Emerging Markets' External Hard Currency Debt

 |  Includes: EEM, UDN, UUP
by: Marc Chandler


External debt hard currency debt is not picked up in national accounts.

Russia and Ukraine have among the highest such debt as percentage of GDP.

It is important to put the external debt in a larger context.

This Great Graphic was posted on Business Insider by Matthew Boesler. He got it from Nomura, who drew BIS and IMF data. It looks at the mix of foreign currency bonds; issued offshore, (red) local currency bonds, issued on shore (gray) and cross-border loans (blue).

Offshore bonds are not picked up in the country-level balance of payments and capital account figures. The traditional national accounts are more interested in residency of the issuance not the nationality of the issuer. Nomura estimates that since 2010, corporations, based in emerging markets, have issued about $400 bln in offshore debt, or about 40% of its total issuance. The bulk is thought to be denominated in dollars.

The bonds issued abroad may offer a potential currency-mismatch and need to be assessed on a company-by-company basis, but a relatively large amount of foreign currency borrowings is potential risk that is often not appreciated when looking at national accounts. Russia has the highest amount of hard currency debt at about 12% of GDP. In Russia's case, this may sound more threatening than it actually is. Consider a company that exports oil, gas, or industrial metals. Its revenue is likely to be large in dollars. Dollar income could be matched with a dollar-denominated bond.

Other companies may not have achieved such a natural offset, but borrowed in dollars because it is cheaper. Such companies may be more exposed to adverse local currency movement. As the local currency falls, such as the Russian ruble, the foreign debt increases, lifting overall debt as a percentage of assets.

This lower chart was tweeted by Niall O'Connor, which he got from UBS. It shows that in several emerging markets, the external debt as a percentage of GDP is lower than 1996. However, the take away might not be so benign as suggesting there is less risk of widespread currency mismatches.

First, only half of the eight countries selected show improvement (Thailand, Indonesia, Philippines and Mexico) and there are some considerations that suggest more than meets the eye. For example, 1996 was the eve of the 1997-1998 Asian financial crisis. External debt in Asia was near a peak. Mexico, for its part, was just getting out of its Tequila crisis.

Second, some countries have actually more external debt than previously. The chart shows this is true for South Africa and, to a less extent, Turkey. Third, even with small improvements, 20% external debt to GDP can still be problematic. It is also important to understand the mix between public and private sector foreign debt. It depends on the provisions, including whether hedging instruments are used and central currency reserves. Risk is also a function of how much of the external debt is short term and how much is long term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.