A new dimension of currency mismatches in EMEs Michael Chui Bank for International Settlements Global debt dynamics initiative: Inaugural workshop 26th May 2016 These slides were prepared on the basis of joint work with Emese Kuruc and Philip Turner. Many thanks for help producing this presentation to Jhuvesh Sobrun and José Maria Vidal Pastor. This presentation reflects my views, not necessarily those of the BIS.

2 Summary 2003–12: an extraordinary decade of EM-led growth due to: Radical EM policy reforms in the 1990s From 2008, advanced economy central banks boost global liquidity The Governor of the Banco de México: “massive capital inflows into EMEs … fuelled primarily by carry trades … [given] ex ante covered interest rates arbitrage … which in turn generated … meaningful real exchange rate appreciations” (Carstens (2015))

3 Recent dynamics of capital flows to EMEs and debt sustainability

4 Strong financial inflows to EMEs come with large reserves accumulation

5 Portfolio investment and banking inflows have picked up since 2009

6 External debts of private sector have grown across most emerging market economies

7 Global growth led by EMEs (excluding China), but that has come to a halt

8 Corporate debts and currency mismatches

9 Non-bank financial corporations turn to capital markets

10 Foreign currency debts, assets and income of residents – including Residence concept Border Nationality concept ADD = Affiliates of local firms based overseas (excluded from export earnings and resident debt) SUBTRACT = Foreign-owned firms operating in the domestic market (included in export earnings and resident debt) Domestic firms offshore Foreign- owned firms vis à vis non-residents (external) and vis à vis other residents (internal) Corporate cross-border flows require special attention

11 Overseas subsidiaries responsible for almost half of the total issuance

12 It is possible to track some corporate financial flows using balance-of-payments data Trade credit Loans Currency and deposits FDI debt

13 EME corporate debt stocks grow rapidly

14 Aggregate effective currency mismatch measures:

15 Simple aggregate measure suggests improvement

16 Augmented measure indicates similar trend

17 Micro-analysis: through a sample of 280 companies with “tradable” international bond issues

18 Corporates’ foreign-currency bond issuance has risen sharply since the crisis

19 Corporates’ foreign-currency bond issuance has risen sharply since the crisis

20 Vulnerabilities are rising

21 Profitability of non-financial companies is declining

22 Debt-servicing capacity is relatively stable, but …

23 Simply wrong hedges could have important financial implications

24 From a macroeconomic perspective... 1.Aggregate currency mismatches have increased in EMs – but standard residence-based statistics do not take account of debt of offshore affiliates of EM companies. 2.Low world real long-term rates have increased borrowing in global dollar bond markets and raised foreign holdings of local currency domestic government bonds. 3.Lengthening of the average maturity of EM bond debt in their portfolios may make foreign investors more “flighty” as interest rate expectations change. (Has it also accentuated contagion from bond to forex markets?) Corporate sector and broader financial stability risks

25... and a microeconomic perspective 4.Many EM companies face financing challenges:  Lower profitability and increased leverage have made the corporate sector more vulnerable to demand shocks, to currency shocks and to interest rate shocks.  Some firms producing non-tradable goods borrowed heavily in dollars – creating microeconomic mismatching.  Debt-servicing capacity – earnings over interest expense – has been declining since late-2012 (eventhough interest rates have remained low).

26 Avdjiev, S, M Chui and H Shin (2014): “Non-financial corporations from emerging market economies and capital flows”, BIS Quarterly Review, December, pp 67–77. Bruno, V and H S Shin (2015): “Global dollar credit and carry trades: a firm-level analysis”, BIS Working Papers, no 510, August. Caruana J (2016): “Credit, commodities and currencies”, Lecture at the London School of Economics and Political Science, 5 February Carstens, A (2015): “Challenges for emerging economies in the face of unconventional monetary policies in advanced economies”, Peterson Institute for International Economics, Washington, DC, 20 April. Chui, M, I Fender and V Sushko (2014): “Risks related to EME corporate balance sheets: the role of leverage and currency mismatch”, BIS Quarterly Review, September, pp 35– 47. Shek, J, I Shim and H S Shin (2015): “Investor redemptions and fund manager sales of emerging market bonds”, BIS Working Papers, no 509, August. Sobrun, J and P Turner (2015): “Bond markets and monetary policy dilemmas for the emerging markets”, BIS Working Papers, no 508, August. References