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Corporate Financing Patterns, Performance and Systemic Risk in Emerging Markets Sanket Mohapatra Dilip Ratha Phil Suttle Columbia University The World Bank The World Bank Washington DC April 16th, 2003 The Willie Sutton principle Willie....why do you rob banks? The Willie Sutton principle Willie....why do you rob banks? ...Because that’s where the money is! The Willie Sutton principle Willie....why do you rob banks? ...Because that’s where the money is! This principle can be extended to financial markets The Willie Sutton principle Willie....why do you rob banks? ...Because that’s where the money is! This principle can be extended to financial markets Where do you get financial market crises? The Willie Sutton principle Willie....why do you rob banks? ...Because that’s where the money is! This principle can be extended to financial markets Where do you get financial market crises? ...You get them where the money is! Private corporate flows now dominate financial flows to emerging markets 5% 1990 PNG debt 27% 2001 Private corporate flows now dominate financial flows to emerging markets 5% PNG debt 27% 200 $ billion FDI 150 100 50 1990 2001 0 Debt flows to public sector '95 '96 '97 '98 '99 '00 '01 Private corporate flows now dominate financial flows to emerging markets 5% PNG debt 27% 200 $ billion FDI 150 100 50 1990 2001 0 Debt flows to public sector '95 '96 '97 '98 It thus becomes increasingly important for us to know what the corporate sector in developing countries is up to '99 '00 '01 Outline of rest of talk Risks associated with recent patterns in corporate financing patterns and performance – Phil Suttle External leverage and corporate performance – Dilip Ratha Key risks Information shortages Excess domestic leverage Excess external leverage Short-term debt vulnerability Profit disappointment risk Information shortages Uncertainty over true state of balance sheets Uncertainty over aggregate performance of corporate sector Uncertainty over nature and magnitude of off-balance sheet risks Excess leverage Corporate debt Percentage of GDP 140 119 120 100 97 88 80 1995 1997 2001 60 40 30 16 20 33 34 35 22 0 East Asia and Pacific Europe and Central Asia Latin America and Caribbean Excess external leverage Corporate foreign debt Percentage of GDP 35 30 25 20 Latin America and the Caribbean Europe and Central Asia 15 10 5 East Asia and Pacific 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Short-term debt vulnerability Short-term debt and current liabilities Percentage of total debt 80 70 60 72 76 66 63 58 62 56 53 50 50 1995 40 1997 30 2001 20 10 0 East Asia Latin America Europe and Central Asia Profit disappointment risk Developing countries: Corporate Profitability Average of 12 major emerging economies Net income relative to sales, percent Argentina 10 9 Brazil 8 Chile India 7 Indonesia 6 Korea 5 Malaysia 4 Mexico 3 Pakistan Not an encouraging trend 2 Peru 1 Thailand 0 Turkey 1985 1987 1989 1991 1993 1995 1997 1999 External debt and corporate performance Benefits: Cheaper financing Larger, more diversified markets Market discipline Risks: Currency mismatch and devaluation risk Maturity mismatch and roll-over risk Global interest rate risks Data Worldscope+Bondware+Loanware External market participants also had high domestic leverage Ratio of debt to assets (average, 1999-2001) Percent Non-participants 66 Market participants 53 52 46 All regions EAP Market participants paid lower interest rates Interest rate Percent 9 Non-participants 8 7 6 Market participants 5 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Market participants, however, were less profitable Profit as a share of assets Percent 6 5 4 Non-participants 3 2 1 Market participants 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Market participants with foreign sales performed better Profit as share of assets Percent 8 7 With foreign sales 6 5 4 3 2 Market participants 1 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 Firms that could roll over external debt were less cyclical Profit as a share of assets Percent 6 5 4 Roll over firms 3 2 1 0 -1 No roll over -2 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Crisis and the trade-off between devaluation risk and interest rate risk Effect of leverage on profits Percent Crisis affects all firms But it affects external borrowers more Devaluation risk dominated interest rate risks No crisis Crisis -0.15 -0.20 Non-participants Market participants -0.23 -0.28 Concluding thoughts We need to be more vigilant about corporate financial risks in the developing world, both domestic and external. We need more information! External borrowing brings a number of key benefits for corporates operating in weak capital market environment, but also obvious risks. In recent years, risks seem to have outweighed benefits.