.
Although reliable data on hedging activities are limited,
corporate sectors in countries such as Mexico and Korea
have relatively better access to more liquid domestic and
offshore markets, which can help in hedging currency mismatches. However, hedging markets in most EMs are not
well developed, with high associated costs continuing to
discourage many firms from hedging FX risk. As noted by
the BIS, one big issue is the lack of liquidity in hedging markets, particularly in times of stress. Given that exposures are
typically hedged with more liquid short-term contracts in an
attempt to reduce hedging costs, it becomes harder to roll
over these contracts as swap dealers become less willing to
sell protection (as seen during the 2013 taper tantrum and
the oil price shock of H2 2014). In some countries, like Brazil, central banks with ample reserves may step in to provide currency hedges to corporates at times of stress. How-
Chart 9
U.S. Dollar
index, end-2012=100
135
130
USD vs DM
USD vs EM
125
120
USD
Appreciates
115
110
105
100
95
2013
2014
2015
Source: Bloomberg, IIF.
Chart 10
EM-30 USD denominated Debt Maturity Profile
$ billions
160
USD Loans
140
USD Bonds
120
100
80
60
40
20
0
2015
2018
2021
Source: Bloomberg, IIF.
Chart 11
EM Corporate Bond - Indusrty Breakdown
Consumer
- 6.4%
Communicatio
ns - 8.1%
Other 7.6%
Financials 40%
Utilities 8.3%
Basic
Materials
- 7.6%
Source: Market Vectors, IIF.
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U
Energy - 22%
page 5
CMM RESEARCH NOTE | June 1, 2015
ever, the expectation of such behavior can also serve to
discourage development of private hedging markets.
■
Higher risk: Specific sectors in some countries are at higher
risk due to high levels of USD exposure and/or a lack of
natural hedges and access to derivatives markets. In particular, firms in the consumer and real estate sectors with local
currency revenues and FX expenses seem to be more exposed to currency risks. This may pose particular problems
for these sectors in countries with economic/political vulnerabilities (see pages 10-12).
Against this backdrop, with EM corporate issuers facing a diverse set of risks, careful attention to credit selection is warranted by investors. While broad valuation measures (e.g., EMBIG
spreads) continue to look attractive relative to those in comparable asset classes (and relative to their long-run averages), bottom-up analysis of currency and refinancing risks will be increasingly important in an environment of rising U.S. rates.
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Chart 12
EM Corporate Bond - Country Breakdown
South Africa,
Turkey,
Indonesia,
India & Brazil
- 23.2%
Others 22.4%
CA Surplus
Countries- 25.6%
GCC 12.8%
Hong
Russia Kong China - 10.4%
8.5%
10%
Source: Market Vectors, IIF.