V Spontaneous Capital Market Financing for Developing Countries

International Monetary Fund
Published Date:
January 1991
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This section discusses the process of re-entry to the international capital markets for developing countries and the factors affecting it. After providing an historical perspective on developing country access to those markets, it describes recent developments in spontaneous portfolio and bank flows. It then highlights some of the obstacles faced by developing countries as they attempt to return to normal borrowing arrangements and discusses techniques to address concerns (particularly regarding transfer and liquidity risks) among foreign porfolio investors. The section concludes by summarizing the factors that may facilitate market re-entry.

Historical Background

Prior to World War II, external financing of developing countries principally took the form of direct investment and sovereign bonds. Bank lending was limited mainly to trade and some project financing. A boom in bond underwriting took place in the 1920s, only to be followed by a virtual disappearance of the market for new issues after 1931, an extreme example of a recurrent pattern.92 After the war, official financing began to play an important role, largely reflecting bilateral development assistance following decolonization, while private financing tended to take the form of traditional bank credits and bond issues were rare. By 1970, more than 50 percent of the long-term external debt of developing countries was owed to official creditors, while bank debt and bonds accounted, respectively, for about 32 percent and 5 percent (Table 9). The relative importance of official debt was, of course, greater in the case of low-income developing countries, representing 84 percent of their total debt, with the share of commercial bank creditors below 5 percent. For the group of severely indebted middle-income developing countries, by contrast, the share of official creditors was about 28 percent, compared with 55 percent for commercial banks and 6 percent for sovereign bond holders.

Table 9.Structure of Developing Country Long-Term Debt(In percent)
All developing countries100.0100.0100.0100.0
Public sector74.782.587.893.2
Official creditors51.335.538.045.2
Private creditors23.447.149.948.0
Commercial banks6.333.036.033.5
Private sector25.317.512.26.8
Memorandum item
Total commercial banks31.650.448.140.4
Severely indebted middle-income countries100.0100.0100.0100.0
Public sector57.176.184.792.1
Official creditors28.417.923.230.9
Private creditors28.758.261.561.2
Commercial banks12.344.850.050.0
Private sector42.923.915.37.9
Memorandum item
Total commercial banks55.268.765.357.9
Low-income countries100.0100.0100.0100.0
Public sector95.894.094.996.9
Official creditors83.765.765.664.9
Private creditors12.128.429.332.0
Commercial banks0.514.113.216.7
Private sector4.
Memorandum item
Total commercial banks4.720.018.319.7
Source: World Bank, World Debt Tables 1989–90.
Source: World Bank, World Debt Tables 1989–90.

Private financing for developing countries increased dramatically in the 1970s and early 1980s, as international bank credit markets gained a competitive advantage over securities markets in channeling the surpluses of oil exporting countries toward the developing world, particularly middle-income developing countries, mainly through the vehicle of general purpose, syndicated bank loans.93 Securities markets were open, however, and in the period 1977–81, for example, publicized new bond issues by developing country borrowers averaged around $3.5 billion a year, or about 9 percent of total international bond issues. Algeria, Argentina, Brazil, Mexico, South Africa, and Venezuela largely accounted for this volume, although Chile, Colombia, the Philippines, and others were also in the market. While this type of financing was not insignificant for the individual developing countries that were frequent issuers, the overall flows through the bond markets paled in comparison with syndicated bank credit commitments, which rose from about $18 billion in 1977 to a range of $30–50 billion a year between 1978 and 1981.

By 1982, commercial banks held 50 percent of the long-term external debt of developing countries, while official creditors held 35 percent—with a marginal increase in the share of multilateral institutions being more than offset by a decline in the share of bilateral creditors. Debt to commercial banks represented of course a much larger fraction of the debt of the severely indebted middle-income developing countries (69 percent), but it had also become a substantial fraction (20 percent) of the debt of low-income developing countries. After 1982, against the background of high real interest rates and deteriorating terms of trade combined with lax domestic policies and a severe curtailment of new lending, a number of major developing country borrowers experienced debt-servicing difficulties and became ensnared in repeated bank debt rescheduling and concerted new money exercises. These countries lost access to voluntary medium-term bank loans as well as to securities markets, even though they generally continued to service their international bonds—a small share of their total debt—on a timely basis. The contagion did not extend, however, to those highly indebted developing countries—including Hungary, India, Indonesia, Korea, Malaysia, Thailand, and others—that had maintained more prudent policies and timely debt servicing.

As a whole, spontaneous medium- and long-term bank credit commitments to developing countries fell from $42 billion in 1982 to an average of $14 billion a year in 1983–88. And while the nominal amount of funds raised through publicized international bond issues by developing country borrowers rose from an average of $3.5 billion a year in 1977–81 to a range of $4–5 billion a year in 1982–88, this represented a sharp decline in their share of total international issues. By 1988, the share of commercial banks in long-term external debt had fallen to around 40 percent for developing countries as a whole, and to 58 percent for the severely indebted middle-income developing countries. The share of bonds in total external debt of the severely indebted developing countries was around 4 percent in 1988, compared with 6 percent in 1982. The closure of the securities markets to developing countries experiencing debt-servicing difficulties during most of the 1980s sharply contrasted with the increasing role of these markets in intermediating payments imbalances in OECD countries.

Over the past two years, however, there have been some indications that borrowers from some developing countries that had experienced debt-servicing difficulties were, after a long hiatus, beginning to regain access to spontaneous flows of private external funding. A substantial part of these new flows have been in the form of securities, marking a return to the historical pattern of capital flows. To date, new issues have been modest, and the phenomenon limited to a narrow range of countries—particularly Mexico, but also Chile, and Venezuela. This incipient process has featured a variety of financing techniques designed to take advantage of ongoing changes in international financial markets while addressing concerns among investors regarding the various risks and transaction costs involved in exposure to developing country borrowers.

