The Emerging Markets' Dollar-Denominated Debt Crisis

Around the world the story is pretty much the same: companies and corporations are being crushed under the burden of their dollar-denominated debt payments. The problem, which is a direct result of a monetary deflation created by the Federal Reserve and compounded by counter-productive monetary policies by governments and insufficient currency hedging by companies in emerging markets, is threatening economic growth around the world and raising the specter of a once unthinkable chain reaction of international debt default.

In Argentina, where the monetary deflation relative to gold has justified a small devaluation of the peso against the U.S. dollar, President Fernando de la Rua's government and particularly Economy Minister Domingo Cavallo, are handcuffed from taking such action due to the inability of Argentina's corporations to pay back their enormous dollar-denominated loans. If the government were to devalue by 50%, as an example, against the U.S. dollar, the dollar-debt burden of Argentina's corporate sector would increase by that much. But it is doubtful that Argentina will be able to hold off such devaluation for much longer as the country is rapidly losing the foreign reserves necessary to maintain its unorthodox currency board. From February to July, Argentina lost 9 billion of its official dollar reserves. As of last week the country was down to $19 billion in cash reserves.

In Brazil where the real has lost over 20% of its value in just this year, corporations and state-owned enterprises are suffering under the weight of their dollar-denominated debts. Among those suffering the worst in Brazil is Globo Cabo, the country's leading cable provider (to over 6 million homes), laden with dollar debt. Globo Cabo's stock has fallen 50% this year. Another major worry in Brazil is Embratel Participacoes SA (EMT), a unit of Worldcom Inc. (WCOM) and Brazil's leading long-distance carrier. Embratel is especially weighed down by the prospects of paying back U.S. debts out of revenue received in the form of a devalued real, especially since BRR1.5 billion of Embratel's BRR2.7 billion in dollar denominated debt isn't hedged against foreign currency fluctuations.

In Egypt, the problems continue to grow as the government devalued its currency, the pound, last week, only 6 months after the Egyptian Central Bank abandoned its nine-year currency peg in favor of a "managed" peg monetary regime. Corporations with the largest market capitalization like Orascom Telecom and MobiNil are suffering as a result of their dollar-denominated debts in the new era of currency devaluations. Orascom Telecom has had to substitute its dollar holdings by making use of a local currency facility and MobiNil, revealed last week that it was working on raising a fresh amount of financial capital in order to repay a $220 million loan. But the devaluation is making the effort more and more expensive. "With regard to the $220 million loan, every one-piastre move (depreciation in pound-dollar rates) will denote a LE2.2 million loss on that loan," MobiNil's chief financial officer, Ossama Deeb, said last week.

In South Africa, the rand's depreciation against the U.S. dollar has reached all-time lows. As of yesterday, approximately 8.26 rand exchanged for 1 U.S. dollar. The depreciation has made it increasingly disadvantageous for South African corporations to take out badly needed loans in U.S. Dollars. Instead, South African corporations are increasingly turning to the issuance of euro-denominated debt for international capital and with mixed results.

In The Philippines, a major vote of no-confidence was issued when Barclays Capital warned against the actions of the government and central bank in light of the weak peso. Barclays warned against plans of the government to issue $200 million in treasury bills in order to support the government. Barclays stated earlier this week, "Dollar (denominated debt) issuance will be extremely large in the second half of 2001 as the government tries to refinance its maturing debt and part of its budget deficit…Overseas investors may prove equally unwilling to finance the budget deficit at existing spread levels especially when multiple billions of dollars worth of debt refinancing has still to take place…"

In Indonesia, the problem is enormous. The near 80% loss in the value of the rupiah against the dollar, since 1997, has literally decimated the balance sheets of Indonesian entrepreneurs, companies and corporations. The country's largest auto maker, PT Astra International, is carrying a debt of $1 billion, and will have to sell assets in order to generate liquidity necessary for a $200 million principal debt payment due in December of next year. The problems in Indonesia, as in Argentina, have been compounded by deleterious policy prescriptions of the IMF.

Unfortunately we look for things to get worse before they get better. With a United States Treasury and Federal Reserve seemingly bent on cuddling a deflated dollar; with the IMF - the international loan shark, dishing out bad advice in emerging markets in exchange for badly needed cash; and with government after government embracing currency devaluations or permitting currency depreciations under floating monetary regimes, these will continue to be the worst of times for many entrepreneurs, companies and state-owned enterprises in many emerging markets.

Now, the question that must be answered is how bad will the ripple effect be, as emerging market after emerging market comes under pressure from the international investing community and speculators who 1) contemplate moving capital to less risky investments and 2) consider shorting battered currencies.

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Cedric Muhammad

Wednesday, August 1, 2001