Rising Latin American Corporate Risk: Walking a Tightrope
IMF Blog, May 25, 2016
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Bibliographic details
- Authors: Carlos Caceres, Fabiano Rodrigues Bastos
- Published: May 25, 2016
Overview and context
- Authors: Carlos Caceres, Fabiano Rodrigues Bastos
- Date: May 25, 2016
- Summary statement: The rapid increase in Latin American corporate debt—fueled by an abundance of cheap foreign money during the past decade—has contributed to an increase in corporate risk.
- Key statistic on debt levels:
- Total debt of nonfinancial firms in Latin America increased from US$170 billion in 2010 to US$383 billion in 2015.
- Growth and external environment:
- Potential growth across countries in the region is slowing, in line with the end of the commodity supercycle, making it more difficult for firms to operate under increased debt burdens and reduced safety margins.
- Sample and scope of analysis:
- Company-specific financial information for close to 500 publicly listed nonfinancial firms between 2005–15 in 7 major economies—Argentina, Brazil, Chile, Colombia, Mexico, Panama, and Peru—was used to gauge factors driving corporate risk dynamics.
Warning signs and empirical findings
- Temporal patterns:
- Corporate risk, as reflected in higher credit default swaps (CDS) spreads, has been rising in 2014–15.
- The peak year in most commodity prices (2011) marks the beginning of risk differences across countries, which have further widened since late 2014.
- In only Argentina and Brazil has corporate risk approached the levels observed during the global financial crisis.
- Drivers of corporate risk (relative importance and heterogeneity):
- All dimensions—company-specific, country-specific, and global factors—play a role, with varying degrees and implications across countries.
- Overall, macroeconomic domestic factors, particularly the pace of currency depreciation and changes in sovereign spreads, are key direct factors placing upward pressure on corporate risk since 2011.
- External conditions—especially measures of global risk aversion (such as the Chicago Board Options Exchange Volatility Index, VIX)—constitute a dominant driver of corporate risk.
- Stress-test result:
- External shocks can generate substantial increases in corporate risk across the region—ranging from 100 to almost 300 basis points in the event that the VIX surges to just half of the spike observed during the global financial crisis.
- Country-specific notes:
- Argentina and Brazil: Domestic macroeconomic and political factors have been particularly important in generating upward pressures on corporate risk through rapid exchange rate depreciation and an increase in sovereign CDS spreads—reflecting significant macroeconomic imbalances.
- Colombia: Higher corporate vulnerabilities driven by large exchange rate depreciation and deteriorating firm-specific factors.
- Peru: Deteriorating firm-specific factors have generated upward pressure on corporate spreads.
- Chile, Mexico, and Panama: Much lower pressures on corporate risk from domestic economic factors.
- Offsetting effect:
- Benign global financial conditions (in particular, low market volatility) have helped to contain corporate risk despite slower external demand and declining commodity prices.
Policy implications and recommendations
- Macroeconomic and fiscal policy:
- Macroeconomic stability and credible policies are an important defense against additional upward pressures on corporate spreads, especially given the link between corporate and sovereign spreads.
- Reining in risks to fiscal sustainability as well as curbing inflation—particularly in Argentina and Brazil—is crucial to contain corporate risk.
- Microeconomic adjustments and corporate sector policy:
- Solid macroeconomic policies alone may not be enough; supporting underlying microeconomic adjustments is imperative to promote firms’ capacity to push through needed adjustments.
- Orderly deleveraging through market-based solutions should be the first line of defense in highly indebted companies.
- Public sector equity should not be used to stave off needed adjustments in the corporate sector.
- For insolvent companies, restructuring and bankruptcy legislation should minimize both administrative costs and economic losses related to default.
- Financial regulation and supervision:
- Enhanced monitoring and supervision and well-targeted macroprudential policies are key to alleviate risks and spillovers, particularly to the financial system.
- Policymakers should monitor closely corporate balance sheets and income flows, particularly in systemically important nonfinancial firms.
- Financial regulators have a critical role; adequate consolidated supervision—particularly where financial and nonfinancial firms are highly interlinked—remains an important risk-mitigating tool.
Source: Rising Latin American Corporate Risk: Walking a Tightrope (IMF blog, May 25, 2016).
Content in this bundle
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