The Coming Emerging-Market Debt Squeeze

Mar 30, 2015 Andrés Velasco

The emerging-market debt crises of the recent past could not only happen again today; they could happen on a much larger scale than in the past. Taking advantage of ultra-low interest rates in the advanced countries, emerging-market banks and firms have been borrowing like never before.

SANTIAGO – Consider the following scenario, one that has played out time and again in emerging-market countries. Local banks and firms go on a borrowing binge and pile up dollar-denominated debt – debt that pundits consider perfectly sustainable, as long as the local currency is strong. Suddenly, something (an increase in United States interest rates, a drop in commodity prices, a domestic political conflict) causes the local currency to drop in value against the dollar. The debt burden, measured in domestic currency, is now much higher. Some borrowers miss interest payments; others are unable to roll over principal. Financial mayhem ensues.

This is how the Latin American debt crisis of the 1980s, the Mexican Tequila crisis of 1994, the Asian debt crisis of 1997, and the Russian crisis of 1998 unfolded. It was also how the financial crisis of 2008-2009 transmitted itself to emerging markets. Every time, borrowers and lenders claimed to have learned their lesson.

Not only could it happen again today; it could happen on a much larger scale than in the past. Taking advantage of ultra-low interest rates in advanced countries, emerging-market banks and firms have been borrowing like never before. A recent paper by the Bank of International Settlements shows that since the global financial crisis, outstanding dollar credit to non-bank borrowers outside the US has risen by half, from $6 trillion to $9 trillion.

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Andrés Velasco

Writing for PS since 2001
110 Commentaries

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

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Jonathan Lam Apr 10, 2015

Gamesmith94134: The Coming Emerging-Market Debt Squeeze

The risk is that a surging greenback and higher interest rates will make it harder to service U.S.-denominated debt held outside the country by non-bank borrowers. This debt is estimated at $9 trillion by the Bank for International Settlements.

Ms. Yellen has the option of being depreciated that growth is negative, or raise the interest rate to release the foreigner's fund to choose whether to stay or go. edging up on short term rate signaling the value of dollar is on par that carry trade is not a proper procedure to secure its currencies and bumpy road laid on the ground that dollar would not be depreciated because it was over priced due to the carry trade that many borrowed the foreign funds instead. Then, the corporate decision must revaluate the further upload of the stock prices before it collapsed or cashing in with the real estates and REIT, knowingly the hedge fund is on its way to be slaughtered. Nine trillion is hard sell to growth since there is no impetus to doing so.

Secondly, the AIIB is ready to intercept on bonds that it carries, and there are volunteers on its supports and redefine the status on currencies and the floating rate situation in IMF; we are much overloaded with its 17% to global economy and the universal underwriter lost its principles on equivalence and balance to adjust like the short-term rate; and the wedge is gone. “let live or die” may not an answer to sustainability.
So, it is a poison pill we may swallow soon or later, but depreciation may escalate in a faster pace than we imagine if the fund managers are not alerted but start panicky ion shuffling the cash out of the DJ. DJ held at 17000 because the carry trade and the nominated dollar demand, like my saying, 2% vs. 17% caused 15% depreciation, but 2% plus 4% equity cost plus 2% labor cost will be a call to even. Regardless how the data can submerge the housing and labor will not go away even with more layoff and redevelopment on condominiums they have to pass the margin of affordability or devaluation; price and value is not the shot that the corporation can made even in diminishing return; actually, it is the call of the aggravated demand through the eyes of the public demand just like Google glass or I watch of Apple.
Thirdly, the recent trend on the money managers and the corporate financiers risks more on the mid caps than the top choice since they see the profit margin is not holding as it seems and the projectors shown defects from the change to negativity, and they sure the current bet on A&M and equity is not profitable as it seems that micro-economics rules. More layoff is coming to compete on the rising cost and low revenue input; it is risky to harbor more assets in dollar or America. Many have already cut their currency reserves from 12 trillion to 11 trillion, it cause the shrinkage in the credit world as well.
The longer Ms. Yellen lingers on the raising the short-term rate the depreciation and layoff will continue as 0.7% or 0.2% last month till once the named corporation makes another loss, the outflow will return to China. Then, many emerging market nations with the foreign debt will be squeezed. It all sounds like the Bad News, Bear. But......how will the global finance return to the normalcy with the 3% risk and compensation on the pension and cushioning?
May the Buddha bless you?
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Procyon Mukherjee Apr 3, 2015

The dollar credits to non-financial institutions and borrowers outside of U.S. touched a whopping $8 Trillion, largely through bond market reach, the spreads have however tapered all through; the real policy implication for the emerging market economies is that the credit expansion of the offshore-affiliates who have borrowed through the bond route could actually mask the real reason for the slow growth of credit in the national economies as such borrowings would not be appearing in the national account statistics; this is the real concern for the spill-over effects of QE.
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Shoshon Tama-Sweet Mar 31, 2015

Excellent and timely article. In the last few years, the dollar loans and Euro bonds have become very popular in Africa, for example, funding the $400 million in Rwanda's airline. However, these economies are very fragile. While not all are directly dependent on the commodity boom or vulnerable to economic slow down in China, all have neighbors that are vulnerable, and there are many opportunities for political instability as well. I do not think the recent boom in dollar denominated loans is going to end well for anyone.
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