Bond Losses Seen as Emerging-Market Company Debt Matches GDP

Sept. 15 (Bloomberg) — Investors in emerging-market debt have become more vulnerable to interest rate and currency shocks after corporate borrowing in some nations rose to match the output of their economies, according to the Bank for International Settlements.

Borrowers from Brazil to China may need to refinance about $90 billion next year and as much as $130 billion by 2017-2018, economists Michael Chui, Ingo Fender and Vladyslav Sushko wrote in the BIS Quarterly Review. That may be challenging should the dollar strengthen and domestic economies slow, they said.

Companies in developing countries issued almost $375 billion of international debt between 2009 and 2012, more than double the amount sold in the four years before the 2008 financial crisis, according to the Basel-based BIS. Higher rates or weaker currencies could push up bond yields which in turn would hold back growth, damaging issuers, economies and bondholders including international investors and local banks.

“Rising interest rates and depreciating exchange rates will tend to raise the cost of servicing these debts, denting profits or depleting capital cushions unless appropriate hedges are in place,” the BIS economists wrote. “Stress on corporate balance sheets could rapidly spill over into other sectors, inflicting losses on the corporate debt holdings of global asset managers, banks and other financial institutions.”

The BIS, known as the central bankers’ bank, hosts the Basel Committee on Banking Supervision which sets global capital standards.

Leverage Boost

Low interest rates have spurred investor demand for higher- yielding assets, allowing companies in developing markets to boost leverage. Corporate debt grew faster than earnings in one third of major emerging economies between 2008 and 2012, according to the report.

Part of the borrowed money was probably used to fund capital expenditure, which has increased by almost a third in recent years, the economists wrote, citing a report from Bank of America Merrill Lynch. While cheap funding can boost the economy by supporting viable investment projects, it also increases the borrower’s interest rate, rollover and currency risks, they said.

Many companies are also tapping bond markets for the first time, meaning the willingness of investors to let them roll over their debt in “adverse circumstances” hasn’t been tested, the BIS analysts wrote. Domestic banks’ desire to help refinance debt may also be limited.

These lenders, which typically provide loans to smaller companies, would also suffer themselves when borrowers withdraw deposits and non-performing loans rise. The fallout would be exacerbated by the herding behavior of international asset managers, who would seek to get out at the same time, according to the BIS.

“Such developments could generate powerful feedback loops in response to exchange rate shocks if credit risk concerns mean that existing bank or bond market funding is not rolled over,” the analysts wrote.

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