Recent Developments

Bank Lending

Spontaneous bank credit commitments to capital importing developing countries (excluding offshore centers) rose to $16.5 billion in 1990 from about $15 billion in 1989; this represented an increase in the developing country share in total international bank credit commitments from about 12 to 14 percent (Tables 10 and A26 and A27). As in the recent past, the bulk of new syndicated bank loans (75 percent) went to developing countries in Asia and was project related. But there was also a notable, albeit modest, resumption in spontaneous bank lending to certain heavily indebted developing countries in Latin America that had rescheduled their debts and were pursuing adjustment programs.

Table 10.Long-Term Bank Credit Commitments to Developing Countries, 1984–90(In billions of U.S. dollars)
Developing countries129.216.022.816.417.518.217.8
Of which:
Spontaneous lending12.713.814.714.111.816.316.5
Capital importing countries128.114.421.416.317.216.817.8
Of which:
Spontaneous lending11.612.213.314.011.514.916.5
Middle East0.
Western Hemisphere16.
Of which:
Spontaneous lending0.
Memorandum items
Other countries31.
Offshore banking centers0.
Source: Appendix Table A26.

Excludes offshore banking centers.

Includes bank loans obtained by Colombia ($1.6 billion in 1989 and $1.8 billion in 1990) on a “semi-concerted” basis to refinance principal payments.

Eastern European countries and entities not included in the developing country category.

Source: Appendix Table A26.

Excludes offshore banking centers.

Includes bank loans obtained by Colombia ($1.6 billion in 1989 and $1.8 billion in 1990) on a “semi-concerted” basis to refinance principal payments.

Eastern European countries and entities not included in the developing country category.

The increase, from $3 billion in 1989 to $3.5 billion in 1990, in spontaneous bank commitments to Western Hemisphere countries conceals the noteworthy re-entry of some Latin American developing countries to voluntary bank lending markets. Spontaneous bank credit commitments to this region in 1989–90 included two large “semi-concerted” loans ($1.6 billion in 1989 and $1.8 billion in 1990) obtained by the government of Colombia from its creditor banks to refinance principal payments falling due in the 1989–94 period (see Section VI). The 1989–90 data also include large loans ($1.1 billion in 1989 and $0.8 billion in 1990) to multinational corporations based in Bermuda. Excluding these loans in 1990, the remaining spontaneous bank credit commitments to developing country borrowers in the Western Hemisphere went to such countries as Chile ($0.3 billion), Mexico ($0.5 billion), and Venezuela ($0.2 billion)—all heavily indebted countries, virtually excluded from the market for nearly a decade, that were involved in restructuring their debts and were implementing adjustment programs. These new credits were mostly project related and thus involved corporate borrowers, from the public as well as the private sectors, except in the case of a $20 million loan made in September 1990 by a Dutch bank to Chile, the first fully voluntary, unsecured, sovereign bank loan to the Latin American region since 1982.

Bank commitments to developing countries in Central and Eastern Europe rose from $3.6 billion in 1989 to $4.7 billion in 1990, reflecting large borrowings in 1990 by the Soviet Union ($3 billion, guaranteed by OECD governments) and Turkey ($1.6 billion).94 By contrast, there were no new bank credit commitments in 1990 for other Central and Eastern European developing countries, including Hungary and Czechoslovakia, two countries that had continuously tapped the syndicated bank loan markets during the 1980s, as uncertainties surrounding the transition to market economies prompted international banks to avoid traditional, unsecured sovereign lending, while private structures to facilitate project lending were not yet in place. Bank credit commitments to African borrowers amounted to $0.6 billion in 1990, compared with $0.5 billion in 1989, and included a relatively large lease-related loan ($0.3 billion) to an Ethiopian airline and a number of smaller project-related loans to Ghana, Kenya, Morocco, and Zimbabwe. Commitments to Middle Eastern borrowers, by contrast, declined sharply to $0.1 billion in 1990, reflecting a one-off entry of Egypt to syndicated bank loan markets in 1989, when a publicly owned Egyptian airline company raised $0.5 billion to finance the leasing of aircraft.

Average terms on spontaneous bank credit commitments to developing countries (excluding offshore centers and Central and Eastern European countries) showed a slight improvement in 1990 as compared with 1989 (Chart 13). Average spreads fell from 68 to 60 basis points and the average maturity increased from about 7 years to around 9 years (Tables 11 and A28). The improvement in spreads largely reflected changes in the composition of borrowers, as certain relatively high-spread borrowers (e.g., Egypt, Kenya, Kuwait) that had tapped the syndicated bank loan market in 1989 did not do so during 1990. Likewise, the average maturity masks a wide dispersion in maturities across countries. Adjusting for changes in country composition between 1989 and 1990, there appears to have been a general tendency for spreads on syndicated bank credits to increase while maturities tended to lengthen.

Chart 13.Terms on International Bank Lending Commitments, 1979–90

Sources: Organization for Economic Cooperation and Development, Financial Market Trends; International Monetary Fund, International Financial Statistics; and Fund staff estimates.

1New publicized long-term international bank credit commitments.

Table 11.Developing Countries: Terms on Syndicated Bank Credits, 1988-901
(In years)(In basis points)(In years)(In basis points)(In years)(In basis points)
Average for developing countries8.9577.3688.660
Of which:
Hong Kong5.2694.6314.462
Average for Eastern European countries8.34911.950
Of which:
Source: Organization for Economic Cooperation and Development (OECD).

Excludes concerted commitments. Country classifications are those of the OECD.

Source: Organization for Economic Cooperation and Development (OECD).

Excludes concerted commitments. Country classifications are those of the OECD.

