1. Debt & Firm Vulnerability Jack Glen IFC March 2004

2. Why Do Firms Get into Trouble? Poor Management Technological Innovation Market Competition Demand Declines Business Cycle Crisis

3. Problem: Fixed Debt Service FX Denominated Debt Mismatched Revenues/Expenses FX Impact on Demand Short-Maturity Debt Inability to Roll-over Interest rate volatility Demand Declines Interest Coverage

4. How to Measure Leverage? Aggregate Measures External Debt Ratios Consumer Debt Component Firm-Level Measures Accurate, but what to Count? Reveals Distribution of Exposure Ability to Service Debt Varies

5. Excess Leverage? Domestic Bank Credit

6. Excess Leverage? Spot the Emerging Market Country Median, Total Liabilities/Total Assets

7. Declining East Asian Debt Levels Total Liabilities/Total Assets, Median

8. Korea: Total Liabilities/Total Assets % of Companies

9. Short-term Debt Vulnerability?

10. Too Much Short-Term Debt? Median Current Liabilities/Total Assets OECD, Low Middle & Upper Middle Income Countries

11. Too Much Short-Term Debt? Spot the Emerging Market Country Median, Total Current Liabilities/Total Assets

12. Excess External Leverage?

13. Private Flows to Emerging Markets $ Billions

14. East Asian Corporate Borrowers LT Debt/Total Debt, Firms with FX Debt & with no FX Debt Allayanis, Brown & Klapper (2003)

15. How Does Foreign Debt Impact Results? Allayanis, Brown & Klapper (2003) Foreign debt no worse than local debt for stock prices & interest coverage FX debt is used because it is longer tenor FX debt is used most when FX sales are available

16. Cash Flow and Interest Coverage Glen (2004) Cash Flow Volatility Business Cycle Currency Depreciation Interest Rate Increases ICR=EBITDA/Interest Expense What is impact of these factors on ICR?

17. The Data Osiris 41 Countries 1994-2001 Manufacturing 7 Sectors 44,424 Firm Years

18. Interest Coverage Ratio All Countries & Firms, EBITDA/Interest Expense, 2000

19. Interest Collection Rate Brazil, All Firms (149), 2000

20. Thailand Interest Coverage Ratio (Median), GDP Growth (%) & Interest Rates (%)

21. The Findings Significant Business Cycle Effect -5% ΔGDP –1 Δ ICR Significant Sector Differences General Manufacturing Hit Hardest Significant Interest & Inflation Effects Both Negative & Economically Large

22. Developed and Emerging Markets Better fit for Emerging Markets GDP impact same DM sensitive to Inflation EM sensitive to Interest Rates

23. Impact of a 5% Decline in GDP All Countries & Firms, EBITDA/Interest Expense, 2000

24. Turnover & Margins Returns correlated with Business Cycle Margin Effects Hard to Discern Turnover Effects Strongly Negative

25. Conclusions Debt Service a major source of Vulnerability Business Cycle Impacts Significant Measuring Vulnerability Product Market Volatility Sensitivity to Business Cycle Does Market Structure Permit a Management Response?