Strong Dollar, Weakened World
Back when the U.S. Federal Reserve was doing whatever it could to keep credit flowing, companies and governments in emerging markets went on a borrowing spree in dollars. Now, with the Fed changing course and the U.S. currency rising, all that dollar-denominated debt is becoming one of the weakest links in the global financial system.
In the years after the 2008 financial crisis, lending dollars in emerging markets looked like a great deal all around. Borrowers benefited from interest rates lower than those they would pay in their local currencies, and global investors reaped better returns than they could elsewhere. The debtors seemed a safe enough bet: Their assets and revenues were ample enough in dollar terms, thanks in part to the relative weakness of the U.S. currency -- and, for energy-exporting countries, the high price of oil.
Consequently, capital flooded into emerging markets. By mid-2013, the dollar-denominated debt of non-bank borrowers in developing countries had reached an unprecedented level of more than $4 trillion, according to research by economists at the Bank for International Settlements. Judging from corporate and government bond-issuance data compiled by Bloomberg, the trend persisted through 2014.
Now, those debts are rapidly becoming more onerous. Expectations the Fed will raise U.S. interest rates have attracted investors back to the dollar, pushing its trade-weighted value up 14 percent since mid-2014. Meanwhile, the currencies of some countries -- such as Ukraine, Russia and Brazil -- have fallen even more sharply against the dollar, and the price of oil has declined almost 50 percent. As a result, dollar-denominated debt burdens have grown much larger in relation to the revenues that emerging-market companies and governments -- especially those that rely heavily on oil production -- command.
Here's a breakdown of selected countries' corporate and government bond debt (including some syndicated and bilateral loans), expressed as a percentage of 2014 gross domestic product (with GDP converted into dollars at the exchange rates of March 26):
The more investors become concerned about the sustainability of emerging-market debt, the greater the chance they will aggravate the situation by pulling money out, starting a vicious circle in which capital flight and debt troubles reinforce each other. If regulators want to protect the broader economy, they would do well to start figuring out who stands to bear the most losses and how to prevent contagion.
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