The incipient revival in spontaneous bank lending to developing countries that have experienced debt-servicing difficulties has in a number of cases been facilitated through the use of certain financing techniques— including leasing, loans linked to commodity prices, and price-hedging mechanisms. Examples include (i) the leasing arrangements by Egypt Air in 1989 and Ethiopian Airlines in 1990, where the corresponding loans were collateralized by a lien on the aircraft being leased; (ii) the borrowings by two Mexican copper companies (Mexicana de Cobre in July 1989 and Mexicana de Cananea in October 1990) hedged against the risk of adverse copper price movements through copper swaps and collateralized by long-term copper sales contracts; and (iii) the oil-indexed loan contracted by the Algerian petroleum company, Sonatrach, in early 1990 under which lenders benefit in terms of an increase in the spread over the London interbank offered rate (LIBOR) in the event of a sustained change in the price of oil.

Portfolio Flows

According to OECD data, publicized new bond issues by developing country borrowers (excluding those from offshore centers) rose somewhat from $4.5 billion in 1989 to $5.1 billion in 1990. Given the sharp decline in bond issues worldwide, this represented an increase in the share of bond issuance by developing countries from 1.8 to 2.2 percent (Table 12). These data, however, understate total developing country borrowings through the bond markets particularly since private placements are not included. Information gathered from alternative sources (some of which is included in Table A29) suggests that the understatement may well exceed $1.5 billion in 1990. In any event, conditions for bond issuance by developing country borrowers appear to have tightened in the fourth quarter of 1990, reflecting not only a general shift to shorter-term, more liquid, and lower-risk instruments following developments in the Middle East, but possibly also a degree of “market saturation” following a bunching of issues in the first three quarters of 1990.

Table 12.International Bond Issues by Developing Country Borrowers, 1984–901(In millions of U.S. dollars)
Developing countries24,387.88,113.34,210.33,711.45,974.34,515.35,131.2
Capital importing developing countries24,112.88,088.34,210.33,711.45,974.34,515.35,131.2
South Africa1,013.9802.237.635.5
Middle East82.035.020.0
Western Hemisphere107.4168.8712.1350.3876.7730.9
Trinidad and Tobago107.4100.6105.378.9
Memorandum items
Offshore banking centers285.6383.3568.7228.0285.1199.075.0
Hong Kong185.658.3325.9204.574.0
Other countries4
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Foreign bonds and Eurobonds. Excludes bonds issued in the context of commercial bank debt restructuring and financing agreements.

Excludes offshore banking centers.

Includes $500 million of sovereign bonds placed on a voluntary basis with commercial bank creditors, in exchange for $400 million of restructured bank debt and $100 million of fresh money.

Not included in the developing country category.

Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

Foreign bonds and Eurobonds. Excludes bonds issued in the context of commercial bank debt restructuring and financing agreements.

Excludes offshore banking centers.

Includes $500 million of sovereign bonds placed on a voluntary basis with commercial bank creditors, in exchange for $400 million of restructured bank debt and $100 million of fresh money.

Not included in the developing country category.

As in previous years, Asian countries that had not rescheduled their debts accounted for the bulk of new bond issues by developing countries in 1990, raising $2.8 billion or more than one half of the developing country total. The most active Asian issuers in 1990 included corporate borrowers from Korea, India, Indonesia, and Malaysia. International bond issues by borrowers from Central and Eastern European developing countries fell from $3.4 billion in 1989 to $2.3 billion in 1990. The main borrowers in 1990 included public or quasipublic institutions from Hungary, Turkey, Czechoslovakia, and the Soviet Union. The Hungarian borrowings included a Eurodollar bond issue by the State Development Bank enhanced by a principal guarantee extended by the World Bank under its newly established Expanded Cofinancing Operations (ECOs) program. The reduced use of bond markets by Eastern European developing countries reflected, in part, the withdrawal of Bulgaria from these markets, following the emergence of debtservicing difficulties, and, more generally, international investors’ heightened concern regarding the risks of major economic transitions, concern reflected in the downgrading of the debt instruments of a number of Eastern European countries by credit rating agencies.

A significant development in developing country access to international bond markets in the past two years was the limited re-entry, after almost a decade, of certain Latin American countries that have embarked on programs of economic adjustment and debt restructurings. This re-entry was led by Mexican public and private sector corporations that began re-entering international bond markets starting in late 1988. In 1990, Venezuelan corporations also began using these markets. While most of the issues by Mexican and Venezuelan corporations were denominated in U.S. dollars, the deutsche mark and Austrian schilling markets were also tapped. According to OECD data, and excluding sovereign bonds associated with restructurings, Mexican and Venezuelan borrowers raised $0.5 billion and $0.2 billion, respectively, on a voluntary basis during 1990 through publicized bond issues. Alternative sources, which include private placements (Table A29), put the amount of new bond issues in 1990 at $2.2 billion for Mexican borrowers and $0.3 billion for Venezuelan borrowers. The limited restoration of spontaneous access to bond markets for these countries has mainly benefited corporations with established international reputations and export bases and was facilitated in a number of cases by the use of collateralization techniques described further below.

Average terms on unsecured developing country bond issues included a wide range of premiums over “risk-free” rates (Table 13).95 For instance, premiums on 1990 bond issues by Mexican public sector corporations ranged between 250 and 420 basis points, significantly higher than those paid by sovereign borrowers from Hungary (100–140 basis points), India (100–160 basis points), or Turkey (50–230 basis points), but substantially lower than premiums in the 600–700 basis point range on unsecured issues by Mexican or Venezuelan private sector corporate borrowers. Even these latter premiums have tended to be somewhat lower than those implied in secondary market prices for the old syndicated bank debt of the respective governments. While maturities on issues by new entrants remained on the short-term range (five years or less) during 1989–90, maturities on issues by certain established developing country borrowers (e.g., Hungary and Turkey) tended to decrease toward this range in 1990. The tightening of bond market conditions for developing country borrowers in the fourth quarter of 1990 was mainly reflected in a virtual halt of new issues, rather than a combination of higher premiums and shorter maturities.

