The risk comes from the potential rise in the US dollar against Asian currencies. Emerging nation borrowers will be squeezed
FOREIGN currency borrowing of Asian governments and corporations has soared to new heights, helping finance companies and boosting growth.
But the danger lies in the potential appreciation of the US dollar and other exchange rates against Asian and other emerging nation currencies. If, for example, the US dollar rises, the interest and loan repayment cost in local currency terms increases and places financial pressure on the borrower. Emerging-nation borrowers were squeezed during the Asian crisis of 1997 to 1998 and also in 2013 and 2014.
Disturbing rise in foreign exchange borrowing
The latest data of the Bank of International Settlements (BIS) shows that the non-bank borrowers of emerging-market economies (EME), notably governments, industry and business, increased their US dollar borrowings by 8.9 per cent to $3.68 trillion.
“The US dollar by far accounted for the largest share of outstanding foreign currency credit to non-bank borrowers in EMEs at end-March 2018,” the BIS states. “It is followed by the euro (644 billion euros or $790 billion) and the yen (¥8 trillion or 70 billion).”
Including euros and yen, Asian and other EMEs’ exposure to key foreign currencies amounted to a whopping $4.54 trillion by the first quarter 2018.
The Asian proportion of these borrowings in US dollars amounted to $1.42 trillion and including euros and yen, totalled $1.56 trillion. The main borrowers were from China ($641 billion), India, Indonesia, South Korea and Malaysia.
The BIS notes that a sizeable proportion of the loans came from the issuance of government and corporation bonds.
At end-March 2018, bonds accounted for 52 per cent of outstanding world-wide US dollar-denominated cross-border credit totalling 11.5 trillion, up from 44 per cent since the end of 2011.
Investors, especially leveraged funds struggle to sell low grade bonds
Bonds also accounted for a high proportion of world-wide euro-denominated cross-border credit to non-bank borrowers totalling 3.1 trillion euros.
Brendan Brown, the London-based head of Mitsubishi UFJ Securities International’s economic research, says hedge funds and other asset managers applied “carry trades” in their search for yield. In other words, they borrowed US dollars, yen and euro at negligible interest rates and invested the money in high-yielding “junk” global corporate bonds and emerging market securities. There are currently fairly wide spreads, that is, yield premiums over US Treasury and German government bond yields.
But Mr Brown is concerned about illiquidity in emerging market and global high-yield “junk” bonds. He maintains that it is difficult to trade the bonds in reasonable volumes.
Traders say that when they try and sell large size positions, they cannot find buyers easily and have to reduce prices. In short, if investors become worried about inflation and rising global interest rates, they could try and sell high-yielding corporate and emerging-market bonds. If the crowd rushes for the exit, they could find it difficult to get out of their positions, Mr Brown warns. Bond prices could tumble, causing profits to be much lower than expected; some investors could experience losses.
Leveraged hedge funds with high borrowings, could be most at risk. Moreover, if chaotic trading conditions ensue, there could be a scramble for dollars, yen and euros, raising the interest and repayment burdens of EME governments and companies that issued the bonds.
Sizeable amounts of Chinese bonds due for repayment
In a column for the Nikkei Asian Review, William Pesek wrote that the yuan’s decline has made it more difficult for Chinese borrowers to repay overseas debts.
“This year marks one of the busiest redemption periods for yuan and offshore debt since the post-Lehman Brothers collapse. Between now and Dec 31, companies face $365 billion of bond payments. The strains show with at least 20 defaults in the first seven months, almost as many as in all of 2017.
“The yuan is down 5.2 per cent versus the dollar this year, with the deepest declines coming in the past six weeks. These coincided with signs that Asia’s biggest economy is losing momentum, prompting capital outflows.
“Normally, traders might conclude Beijing is manipulating exchange rates for competitive gain. But the yuan’s fall does not seem intentional. The reason: The weaker the yuan, the greater the risk of defaults on overseas debt.”
Global banks will have to paper cracks in an emerging market crisis
In a BIS paper, Cathérine Koch and Eli Remolona write: “The ‘common lender channel’ is a mechanism that facilitates the spread of financial shocks around the globe.
“At the time of the Asian financial crisis in 1997, Japanese banks dominated lending to emerging Asia. When these banks cut their credit sharply, less exposed European banks took over as leading lenders. When the Great Financial Crisis of 2007-09 and the European sovereign debt crisis of 2010 struck, it was euro-area lenders’ turn to pull back from Asia, owing to their extensive exposures. By contrast, less exposed Japanese banks lent more money.”
This article was first published in The Business Times, Singapore
Neil Behrmann is London correspondent of The Business Times. Jack of Diamonds his thriller on global diamond mining and smuggling, has recently been published. It is the sequel to the thriller, Trader Jack, The Story of Jack Miner.
See reviews of both books on https://www.amazon.co.uk/Neil-Behrmann/e/B005HA9E3M