Since the financial crisis, big Western banks, short of capital and weighed down by regulation, have become much less enthusiastic about lending to companies in emerging markets. Investors, meanwhile, have been hunting for higher-yielding assets than rich-world government bonds.
The result has been a big jump in bond issuance by emerging-market firms, much of it by their foreign subsidiaries. Since the collapse of Lehman Brothers, according to the Bank for International Settlements (BIS), firms other than banks in the emerging markets have issued $692 billion in international bonds — $89 billion in the first six months of this year alone.
Such debts are a worry at a time when many emerging-market currencies are falling against the dollar (the most common currency for offshore issuance), since they are becoming more expensive to service in terms of the local currency of the issuers. The risk is all the more acute because national accounts often fail to capture local firms’ exposure.
Many of the bonds are issued through offshore subsidiaries in low-tax jurisdictions such as the Cayman Islands. That appeals to asset managers, since many of them are restricted from investing in domestic bond markets outside the rich world; it also appeals to firms in places such as Brazil and China (the biggest issuers) since it helps them to skirt capital controls. But it means that the bonds have technically been issued by a Caribbean entity, not a Chinese or Brazilian one.
This is a big distortion. Counted by the standard method, the outstanding stock of foreign-currency bonds issued by emerging-market firms was $679 billion at the end of June. But the BIS estimates that the true figure was $1.2 trillion (that includes a small number of bonds issued offshore, but in the firm’s domestic currency). Russia’s stock jumps from $42 billion to $115 billion; Brazil’s from $64 billion to $175 billion.
Some emerging-market firms are multinationals with sizable foreign revenues that should allow them to cope with shifts in exchange rates. But researchers at the BIS point out that property firms, which have little if any foreign income, are China’s most prolific issuers.
Firms also claim they are protected from the whims of the bond market by the lengthening duration of their debts. The average term of emerging-market bonds has grown from just over seven years in 2000 to just under 10 years in the first half of this year, according to Hyun Song Shin of the BIS. But the prices of long-lived bonds of are very sensitive to rising rates, Shin points out, since bondholders are especially unwilling to be stuck with low returns for long periods.
The BIS fears that emerging-market firms that have issued offshore bonds will cut back on other spending to service them, or hoard cash for fear they will not be able to roll over their debts, causing growth in the countries concerned to decelerate further. Asset managers would see this as another reason to trim their holdings of both offshore and domestic debt in such places, exacerbating the problem.
It would not take much to set off a vicious cycle: a reallocation of 1% of the total holdings of the world’s 500 biggest asset managers away from emerging markets would amount to $700 billion in outflows, nearly three times the sum that fled those markets in 2008, according to the BIS.
© The Economist Newspaper Limited, London (November 8, 2014)