ISSUANCE OF BONDS BY EMERGING MARKET ECONOMIES AND THE ROAD AHEAD – BY Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

September 24, 2014 | Posted by bobbysrinivasan << back to blog

The recent release of data by the BIS shows that after the Lehman collapse in 2008, about 50,000 companies in emerging economies such as Brazil, China and Russia suffered a loss of $30 billion, when the dollar surged as safe haven currency. All because the companies held derivative positions and nobody expected currencies to swing wildly.

Observation 1: In a tightly interconnected world, unexpected surprise event in one major economy could have a fall out on other economies.

Janet Yellen of the US Federal reserve announced this week that she plans to tighten the US monetary policy. This pushed the US dollar’s value against its trading partners to a 17-month high as higher rates will make US assets attractive. This is not good news. Since 2008, western central banks have maintained loose monetary policy resulting in low interest rates. Money flowed from the US to the emerging market economies and gobbled up both debt and equities and this enabled the investors to receive higher rates of return from their investments. Russia and China have been borrowing huge monies in US dollars by selling bonds. This is where the risk is. If the US interest rate increase, some of these flow into the emerging markets could go into the reverse, creating unexpected chain reactions.

Observation 2: Remember the announcement last year that the Fed was about to taper its super loose monetary policy and the Indian rupee value dropped from Rs.58 to Rs.68.35 to a dollar.

Company report of China, Russia and India shows that their outstanding bonds amount to $1.2 trillion dollars. Any sell out here, we will have the making of 2008 again. If an Indian or Chinese company defaults on a bond interest payment, it would create a bigger stampede to exit as these companies have sold debt through off-shore vehicles which are hard to track. The worst possibility is if this trend goes hand-in-hand with growing currency mismatches, economic catastrophy will be the outcome. These bonds are denominated in the US dollars and are being serviced by revenues in domestic currencies.

RBI Governor Raghuram Rajan has pointed this out recently about the Indian company mismatches. Currently, property developers in China and energy and utility firms in India have been the most active debt issuers.

The asset management industry in the world is highly concentrated, creating a tendency among the bond investors to act as a herd. Any Indian or Chinese company’s default could create a chain reaction. These bond investors would rush to exit all together at the same time.

For Indian companies, it is time to take a hard look at their overseas borrowing. Our external commercial borrowing is around $250 billion. The cheap US dollar made Indian companies to raise money in dollars as the interest rate spread is more than 7-8%. RBI may have enough foreign reserves for this eventuality. However, it is time for Indian companies to accept that cheap money days are numbered. Going forward in 2015, they should be prepared for currency volatility by appropriate hedging strategies. Failure to do so, these companies could take the country’s future with them.

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