Table 13.Average Terms on International Bond Issues by Selected Developing Country Borrowers
New entrants
Secured issues5.01604.73602.83204.6280
Unsecured issues
Public sector5.08705.02507.54203.63803.8350
Private sector2.08002.07303.06005.0600
Secured issues5.5250
Unsecured issues
Public sector5.0260
Private sector5.07305.0650
Other selected borrowers
Algeria (public sector/unsecured)5.01205.01805.0100
Hungary (public sector)
Secured issues10.0190
Unsecured issues6.0708.01207.02307.0907.01406.01305.0905.6140
India (public sector/unsecured)10.01607.01605.0907.01607.0100
Turkey (public sector/unsecured)8.014010.82208.51607.02307.0505.0190
Sources: Statistical Appendix Table A29; and International Financial Statistics.Note: M = maturity in years; P = premium in basis points, defined as the difference between the bond yield at issue and the prevailing yield for industrial country government bonds in the same currency and of comparable maturity.
Sources: Statistical Appendix Table A29; and International Financial Statistics.Note: M = maturity in years; P = premium in basis points, defined as the difference between the bond yield at issue and the prevailing yield for industrial country government bonds in the same currency and of comparable maturity.

Equity portfolio flows to developing countries take various forms, including foreign purchases of shares in a developing country corporation directly in the local stock market; developing country corporate equity issues in developed country stock markets; or indirect foreign purchases of shares in developing country corporations, through, for example, “country funds” that specialize in investing in emerging developing country stock markets. Published aggregate statistics on these types of flows are unavailable, but a broad idea of the orders of magnitude may be obtained on the basis of partial information. A study by the World Institute for Development Economics Research (WIDER) estimated the market value of the stock of nonresident portfolio equity investments in emerging markets at the end of 1989 at around $15 billion, comprising about $8 billion in assets held by country specific or multicountry funds and about $7 billion invested in equity of developing country corporations issued either in developed stock exchanges or in local developing country markets.96 These investments, which constituted about 2 percent of foreign equity holdings in institutional portfolios of OECD countries, have been concentrated in Taiwan Province of China, Korea, India, Indonesia, Malaysia, the Philippines, and Thailand, although equity investments into certain Latin American countries (particularly Chile and Mexico) and some Eastern European countries (particularly Hungary) have increased recently.

Gross foreign portfolio equity flows into emerging markets are estimated to have averaged about $1 billion a year during the past four years, again largely concentrated on Asian developing countries. Mainly as a result of substantial declines in share prices in certain emerging stock markets during 1990, the market value of the developing country stocks held by foreign portfolio investors fell sharply in 1990.97 Country-specific or multicountry funds have been an important vehicle for equity portfolio flows to emerging markets. The gross initial size of each fund has normally been in the $50–150 million range. By late 1990, there were over 100 closed-end publicly offered country-specific and regional funds for investment in emerging markets and at least an equal number of open-end and privately placed closed-end funds. In the second half of 1989 and early 1990, a rapidly increasing number of country-specific and regional funds were launched, and a large number rose to very high premiums over net asset value. A situation of oversupply consequently emerged during the course of 1990 and, as share prices for most funds declined, investor interest was considerably reduced. At the same time, sophisticated portfolio managers appear to have increasingly bypassed country funds and invested directly in the more open emerging markets. The fall in the Tokyo stock market exacerbated matters as Japanese investors sold country fund shares in order to meet margin calls. The void left by the withdrawal of Japanese investors was not filled by other international investors, partly in reflection of the portfolio shifts associated with the Middle East crisis. By the fourth quarter of 1990, most country funds were trading at substantial discounts relative to net asset value and new issues had come to a virtual halt.

Despite the slowdown in new issues of country funds during 1990, resources raised by such funds for investment in emerging markets for the year as a whole are estimated to have been in the $1.5–2 billion range, including around $1 billion raised for investment in Eastern Europe but not fully deployed in the region. During the year, some developing country corporations also raised new foreign financing, albeit in very modest amounts, through equity securities issued in industrial country stock exchanges. For instance, in April the Hungarian state-owned travel agency and tour operator, IBUSZ, became the first Eastern European company simultaneously to place shares in Western developed markets and the recently opened Budapest exchange. The international-tranche issue, listed in the Vienna stock exchange, reportedly raised around $7 million. In June, the privatization of Poland’s Foreign Trade Enterprises, known as “Universal,” involved the flotation of $20 million in equity issues, of which $6.6 million was made available to foreign investors on a private placement basis. In July, there was a public equity offering by the Chilean privately owned telephone company, CTC, which raised $98.3 million ($90.5 million net of commissions and other costs) through the issue of American Depository Receipts (ADRs) on the New York Stock Exchange—reportedly the first international public equity offering by a Latin American corporation since 1963.

Foreign portfolio investors have also acquired equity participations in developing country corporations in the context of privatization programs. During the past two years, the privatization programs in a number of developing country (e.g., Argentina, Chile, Indonesia, Malaysia, Mexico, and the Philippines) have involved flotations of shares accessible to nonresident portfolio investors either because some of these shares have been issued and placed in industrial country securities markets (as in, for instance, the privatization of Telmex, the Mexican telephone company) or, more commonly, because the shares issued in the local developing country market have been available to nonresident investors, either directly or through a country fund. In some cases, as discussed previously, privatization programs have allowed investors to swap eligible external debt for privatization shares at a discount. It should be noted, however, that debt-equity swaps represent a change in the composition of nonresident claims on developing countries and thus do not entail of themselves a net inflow of fresh financing to developing countries. In effect, owing to such potential problems as round-tripping and lack of “additionally,” debt-equity swaps may even entail net foreign exchange outflows.

