Foreign borrowers wary of dollar rise

China offered investors a cautionary tale this week of what can happen when a company borrows heavily in dollars.

On Monday, Kaisa Group became the first Chinese property developer to default on its dollar-denominated bonds as a housing market slowdown left the company struggling to service its heavy debt burden.

Investors fear such defaults could soon become commonplace as the dollar's growing strength threatens to unravel a glut of global borrowing now estimated to exceed $9tn.

In the years since the financial crisis, companies and governments outside the US have doubled their dollar-based debt, taking advantage of near zero rates and the dollar's exchange rate relative to local currency.

While emerging markets account for the lion's share of borrowing, they are not alone. Global dollar credit to non-bank borrowers in the eurozone has increased from $1.3tn in late 2008 to $1.6tn at the end of September 2014, according to the Switzerland-based Bank for International Settlements, while the UK's share has grown from $800bn to $1.05tn.

There is a reason economic data from the US are being scrutinised by finance ministers and corporate treasurers around the world right now. A stronger dollar means borrowers outside the US require more of their own currency to service their dollar debt. Once the US central bank raises interest rates, refinancing that debt will become more expensive.

The repercussions could be defaults, volatility and waning market confidence.

Concern has risen as the dollar has gained momentum. The dollar index is up more than 13 per cent over the past six months and last week finance ministers of G20 countries urged the US to "minimise negative spillovers" when the Federal Reserve finally raises rates.

For some countries a stronger dollar provides trade benefits, but those with heavy dollar-denominated debt are experiencing "tensions between financial stability and competitiveness", said the International Monetary Fund in its outlook report last week.

Yet some policy makers and corporations remain oblivious to the problem, says Stephen Jen, head of currency hedge fund SLJ Macro.

"It's not that they're ignoring the elephant in the room," he says. "They don't see the elephant."

Critics worry that emerging market corporate bonds in particular have become overinflated, with eager borrowers and lenders encouraged by a commodities super cycle, desire for yield and flood of cheap money on the back of central bank policies.

Emerging market hard-currency corporate bonds, an asset class that hardly existed a decade ago, now amount to an estimated $2tn, bigger than the $1.6bn market in US high-yield corporate bonds.

In India, the corporate sector has borrowed heavily in foreign currencies, with its debt load doubling in the past five years, according to the IMF. In Africa, governments and companies have increased dollar borrowing from $6bn in 2010 to $14bn last year, according to data provider Dealogic. In Russia, thousands of borrowers have mortgages denominated in dollars.

Muddying the waters is the fact that since the financial crisis, lending in dollars has moved from banks to capital markets. According to the BIS, the share of dollar lending via bank loans has fallen from two-thirds in the late 1990s to about 50 per cent last year.

This makes it more difficult to untangle who is at risk in a dollar strength fallout, and more likely that the effects could be widespread, touching asset managers, insurance companies and pension funds across many countries.

Not everyone is overtly concerned. "High dollar debt is not automatically a threat to financial stability," says Neil Shearing, chief EM economist at Capital Economics. "If you dig down, there is a lot of dollar borrowing in emerging markets that is intercompany lending, which is less risky than corporate borrowing on bond markets. And large corporates that have borrowed may well have hedged their dollar debt."

Some governments have also taken steps to avoid trouble. Turkey's central bank is curbing short-term foreign exchange borrowing while Brazil and Russia have raised rates to stem capital outflows and Indonesia introduced rules on January 1 to make it more difficult for non-finance corporations to issue overseas debt. But the rules have caused hardly a ripple in the market.

Steve Barrow, G10 currency strategist at Standard Bank, says warnings from the likes of the IMF and the BIS were designed "to scare the living daylights out of people deliberately" and to ensure they hedge their dollar exposures.

The scale of global dollar credit will rise, he acknowledges. "It is a danger, but if someone keeps warning you need to do something, they will respond. So when US rates go higher, the reaction will not be that bad."

Additional reporting by Jonathan Wheatley

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