Walter Molano | The changing tide of emerging market financing
The emerging markets landscape has changed dramatically over the course of the past decade. Booming commodity prices filled government coffers and reduced their need for external resources.
In 1998, Latin America's external debt-to-GDP ratio was 40 per cent. Today, it is 26 per cent of GDP. That's not to say that governments became completely self-sufficient. Instead of relying on external savings, they turned to their domestic markets.
Since 2000, emerging market local currency debt exploded more than fivefold, jumping to US$5 trillion, from under US$700 billion. The three biggest issuers were China, Brazil and Mexico. They comprise more than half of the outstanding local currency obligations. Much of it is owned abroad. In the case of Mexico and Brazil, more than a third is held by foreigners. In China, it's about an eighth.
A reduction in the appetite for emerging market local currency instruments could lead to a decline in international reserves, the devaluation of the currency and an increase in local inflation rates. Such a scenario could be socially and politically destabilising. Therefore, it is important to keep an eye on them.
Another important financing risk is the rapid growth of emerging markets domestic credit. During the past five years, all of the large Latin American countries, except for one, witnessed a significant increase in credit to the private sector, which includes corporate and consumer debt.
Chilean domestic credit, for example, rose from 68 per cent of GDP to 80 per cent between 2010 and 2015. Brazil increased from 46 per cent of GDP to 60.5 per cent of GDP. Colombia went from 33 per cent of GDP to 48 per cent of GDP. Argentina was the sole exception. It remained flat.
The biggest increases were in consumer debt, which accounted for most of the expansion across the regional spectrum. Most countries, except for Argentina, posted 25 per cent-plus increases in consumer debt as a percentage of GDP over the past five years. Chile was the country with the highest level of consumer debt at 35 per cent of GDP. Brazil was next with 26 per cent, followed by Colombia with 20 per cent, and Argentina last, with six per cent of GDP.
Interestingly, there was not much change at the corporate level. It was pretty steady, in the 20 per cent to 30 per cent range. The sole exception was Chile, where corporate debt jumped to 115 per cent of GDP. The reason for this anomaly was probably the cost of funding. Chilean firms find it much cheaper to go to the international capital markets rather than to the domestic banks, thus forcing the local financial institutions to push more credit products on to the consumer market.
It is interesting to see how all of this credit expansion was funded. In the cases of Peru, Brazil and Colombia, it was sourced domestically. This makes these three countries less vulnerable to violent swings in external capital flows. The problems are in Argentina, Mexico and Chile. While Argentine banks cover all of the consumer credit and some of the corporate credit needs, many companies prefer to go abroad for their funding. They probably do this to secure better terms.
The amazing thing is that Chilean banks cover only half of the country's credit needs. This could put many Chilean companies at risk, especially if external liquidity dries up.
The third major change in the emerging market landscape is the new reporting trends by international banks. An estimated US$21 trillion sits in offshore accounts. A good chunk of this money will soon come to light, as banks are forced to report their holdings.
This has important implications for most of the emerging world. Chinese nationals hold approximately US$1.3 trillion abroad. Russian external holdings are estimated at US$800 billion. The three largest offshore holdings in Latin America are Brazilian (US$520 billion), Venezuelan (US$406 billion) and Argentine (US$400 billion). Many governments see this as a potential form of external funding.
The next Argentine administration is expected to announce a tax amnesty plan that could result in more than US$20 billion of repatriated funds. Faced with possible jail sentences, many individuals are warming up to the idea. These funds could result in a massive inflow of capital at the very moment when international investors are heading out the door.
The sea change in the emerging markets financing environment is dynamic. There are forces that highlight possible vulnerabilities, but they could be countered by variables that could result in unexpected inflows.
Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.