Re-Entry to Capital Markets: Addressing Investor Concerns

Investors holding claims on developing country borrowers must be in a position to evaluate the risks involved; they must assess the risk of default (counterparty credit risk) and the risk that a government may not make foreign exchange available to the borrower to meet his debt-servicing obligations (country transfer risk). Investors must also consider the ease with which the claim is likely to sell at a quoted price should they wish to dispose of it before maturity (liquidity risk). Availability of information is critical to this evaluation process. In the absence of sufficient information, lenders may not be able to price the instrument offered by the borrower and would not accept it even if the borrower were willing to pay a very high premium. Investors’ willingness to acquire new debt claims may in fact decline in response to very high-premium offers, because such offers may reasonably be interpreted as a sign of actual or impending financial weakness. Consequently, for re-entry to take place, investors’ concerns must be addressed in a way that would not only make pricing possible, but would also bring prices to a range where new borrowing is a realistic possibility.

Counterparty Credit Risk and Country Transfer Risk

In the case of a sovereign borrower, where there is no intermediary that can restrict payments, there is, in effect, no “transfer risk,” but counterparty credit risk remains. Corporate credit risk is familiar terrain for investment analysts, who can base their assessments on balance sheets, cash flow positions, business prospects, and quality of information. Country transfer risk is more difficult to assess, since it depends on the government’s ability to marshal resources, which is a function of a host of economic, social, political, and other factors subject to large uncertainties and not always amenable to measurement.

During the 1970s, it was sometimes argued that country transfer risk was negligible because “countries do not go bankrupt.” Behind this opinion was the perception, not entirely unfounded, that debtor countries and their bank creditors could count on official reserves if debt-servicing difficulties posed a serious threat to the integrity of the system. This view was, of course, progressively modified in light of the experience of the 1980s, and careful, if still problematic, assessments of country transfer risk have become relatively formalized. These assessments, increasingly quantitative, tend to give significant weight to selected economic variables but also take into account political factors.

The assessments by international credit rating agencies, often a key input in portfolio investors’ decisions, illustrate the prominence given to transfer risk. Moody’s Investors Service, for instance, in evaluating the risk of a particular international bond issue, considers separately the individual counterparty credit risk and the more general country transfer risk; the final overall rating, however, follows a “sovereign ceiling rule” whereby no international bond issuer can be rated above the sovereign rating given to the country where the borrower operates. Moody’s thus takes the view that, although a non-sovereign entity may for various reasons be able to honor its obligations better than its government over a given period of time, it is in general not possible to insulate a borrower consistently and over a long period of time from the sovereign risk of its home country.98 Some form of a sovereign ceiling rule seems to be widely accepted by market participants. In effect, the international bond issues by major OECD governments set a benchmark cost of funds rate for their country, with other borrowers from the same country normally having to pay a premium above this rate. A somewhat greater variance of market views seems to exist, however, when it comes to developing country borrowers, partly because there are a number of private sector companies from developing countries that have, over the past decade, established a better track record of external debt servicing than their governments.

The good debt-servicing record of a number of private sector companies in developing countries reflects, inter alia, the flexibility with which these companies have adapted to changed economic conditions; and an improved policy environment in many developing countries associated with a reduced readiness on the part of the respective governments to resort to foreign exchange restrictions to deal with balance of payments problems. Even in cases where quantitative restrictions on access to foreign exchange at the official rate have been present, governments have in a number of cases allowed unrestricted access to flourishing parallel markets, which have been used as necessary by private sector debtors to remain current on their obligations. Such developments in some cases seem to have relaxed market perceptions of rigid linkages between country transfer risk and the counterparty credit risk of an individual developing country corporate borrower. This may in part explain the fact that some private sector companies from developing countries have recently been able to raise funds through unsecured international bond issues at somewhat lower yields than those implicit in the secondary market prices for the syndicated bank debt of their respective governments. Nonetheless, concerns among investors regarding country transfer risk continue to be crucial and need to be addressed by developing country borrowers entering international capital markets. There are a number of ways in which country transfer risk may be reduced.

At the most fundamental level, it is widely recognized that there is no substitute for sustained implementation of sound macroeconomic policies and structural reforms if a lasting reduction of country transfer risk is to be achieved. The maintenance of a realistic exchange rate, the restoration of fiscal and monetary discipline, movements in real wages that are not grossly misaligned with productivity increases—all are crucial to re-establish business confidence and develop a strong export base and debt-servicing capacity. The salutary effects of sound macroeconomic policies, however, may take time to materialize, especially where the shift toward better policies follows a period of economic mismanagement that has seriously undermined a government’s credibility. A wait-and-see attitude may in effect be the response from investors, even while sound macroeconomic policies are being implemented.

Decisive, significant steps in structural reforms can play a crucial role in reducing these remaining uncertainties, provided that macroeconomic adjustment policies continue to hold a steady course. Concrete progress in key structural reforms provides evidence of a government’s political capacity to overcome entrenched interests and replace outmoded and inefficient structures. Reforms that more closely integrate tradable sectors to the world economy, such as liberalization of the exchange, trade, and direct investment systems, can have particularly beneficial effects on reducing investor perceptions of transfer risk. Integration in effect raises efficient productive capacity and debt-servicing capacity, while increasing the economic and political cost of subsequently imposing restrictions on external payments and flows. Progress in the reform process itself would be expected to strengthen supportive political constituencies, thus lowering the risk that new policies would be reversed.

