By Jac Laubscher, 8 April 2014
Although the bond and equity markets as well as currencies in emerging-market countries have recovered well since the volatility in January, there are still analysts who regard it as the calm before the actual storm.
By this time the financial markets have had ample opportunity to consider and discount possible future scenarios, but markets could still react negatively if developments prove to be more unfavourable than expected. The biggest risk in this regard is the possibility that the Fed could start hiking interest rates sooner than is currently being discounted.
The extent of emerging markets’ exposure to foreign capital, which determines their vulnerability, remains a point of discussion. In this regard, in a recent article* Philip Turner of the Bank for International Settlements made an interesting new contribution to the ongoing debate.
Turner pointed out that the abnormally low level of global long-term interest rates encourages companies in emerging-market countries to issue, often through their offshore subsidiaries, more bonds denominated in foreign currencies in international bond markets. These developments have major implications for risks in foreign exchange markets and for the local banking system, which are totally underestimated.
The problem lies in the distinction made between the nationality of the borrower and his country of residence in the compilation of the relevant statistics. Turner points out that the balance of payments and foreign debt positions of countries are composed on the basis of the borrower’s country of residence and not nationality, which means loans by international subsidiaries of local companies are not taken into account and the gross debt position is consequently underestimated. This means that on both a micro (company) and macro (balance of payments) level emerging-market countries are more susceptible to a tightening in global liquidity than is implied by the official statistics.
Measured by their nationality, from 2010 to 2013 companies in emerging-market countries issued bonds to the value of $705 billion in foreign currencies, which is more than double the amount they borrowed from international banks. Approximately 48% of these loans were raised by foreign subsidiaries and are therefore not reflected in balance of payments and foreign debt statistics.
There are no indications that companies used these funds to redeem their foreign currency short-term debt at banks and the increase in foreign bond issues by subsidiaries can also not be attributed to higher exports. If the proceeds of the loans were used to acquire local assets (Chinese property developers, for example, raised loans to finance local projects) it will inevitably result in greater mismatching of currencies.
If this source of financing dries up and it becomes impossible to roll over loans that are expiring, it could have serious implications for the local banking system. Turner distinguishes three channels along which these implications could manifest:
This inevitably leads to the question of where South Africa fits into the picture.
According to Turner, global corporate bond issues by companies in emerging-market countries in the second half of 2013 amounted to 55% of the amount outstanding at the end of 2011. China took the lead with an increase of 134%. In the case of South Africa the increase was only 18% and South African companies were responsible for only 0,8% of total issues from 2010 to 2013. These figures also include semi-government corporations such as Eskom and Transnet, which were responsible for a large part of the increase.
According to a study of the eight leading emerging-market countries by analysts from Morgan Stanley**, South African corporates are very well placed in terms of their debt levels, including foreign currency debt. South Africa has the lowest gross gearing ratio (1,6x compared with the median of 2,8x) of the major emerging-market countries, while 70% of short-term loans are covered by cash holdings. The latter figure is only slightly higher than the median of 60%, which shows that the amount of cash South African companies keep on their balance sheets and for which they are often criticised, is not unusual.
The low debt levels of South African companies more than compensate for the fact that short-term debt represents a relatively large part of the total (18% compared with the median of 7%) and that debt denominated in foreign currencies similarly accounts for a relatively large part of the total (21% of total debt compared with the median of 13%).
All in all, the Morgan Stanley analysts put South Africa among the top three countries in terms of its corporate sector’s ability to cope with a tightening in global liquidity.
The conclusion is thus that there is no significant additional risk for South Africa if corporate debt is measured according to the borrower’s nationality rather than his country of origin. The risk for South Africa is rather that of contagion, viz. it could be sucked into a general emerging-market crisis because investors do not distinguish clearly and adequately between countries.
The global long-term interest rate, financial risks and policy choices in EMEs. BIS Working Papers No 441. February 2014.
**Obrtacova, Kristina en Vanessa Barrett: EM Corporates:
Rising Leverage, Rising Risk. Morgan Stanley Research. 18 November 2013.