The hid­den debt bur­den of emerg­ing mar­kets

Financial Mirror (Cyprus) - - FRONT PAGE -

As cen­tral bankers and fi­nance min­is­ters from around the globe gath­ered for the In­ter­na­tional Mon­e­tary Fund’s an­nual meet­ings here in Peru, the emerg­ing world is rife with symp­toms of in­creas­ing eco­nomic vul­ner­a­bil­ity. Gone are the days when IMF meet­ings were mo­nop­o­lised by the prob­lems of the ad­vanced economies strug­gling to re­cover from the 2008 fi­nan­cial cri­sis. Now, the dis­cus­sion has shifted back to­ward emerg­ing economies, which face the risk of fi­nan­cial crises of their own.

While no two fi­nan­cial crises are iden­ti­cal, all tend to share some tell­tale symp­toms: a sig­nif­i­cant slow­down in eco­nomic growth and ex­ports, the un­wind­ing of as­set-price booms, grow­ing cur­rent-ac­count and fis­cal deficits, ris­ing lever­age, and a re­duc­tion or out­right re­ver­sal in cap­i­tal in­flows. To vary­ing de­grees, emerg­ing economies are now ex­hibit­ing all of them.

The turn­ing point came in 2013, when the ex­pec­ta­tion of ris­ing in­ter­est rates in the United States and fall­ing global com­mod­ity prices brought an end to a multi-year cap­i­tal­in­flow bo­nanza that had been sup­port­ing emerg­ing economies’ growth. China’s re­cent slow­down, by fu­el­ing tur­bu­lence in global cap­i­tal mar­kets and weak­en­ing com­mod­ity prices fur­ther, has ex­ac­er­bated the down­turn through­out the emerg­ing world.

These chal­lenges, while dif­fi­cult to ad­dress, are at least dis­cernible. But emerg­ing economies may also be ex­pe­ri­enc­ing another com­mon symp­tom of an im­pend­ing cri­sis, one that is much tougher to de­tect and mea­sure: hid­den debts.

Some­times con­nected with graft, hid­den debts do not usu­ally ap­pear on bal­ance sheets or in stan­dard data­bases. Their fea­tures morph from one cri­sis to the next, as do the play­ers in­volved in their cre­ation. As a re­sult, they of­ten go un­de­tected, un­til it is too late.

In­deed, it was not un­til af­ter the erup­tion of the 1994- 1995 peso cri­sis that the world learned that Mexico’s pri­vate banks had taken on a sig­nif­i­cant amount of cur­rency risk through off-bal­ance-sheet bor­row­ing (de­riv­a­tives). Like­wise, be­fore the 1997 Asian fi­nan­cial cri­sis, the IMF and fi­nan­cial mar­kets were un­aware that Thai­land’s cen­tral-bank re­serves had been nearly de­pleted (the $33 bln to­tal that was re­ported did not ac­count for com­mit­ments in for­ward con­tracts, which left net re­serves of only about $1 bln). And, un­til Greece’s cri­sis in 2010, the coun­try’s fis­cal deficits and debt bur­den were thought to be much smaller than they were, thanks to the use of fi­nan­cial de­riv­a­tives and cre­ative ac­count­ing by the Greek gov­ern­ment.

So the great ques­tion to­day is where emerg­ing-econ­omy debts are hid­ing. And, un­for­tu­nately, there are se­vere ob­sta­cles to ex­pos­ing them – be­gin­ning with the opaque­ness of China’s fi­nan­cial trans­ac­tions with other emerg­ing economies over the past decade.

Dur­ing its do­mes­tic in­fra­struc­ture boom, China fi­nanced ma­jor projects – of­ten con­nected to min­ing, energy, and in­fra­struc­ture – in other emerg­ing economies. Given that the lend­ing was de­nom­i­nated pri­mar­ily in US dol­lars, it is sub­ject to cur­rency risk, adding another di­men­sion of vul­ner­a­bil­ity to emerg­ing-econ­omy bal­ance sheets.

Even where data ex­ist, the fig­ures must be in­ter­preted with care. For ex­am­ple, data col­lected on a pro­ject-by-pro­ject ba­sis by the Global Eco­nomic Gov­er­nance Ini­tia­tive and the In­ter-Amer­i­can Dialog could pro­vide some in­sight into Chi­nese lend­ing to sev­eral Latin Amer­i­can economies. For ex­am­ple, it seems that, from 2009 to 2014, to­tal Chi­nese lend­ing to Venezuela amounted to 18% of the coun­try’s an­nual GDP, and Ecuador re­ceived Chi­nese loans ex­ceed­ing 10% of its GDP. Chi­nese lend­ing to Brazil was closer to 1% of GDP, while lend­ing to Mexico was com­par­a­tively triv­ial.

But ac­tual dis­burse­ments may have fallen short of the orig­i­nal plans, mean­ing that these coun­tries’ debts to China are lower than es­ti­mated. Al­ter­na­tively – and more likely – the data may not in­clude some projects, lenders, or bor­row­ers, mean­ing that the debts could be much higher.

More­over, other forms of bor­row­ing – such as trade fi­nance, which is skewed to­ward shorter ma­tu­ri­ties – are not in­cluded in these fig­ures. Cur­rency-swap agree­ments, which have been im­por­tant for Brazil and Ar­gentina, must also be added to the list. (This high­lights the im­por­tance of track­ing net, rather than gross, re­serves.)

In short, though emerg­ing economies’ debts seem largely mod­er­ate by his­toric stan­dards, it seems likely that they are be­ing un­der­es­ti­mated, per­haps by a large mar­gin. If so, the mag­ni­tude of the on­go­ing re­ver­sal in cap­i­tal flows that emerg­ing economies are ex­pe­ri­enc­ing may be larger than is gen­er­ally be­lieved – po­ten­tially large enough to trig­ger a cri­sis. In this con­text, keep­ing track of opaque and evolv­ing fi­nan­cial link­ages is more im­por­tant than ever.

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