The perception of country transfer and sovereign risk on new flows may also be reduced through the restructuring of existing debt obligations. Where a debtor country faces a severe liquidity crisis, new lenders would resist providing fresh money. In this case, agreements with existing creditors on debt rescheduling or refinancing, which would require a concerted approach since incentives to free rides exist, could provide the “breathing space” needed to implement adjustments and thus pave the way for new lending. In cases where a more serious solvency problem exists, elements of debt and debt-service reduction would need to be included in restructuring agreements if country transfer risk is to be reduced. Solvency is at issue where there is a widespread market perception that a sovereign debtor’s capacity to pay (i.e., its discounted stream of expected income available for debt servicing) falls short of its contractual debt obligations (measured in present value terms). This problem (often referred to as debt overhang) is likely to complicate the implementation of adjustment policies owing to, for instance, the vulnerability of the fiscal position to external shocks.

Also, in view of the limitations of informal subordination mentioned earlier, this problem would represent a major obstacle for the resumption of new lending and the recovery of investment, as lenders and investors—foreign and domestic-would fear that their new claims on the country’s resources would not be given priority relative to old debt contracts.99 By including elements of debt and debt-service reduction where appropriate, restructuring agreements would, in combination with sound domestic policies, help ease the constraints on adjustment, investment, and new lending, thus raising the country’s capacity to pay and reducing transfer risk. Experience with recently implemented bank debt packages suggests that these packages may have immediate favorable effects on confidence and, therefore, on risk premiums.

The perception of transfer risk may be reduced for certain classes of debt by giving give them an effective payment priority and excluding them from rescheduling exercises. Well-established, fully enforceable seniority arrangements do not exist for international contracts involving sovereign risk and subordinating old syndicated bank credit has been difficult, but developing countries experiencing payments difficulties have at times succeeded in protecting their access to flows vital to their economies, such as trade and interbank credit, by giving them priority in servicing. On balance, however, commercial bank debt workouts have been much less effective in protecting new flows than official debt reschedulings under the aegis of the Paris Club, which have strictly adhered to the principle that debts contracted after a cut-off date agreed to at the time of the first rescheduling would not be subject to subsequent reschedulings. This principle has been essential to the maintenance of access to new official bilateral loans, including credit and guarantees from official export credit agencies.

Market participants have often noted that it has been difficult to raise new commercial bank loans, including loans to heavily indebted countries now regaining access to other segments of international markets, because of a perceived lack of flexibility in creditor countries’ provisioning requirements.100 In many cases (e.g., Belgium, Canada, Japan, and the Netherlands), these provisioning requirements have been specifically triggered by debt-servicing difficulties as reflected in payments arrears or debt rescheduling, and regulations typically specify that provisions must be maintained for at least five years after the most recent rescheduling agreement. In other cases (e.g., Germany, the United Kingdom, and the United States), a recent rescheduling or an episode of arrears would be a factor justifying a presumption that provisions would be necessary. As a general rule, regulatory authorities will clearly be cautious about reducing provisioning levels on debtors whose performance has improved, at least until it can be demonstrated that the improvement is not temporary. Nevertheless, regulatory authorities in a number of countries do provide some flexibility in such cases. In Canada, for example, the Superintendent of Financial Institutions may remove a country from the provisioning list two years, rather than the normal five years, after the most recent rescheduling, if the country has demonstrated its ability to raise spontaneous, unsecured financing with a maturity exceeding one year on international capital markets.

While it can be expected that provisioning requirements will ease only slowly, it should be noted that loan classes with superior debt-servicing records—such as short-term trade credits, cofinancing, or credits with third-party guarantees—are in some countries specifically exempted from provisioning requirements. In the United States, for example, specific provisions (Allocated Transfer Risk Reserves—ATRRs) are established by regulators on particular claims that are classified as value impaired and are not required on claims that continue to be serviced in full and would not necessarily be required on new money if there were a presumption that such claims would be serviced. Despite the limitations in credibly privileging new flows through differential payments policies, however, secondary market prices for developing country debt have reflected perceptions of differential payments priorities. For instance, in December 1990, the average yield to maturity on Venezuela’s restructured bank debt was about 17.5 percent compared with 13 percent on its sovereign (nonrestructured, nonconcerted) floating rate notes; the yield to maturity on Argentina’s syndicated bank debt was about 40 percent, compared with 23 percent on its sovereign bonds and about 21 percent on its Trade Credit Deposit Facility; and the average yield to maturity on Mexico’s restructured bank debt was 18.5 percent, compared with around 14 percent on interbank credits. This tiered pricing is considered to have made room for some of the new unsecured issues by corporate developing country borrowers at comparatively favorable yields.

Country transfer and counterparty credit risks, as well as risk premiums, can also be substantially reduced through various collateralization techniques, which provide a lender with the right to take possession of certain specified assets if the borrower fails to pay. The collateral pledged to secure a claim may be a physical good or a document that gives the claim holder the right to payments or assets. Investors generally expect pledged assets to meet certain basic conditions: easily ascertainable market value, an understood structure, and uncomplicated and certain procedures for disposal. Assets that meet these conditions and have been used by developing country borrowers to remove or reduce transfer risk include income streams generated overseas, liquid assets (such as bank deposits, securities, or precious metals) located overseas, and physical assets used outside the country (such as boats or aircraft). The recent use of collateralization by developing country borrowers that are new entrants to the international capital markets has mainly involved private sector corporate borrowers or public sector corporations raising debt without explicit guarantees from their central governments. Recent borrowing by the Mexican telephone company provide an illustration of collateralization and its effects.

