Whiplash In Emerging Marketsby
When Brazil completed a deal to restructure $52 billion in foreign loans on Apr. 15, many observers were a little too quick to pronounce the end of the Latin American debt crisis. While the pact was a big achievement, debt troubles in Latin America and other emerging markets are far from over.
The reason: the recent sharp plunge in emerging-market debt and equity prices throughout the world, precipitated by the Federal Reserve Board's hike in interest rates on Feb. 4. The Fed's move effectively punctured a huge speculative bubble that had buoyed emerging markets far beyond reasonable levels. Throughout the developing world, liquidity has dried up, burned investors have run for cover, and financing deals have been postponed.
SLOW MEND. The psychology has shifted dramatically from euphoria to a sober realization that emerging-market dealings can be much more hazardous than was once thought. Investors and dealmakers have gained a new appreciation of political and market risks. In this climate, there are few signs that market prices will recover to 1993 levels anytime soon.
The impact of these developments will be painful from Beijing to Buenos Aires. Raising capital will become more difficult for thousands of companies in emerging markets. "It will be much more expensive to borrow from abroad," says Lawrence Krohn, chief economist for Latin America at Lehman Brothers Inc. "A lot of the projects won't get done, and that's going to slow future growth."
The flow of deals has already ebbed--and that is costing Wall Street dealers plenty of money. Says Arthur E. Byrnes, chairman of the New York money-management firm Deltec Asset Management Corp.: "I used to get several faxes a day [inviting Deltec to participate in upcoming deals]. I don't get any faxes these days." If companies defer or cancel huge planned investments in productive equipment, they run the risk of leaving themselves stagnant and inefficient at a time when their countries badly need private-sector growth.
The change in sentiment is most pronounced in Latin America. In January, market watchers predicted there would be more than $8.5 billion in new Eurobond offerings from Latin America in 1994, with $3.1 billion coming from Brazil alone. But the actual volume will be far less. Already this year, the giant state gil company Petrobrs postponed a planned offering. Jose Berenguer, capital markets director at ING Bank in So Paulo, estimates that close to 15 Brazilian Eurobond deals worth at least $1 billion are on hold.
The slowdown is equally dramatic in Mexico, where two dozen planned bond offerings totaling $6 billion face an uncertain future. Although Mexican issuers placed more than $1 billion in new debt in January, new-issue volume has subsequently fallen, and the only offerings since mid-March have been for sovereign issuers, according to Salomon Brothers Inc. In recent years, many aggressive Mexican companies have obtained as much as 90% of their debt in dollars, according to Hugo Jaime Garcia, corporate financing director at Monterrey-based Vitro. But Vitro, taking a conservative tack, has eased away from international bond markets over the past year. Even cement giant Cementos Mexicanos, which issued a record-setting $1 billion Eurobond last year, is expected to put off major new borrowings. Says Richard D. Grant, managing director for project finance at Chase Manhattan Bank: "Right now, the public market for Latin America is dead with a capital D."
FADING PROSPECT. The weakness in emerging markets is causing some pain to even the largest, best-quality corporations. But the impact on midsize companies will be acute. Unlike their larger brethren that have the wherewithal to wait until conditions improve, these companies need money now--and they'll have trouble borrowing at home, where short-term rates have jumped from 9% to 15% since January. That has political ramifications as well as economic ones, according to Neil Perry, chief of research at Baring Securities Inc.'s Mexico City office. "The Mexican government wanted to get lending rates down, so that small and midsize companies would make new investments and create plenty of jobs before the [Aug. 21 presidential] election," he says. Now, that prospect is fading.
Equity offerings are also slower for Mexican companies. Prices on U.S.-traded shares of the biggest Mexican corporations have fallen precipitously. Telefonos de Mexico, for example, fell from 76 on Feb. 9 to 521/2 on Apr. 20. And when the Pepsi bottler Grupo Embotellador de Mexico came to market recently, sources close to the deal say founder Enrique Molina had to slash the number of shares he was selling by 75%. Moreover, investors in Mexico are likely to shun volatile equity investments when government bond rates are in the double digits.
Even Asia's booming economies are having trouble raising cash. Chinese borrowers will find it harder to raise money than they did earlier this year, when the government issued 10-year bonds at a yield just 85 basis points (one-hundredths of a point) over U.S. Treasuries. Now, that premium has nearly doubled, and the bonds are trading at about 90 cents on the dollar.
The dearth of liquidity in the market has been especially harmful for smaller countries. Prices on so-called exotic debt from nations such as Peru were marked down more than a point at a time during the worst of the market turmoil. In Hong Kong, Lehman Brothers is rumored to have been stuck with big inventories of so-called Dragon bonds--dollar-denominated bonds issued in Asia and sold to Asian investors--when buyers disappeared in the market rout. The company says it has normal inventories of Dragon bonds and continues to trade in most bonds.
High interest rates and illiquidity aren't the only reasons for the continuing emerging-market problems. Speculation, fueled by excessive leverage, also played a big role. For example, market sources say that some investors took positions in "when-issued" Brazilian bonds. Brazil was to issue the bonds, as it did on Apr. 15, after reaching an accord with its creditor banks. The bonds were to be collateralized with U.S. Treasuries. Since the bonds were being traded only on a when-issued basis, investors were able to avoid putting up any cash. When the price for when-issued bonds rose, investors used their paper profits as collateral to buy other securities on margin. It was a great scheme when prices were rising. But when prices fell, investors got hit hard because they had to meet margin calls.
"CLEANSING EFFECT." Political volatility has also dimmed prospects for some markets. In Mexico, peasant uprisings, the kidnapping of a prominent banker, and the assassination of a leading presidential candidate have spooked investors and could curb economic recovery. And the leading candidate in Brazil's upcoming presidential election is a socialist who has pledged to undo some economic reforms.
Nobody, though, is writing off the emerging markets. Observers say the free fall in debt prices has little to do with underlying conditions in the countries. Argentina's economy continues to improve, they say, and many of the Asian economies are booming. Donald G. McCouch, of Chemical Banking Corp., says the fall in prices "has had a cleansing effect" on the market. While he expects emerging-market borrowers to continue to have to pay high rates relative to Treasuries, he expects the market to become more liquid. And no one expects the low prices to last forever. Indeed, Dana F. McGinnis, president of San Antonio Capital Management Co., has been "dramatically increasing" his holdings of emerging-market debt.
Many involved with emerging markets expect the toughest times will end soon. Jose Angel Gurria, who left the directorship of Mexico's development bank Nafinsa to be international affairs director for the Institutional Revolutionary Party (PRI), predicts Mexico's market will stabilize in tandem with the market for U.S. Treasuries. "The rates went up pretty fast," he says. "I just hope they're as fast in returning to normal." Unfortunately, normal may not be as cheap as Gurria hoped only a few months ago.
WHY THE DEBT CRISIS ISN'T OVER YET
SHELL-SHOCKED Many investors were newcomers to the
INVESTORS emerging markets last year, and now it appears that they came
in at the top. When prices plummeted, liquidity almost
vanished. New investors will be very leery.
WARY Investment bankers are holding back
UNDERWRITERS new offerings until markets stabilize. But few expect a return
to last year's high level of deal flow anytime soon.
POLITICAL The assassination of Mexico's leading
UNCERTAINTIES presidential candidate has thrown the country into turmoil.
Interest rates are rising, and the peso is weakening. Although
Brazil reached a debt accord with banks, the prospect ef a
socialist winning the upcoming presidential election has made
dealmakers and investors wary.