As an exporter, you may be accustomed to the risk of doing cross-border deals. You may also be familiar with the saying that the “business of the business” is the focus of all risk management activities. Perhaps you have insurance policies on your more risky transactions and maybe you’re comfortable with other buyers who have good payment histories in stable economies. Now may be a good time to re-examine your coverage options and comfort level with your buyers, especially if they are in emerging markets. Here are a few reasons why:
Emerging Market Debt and the Domino Effect
A report by Fitch Ratings shows 2015 total foreign- and local-currency private-sector debt increased to 78 percent of GDP in the largest emerging markets: Brazil, India, Indonesia, Mexico, Russia, South Africa and Turkey, with foreign currency denominated debt rising as a percentage of the total. Part of the reason for this increase was yield seeking foreign currency flows to emerging markets supporting easy credit and fueling a borrowing binge in hard currency loans. This flow has waxed and waned, coming to a screeching halt earlier this year then recovering slightly in March and April only to nosedive again this month as the prospects of US interest rates rises edge up.
The rise in private-sector hard currency debt not only heightens bankruptcy risks, it also increases the systemic risk to these country’s economies, their financial systems and sovereign creditworthiness raising political risks.
The problem is a majority of these loans are maturing in the next three years and local currencies have been steadily depreciating for the last two years. Local businesses will find it increasingly difficult to service these foreign currency loans.
Additionally, local banks that offer hard currency loans usually don’t have sufficient loan-loss reserves in place. This will impact banks and their ability to lend. Emerging market bank lending conditions have already tightened in the first quarter of 2016 with non-performing loans on the rise; a further deterioration is expected this quarter. If businesses are experiencing cash flow problems meeting fixed payments and are unable to rollover the debt, their ability to pay receivables will also be impaired.
This domino effect could increase the likelihood of your buyer going into bankruptcy or facing steep currency losses on shipments. When you consider the risk posed by China’s debt binge, the picture gets gloomier still. The IMF recently drew attention to the rising risk in China of corporate defaults leading to bank losses and the ripple effect this could have on the world economy.
The Trouble with China…when, not if
The tipping point may have already been reached. China’s attempt to rebalance its economic growth model in favor of domestic consumption has led to a credit binge of historic proportions. The Economist reports that China’s debt-to-GDP has soared from 150 percent to 260 percent in just a decade. However, as a net creditor China has ample fiscal space to weather these high debt-to-GDP ratios. Of particular importance is the credit trend and the effect this debt has on the economy and productivity.
Non-performing loans have doubled to 5.5 percent of bank lending and that only reflects official numbers. Though China’s shadow banking sector is down to three-fifths of all new credit, a large portion of lending is going into “shadow assets” offering higher rates of return. Bank deposits are guaranteed by the government but shadow lenders are at risk. As banks try to compete with this asset class, they are skirting regulations with their own form of off-balance sheet “shadow lending.”
Want to Learn More?
Contact an EXIM Bank Trade Finance Specialist in your region and find out how you can protect your exports from unforeseen political and commercial risks of doing business in Emerging Market economies.