In March 1990, Telefonos de Mexico (Telmex), which was then not yet privatized, raised $280 million at an initial yield of 11 percent through a privately placed 5-year bond issue secured by a lien on its accounts receivable from a U.S. telephone company. Since the telephone traffic patterns between Mexico and the United States are such that the U.S. telephone company was expected to owe Telmex upward of $1 billion a year for the foreseeable future, the principal risk to the investor was the risk that the U.S. company would refuse to pay Telmex and Mexican transfer risk was thus virtually eliminated. The initial yield on the Telmex collateralized issue was about 320 basis points above the yield then prevailing on 5-year U.S. Government bonds, which may be compared with an initial yield of about 475 basis points over the yield on U.S. Government bonds paid on the company’s unsecured July 1990 issue ($150 million, 1.5-year maturity).

It needs to be noted that there are limitations on the use of collateralization to secure new borrowings. First is the issue of potentially reduced seniority (subordination) for creditors with unsecured claims; pledging assets that could be used to service any obligation in effect raises the risk of loss for such creditors.101 A related limitation of collateralization is its potential effect on a borrower’s prospects for future market access on an unsecured basis. By unduly encumbering its assets through liens, a borrower may significantly raise the cost at which it could raise such funds. Finally, where valuation of assets is not straightforward, debtors may overpay to get liquidity and deprive themselves of future flexibility. In all, it is doubtful that collateralization techniques could mobilize on a sustained basis substantial new inflows to developing countries. At times, however, such techniques may serve a useful purpose, especially for nonsovereign borrowers that are new entrants to international capital markets.

Country transfer risk can also be reduced through explicit third party guarantees (or insurance) attached to developing country borrowings. The value of the guarantee to an investor is related mainly to the degree and type of coverage as well as to the creditworthiness of the guarantor. The degree to which the guarantor exposes itself to risk is not only dependent on the coverage of the guarantee but also on the extent to which the guarantor enjoys such advantages vis-à-vis other claim holders as seniority, better capacity to collect payments, or superior knowledge of the borrower. Explicit guarantees by multilateral institutions or official OECD governments have the greatest value for private investors or bank creditors. Prominent examples include cover provided by official export credit and insurance agencies, and by explicit guarantees or insurance provided by multilateral institutions (e.g., the World Bank’s Expanded Cofinancing Operations, International Finance Corporation, and Multilateral Investment Guarantee Agency). Terms and conditions for guarantees or insurance provided by official export credit agencies are determined on a case-by-case basis. Cover may be available for short- and medium-term export-related credits extended by either an exporter (suppliers’ credit) or a commercial bank, but export credit agencies have tended to concentrate on middle-income developing countries that have averted payments difficulties or to some developing countries experiencing debt-servicing difficulty but implementing sustainable policies. According to unpublished data compiled by the OECD, new commitments to provide medium- and long-term cover to developing countries in 1988 totaled $25.4 billion, which may be compared with $11.8 billion in medium- and long-term spontaneous bank credit commitments to developing countries (excluding offshore centers) in that year. On balance it appears that in recent years officially supported export credits to developing countries have been significantly greater than non-guaranteed export financing from commercial banks.102

Liquidity Risks and Transaction Costs

A key consideration for an investor assessing an asset’s attractiveness is its liquidity, that is, the degree to which the asset can be bought and sold readily at prevailing market prices. The liquidity of securities issued by industrial country borrowers varies widely, from bond issues of national governments and equity claims on major corporations at one end of the scale—for which markets are normally deep and transaction costs low—to more speculative stocks and bonds of smaller or new companies for which markets may be much thinner. Securities issued by borrowers from developing countries typically fall at the latter end of the spectrum. Issues are usually small in scale, particularly for borrowers other than the government and the largest parastatal enterprises, while domestic capital markets are thin and underdeveloped. Foreign investors, therefore, face the prospect that transactions that are small in relation to the size of their own portfolios may nevertheless be large relative to the market. Moreover, transaction costs and risks incurred through clearance and settlement procedures in local markets may be relatively high. In combination, these factors may provide strong disincentives for investment in instruments issued by developing country borrowers.

A number of techniques have been used to try to address these difficulties. One approach is to place and trade securities directly on an established exchange outside the country of the issuer, a fairly common practice for the stock of major corporations from industrial countries. In the United States, foreign equity may be issued and traded on an exchange by setting up American Depository Receipt programs (ADRs).103 The registration and disclosure requirements that need to be satisfied for public issues in most established markets are typically onerous and may be prohibitively expensive for developing country issuers, although they may be reduced, for example, by marketing through private placements. In the past, this latter technique has reduced initial costs, but liquidity in the secondary market has been typically limited. Recent regulatory changes in the United States (Regulation S and Rule 144a of the Securities and Exchange Commission) have liberalized provisions in this area, although liquidity concerns remain for sub-investment grade paper. An alternative route is the packaging of a number of securities issued by developing country borrowers in an investment fund. Such funds may be attractive to investors because shares of the fund are traded on established exchanges and information costs are reduced, thus potentially offering a deeper market while pooling transaction costs.

Facilitating Market Re-Entry

In sum, developing country borrowers attempting to regain access to spontaneous private financing in international markets confront difficult obstacles. Negative market perceptions are not easy to remove in the face of, inter alia, concerns about interruptions and reversals in adjustment and structural reform efforts, poor debt-servicing records, the complexities in evaluating sovereign risk, and the absence of well-established and enforceable seniority arrangements to privilege new private flows. Nevertheless, as discussed, few highly indebted middle-income developing countries, particularly from Latin America, have in the past two years initiated a modest return to spontaneous market access, following a long period of exclusion. While limited in scope, their initial experiences point to a number of factors likely to characterize a more generalized process of market re-entry.

