Emerging Market Corporate Debt in Foreign Currencies

IMF Blog, October 1, 2015

Source details

Title: Emerging Market Corporate Debt in Foreign Currencies
Authors: Selim Elekdag, Gaston Gelos
Publication date: October 1, 2015
Topic: Risks and measurement of emerging market firms' debt denominated in currencies other than their own, and implications of a stronger U.S. dollar as U.S. Fed policy normalizes.

Approach:
- Foreign-exchange exposure is estimated indirectly by the reaction of firms’ stock returns to changes in the exchange rate.
- This stock-return–based estimate in principle accounts for:
- Financial hedges, such as swaps.
- Natural hedges, such as export receipts in a foreign currency.
- Local market conditions.
- Firm-level data on foreign currency holdings are generally unavailable, making this indirect estimation advantageous.
Data scope:
- Estimates are based on data from thousands of individual publicly-listed firms.

Key points:
- Various papers document a rise in foreign currency–denominated bond issuance by many emerging markets, but bonds alone do not capture total exposure.
- Bank lending remains the most important source of financing for many firms, accounting for over 80 percent of corporate debt.
- Firms may use financial instruments (e.g., swaps) to hedge currency risk.
- Overall foreign-currency exposure depends on balance sheet composition (assets) and the nature of business operations (exports vs. imports).

Findings:
- Nontradable sectors (example: construction) tend to have positive foreign exchange exposures — local currency depreciation affects them adversely.
- Rationale: Sectors like real estate tend to do well during periods of capital inflows and currency appreciations.
- Export-oriented sectors (example: mining) tend to have negative foreign exchange exposures — they benefit from local currency depreciation.
- The construction sector experienced rapid growth in its debt-to-assets ratio and is perceived by stock markets as having strongly increased its exposure to exchange rate fluctuations since the crisis.

Findings:
- The evolution of foreign exchange exposures after the global financial crisis differs across regions.
- Foreign currency exposures appear to have risen the most in Latin America, on average, after the crisis.
- Outside of Asia (Europe, the Middle East, Africa and Latin America), the fraction of firms with positive foreign exchange exposures increased across all sectors from 2010 to 2014.

Finding:
- Firms that have increased their debt-to-assets ratios have generally also increased their overall sensitivity to changes in the exchange rate (exchange-rate exposure), based on the stock-return exposure estimates.

Emerging markets should prepare for the implications of a continued appreciation of the U.S. dollar as the U.S. Fed begins to normalize monetary policy, given the increased foreign-currency exposure and higher corporate leverage in several sectors and regions.

Source: Emerging Market Corporate Debt in Foreign Currencies, Selim Elekdag and Gaston Gelos, October 1, 2015.