The Future of Domestic Capital Markets in Developing Countries

Chapter 15. Corporate Financing Patterns and Performance in Emerging Markets

 Corporate Financing Patterns and Performance in Emerging Markets 15       The sustainability of financial flows to developing countries depends heavily on the health of the corporate sector, which has been at the center of several recent crises. Corporate borrowers now account for more than a fifth of cross-border debt flows, compared with less than 5 percent in 1990, and flows of foreign direct investment (FDI), the dominant form of external financing for developing countries, are ultimately tied to corporate performance. This study examines corporate balance sheet data for major emerging markets to document trends in, and relationships between, corporate financial structure and corporate performance in the 1990s. The chapter is organized as follows. The first section examines shifting patterns of corporate debt dependence in three major regions: East Asia and the Pacific, Europe and Central Asia, and Latin America and the Caribbean. The second section addresses vulnerability to short-term debt, while the third section examines trends in corporate profits. The final two sections are devoted to the benefits and risks associated with external borrowing. The authors would like to thank Jack Glen and William Shaw for comments on an earlier draft. Shifts in Corporate Sector Debt Dependence It is widely accepted that excess corporate leverage was at the heart of the financial troubles of many East Asian developing countries in 1997–98.1 Their total corporate debt grew at a compound annual rate of 16 percent between the end of 1990 and the end of 1997, swelling from $717 billion to $2.4 trillion (or from 80 to 105 percent of national income). Their debt-equity ratio, valued at the market price of equity, rose from 3.8 at the end of 1990 to 4.2 at the end of 1997. The foreign debt of the corporate sector (mainly debt owed to banks) grew at a compound annual rate of 27 percent during the same period, far more rapidly than overall debt. As a share of total corporate debt, foreign debt rose from 6 to 10 percent. The corporate collapses in East Asia and the Pacific in 1997–98 produced sharp overall declines in gross domestic product (GDP) and forced severe and wrenching adjustments in corporate balance sheets; the severity of the adjustments reflected the need for a sharp and sustained shift in the private sector’s financial balance. That shift has occurred. The aggregate current account balance of crisis countries in the region (the four crisis countries— Indonesia, Korea, Malaysia, and Thailand—plus the Philippines) shifted from a deficit of 4.8 percent of GDP in 1996 to a surplus of 2.6 percent in 1998. Over the same period, the budget balance of the region moved from a surplus of 0.2 percent of GDP to a deficit of 1.3 percent. The implied swing in the private sector’s financial balance—equivalent to 8.9 percentage points of GDP—was carried out largely by a severe compression of spending. One key result of this shift into financial surplus was that companies in East Asia were able, in the aggregate, to arrest and partly reverse the sustained rise in corporate debt relative to GDP that occurred through the first half of the 1990s. The corporate “deleveraging” in East Asia had three other important dimensions. First, there was a sharp drop in foreign borrowing. The share of foreign debt in total corporate debt rose steadily between 1990 and 1997 for East Asian economies as a whole and through 1998 for the four crisis economies, but this ratio has fallen sharply since then. Asian companies paid dearly for their brief foray into international borrowing, and the experience has made them far more cautious about foreign currency borrowing, even as their economies have recovered. Also, the shift to a flexible exchange rate regime, by reducing implicit guarantees against  , ,   1. See Dadush, Dasgupta, and Ratha (2000); Dasgupta and others (2000); Radelet and Sachs (1998); World Bank (2000). devaluation risks, has reinforced firms’ reluctance to take on foreign debt. The result is that the foreign currency debt of Asian corporations is now in short supply relative to the demand and is trading at relatively tight spreads compared to similarly rated paper from borrowers in other regions.2 Second, some effort has been made to diversify sources of domestic funding. In East Asia, for example, important efforts have been made to strengthen bond markets, helping to reduce dependence on bank finance...