Sound macroeconomic policies accompanied by wide-ranging structural reforms are critical to regaining the confidence of creditors and investors. Where excessive debt burdens give rise to serious doubts that new flows could be credibly protected from contagion effects, a major reorganization of the old debt, including by means of debt and debt-service reduction, is often also required. Given such a context, the transition process may be facilitated at the margin by a number of other factors, including the insulation of new flows, the establishment of differential debt payment policies, collateralization, and supportive guarantees or insurance from external agencies. Market re-entry may also be conditioned by measures to reduce transaction costs and liquidity risk. Private placement of securities issues and other vehicles may be helpful in this regard.

Recent experiences of re-entry to the international capital markets bring to light three further factors that can help make the transition successful. First, the developing country borrowers recently gaining access have for the most part been corporations, both from the public and private sectors, rather than central governments. Most sovereign borrowers of the re-entering developing countries were in the process of restructuring their debts, including through debt and debt-service reduction, and the time was thus not ripe for them to attempt tapping voluntary sources of funds on any significant scale. Re-entry for these sovereign borrowers must therefore wait until investors have had time to reassess new risk-return trade-offs and examine the improved reliability of price signals from deeper and more liquid secondary markets for their old debts. In contrast, re-entering developing country corporations have been helped by the increased availability of information that has allowed foreign investors to identify strong balance sheets and good business prospects. Second, international bond and equity markets have constituted important points of re-entry. Since the role of bank lending to developing countries in the foreseeable future is expected generally to be limited to project, trade, and interbank credits, and since large pools of investment funds worldwide are increasingly being channeled through securities markets, any significant resumption of market access for middle-income developing countries will probably focus on these latter markets. Finally, market participants report that flight capital has been an important source of demand for many of the international bond and equity issues of new developing country entrants. As a result of cultural, family, and business connections, developing country nationals or residents holding substantial assets abroad may be relatively better able to gauge the significance of policy changes in their countries and to assess the risks involved in holding claims on a given corporation. It is thus not surprising that pools of flight capital—which often became significant just before the loss of spontaneous market access by a number of heavily indebted middle-income developing countries—are now among the first sources to respond to attempts by developing country borrowers to tap international securities markets. This phenomenon again highlights the importance of sound policies that send clear and credible signals to those markets and help restore investor confidence.

Note: This section was prepared by Augusto de la Torre, Alessandro Leipold, and Can Demir.


For greater detail, see Eichengreen and Lindert (1989).


Two developments are considered central in explaining the comparative advantage of the international banking market in “recycling” the oil surpluses. First, there was a de facto widening of the official safety net in OECD countries in favor of money center banks, which reduced the risk of holding deposits in the international banking system. Central banks and deposit insurance agencies moved to assume a larger portion of default risk on money center deposit liabilities, while the official sector’s informal encouragement for banks to play an active role in the recycling process was perceived to be backed by implicit understandings regarding the availability of lender-of-last-resort facilities. Second, legal innovations in syndicated loan contracts increased the risk of default to developing country borrowers by aggregating risks of various borrowers within the same developing countries (through cross-default clauses) and tightly binding the interests of creditors (through sharing clauses). For a discussion of these topics see Folkerts-Landau (1985).


These figures include $1.5 billion in 1989 and $3 billion in 1990 in bank credit commitments to certain Eastern European countries classified under other countries in Table 10.


Rates on bond issues by the major industrial countries are used as a proxy for the theoretical risk-free rate.


According to the International Finance Corporation’s (IFC) Emerging Stock Market Data Base, during the 12-month period ended December 1990, total return indices (measured in U.S. dollar terms) declined sharply in Brazil (68 percent), the Philippines (52 percent), Taiwan Province of China (51 percent), Argentina (38 percent), Portugal (34 percent), and Korea (27 percent). Total return indices of some markets, however, rose significantly, including Venezuela, (556 percent), Greece (88 percent), Chile (31 percent), Colombia (26 percent), Mexico (25 percent), and India (16 percent). These performances may be compared with a 6 percent decline in the S&P 500 over the same period.


Other international rating agencies include Standard & Poor’s and Political Risk Services (PRS). The latter specializes in country risk assessments for less creditworthy countries that are not normally rated by Standard & Poor’s and Moody’s. PRS calculates medium-term country ratings based on four equally weighted factors: capital repatriation regulations, export payment delays, fiscal and monetary policies, and external indebtedness.


The disincentive effects of excessive debt burdens on new lending and investment have been discussed at length elsewhere. See, for instance, Frenkel and others (1989).


While specific provisioning regulations vary from country to country, average bank provisioning levels against problem country exposure exceeds 50 percent in all of the main banking center countries except Japan. Further information on national regulatory frameworks is contained in International Monetary Fund, International Capital Markets (1990), Section V.


Negative pledge clauses in loan contracts are the main legal device used by lenders to reduce this risk of subordination through collateralization in new loan contracts. Through negative pledge clauses, a lender may block any pledge of collateral on a new contract, except if the debtor offers him a comparable security. Other borrowing vehicles, like leases on particular capital goods, can sometimes offer an alternative.


For further discussion, see Johnson, Fisher, Harris (1990).


ADRs are U.S. dollar-denominated equity-based instruments issued in the United States. ADRs are backed by a trust containing stocks of non-U.S. companies and set up with a U.S. bank by an intermediary who buys those stocks in foreign markets. The price of ADR certificates and dividends received by investors depends on the performance of the underlying ordinary shares that are held by the bank as custodian. Owners of ADRs are always able to convert these claims into the underlying securities as desired. The creation of an ADR does not necessarily constitute a listing on a U.S. stock exchange but represents a separate process that improves the marketability in the U.S. of equity securities issued abroad. In particular, ADRs may be traded directly among U.S. investors, with clearance and settlement handled by the custodian bank in the United States. Thus, potentially expensive and risky clearance and settlement on foreign markets are avoided.

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