The rising dollar translates into an increase of the debt burden of issuers located in emerging markets if they use the proceeds of their bond issuance to invest in projects denominated in local currency.
“Should the US dollar – the dominant international currency – continue its ascent, this could expose currency and funding mismatches, by raising debt burdens,” said Claudio Borio, head of the BIS’s monetary and economic department in its quarterly review. “The corresponding tightening of financial conditions could only worsen once interest rates in the United States normalise,” he warned.
In the past 6 months, the ruble lost most ground versus the dollar: it is down 35%. Most other emerging market currencies also lost significant ground, with the notable exceptions of commodity importers China and India (see chart).
Hidden currency exposure
The ‘bank of central banks’ noted that cross-border loans to emerging market economies, issued mainly in US dollars, amounted to $3.1 trillion in mid-2014. And total international debt securities issued by emerging market companies stood at $2.6 trillion, of which three quarters was in dollars.
However, the net exposure of emerging market companies to dollar debt is even much higher than this, the BIS notes. These companies increasingly borrow abroad through debt securities issued by subsidiaries abroad. These within-company flows are disguised as foreign direct investment. If the overseas bond proceeds are repatriated onshore to invest in domestic projects with little foreign currency revenue, the firm will face currency risk. According to BIS data, so-called within-company flows from China, Brazil and Russia have increased markedly over the past years.
Fund selectors in Europe are still pretty confident about emerging corporate bonds though. Our latest data collected this month suggest about a quarter of them will increase exposure, unchanged from September. However, the share of fund buyers planning to sell emerging market debt has doubled, though it stays relatively low at 16%.