V Recent Developments in Private Market Financing for Developing Countries
- International Monetary Fund
- Published Date:
- January 1992
An important recent development in private financing for developing countries has been the restoration of access to voluntary financing for several countries with recent debt-servicing problems.80 This process of market re-entry gathered momentum in 1991, with the improvement in economic prospects for these countries. Much of the increased financing was provided through international bond and equities markets; and, in contrast to the initial re-entrant countries, recent borrowers have included not only countries that are current with their commercial bank creditors but also some with significant arrears. The sources of demand for re-entrants’ issues have also broadened to include a wider range of institutional and retail investors in a larger group of industrial countries. Meanwhile, voluntary bank lending has remained limited.
Several factors have influenced the way in which some developing countries have regained access to international capital markets (i.e., through the securities markets rather than bank lending). These include changes in securities market regulations in industrial countries, industrial country receptivity to risk, and constraints on banks’ lending that are due in part to a deterioration in their financial performance.
Developing Country Access to Voluntary Financing
Against the background of improved economic prospects and reduced borrowing costs for several countries, private market financing for capital importing developing countries rose in 1991 by 9 percent to $30 billion (Table 8).81 The additional flows reflected in part increased bond financing to a number of Latin American countries that had experienced debt-servicing difficulties in recent years. At the same time, Asian countries that had avoided debt-servicing difficulties were able to maintain or expand their access to private market financing. Private flows to European countries, however, dropped sharply, reflecting a halt in lending to the former U.S.S.R., although some Eastern European countries maintained market access. Flows to African countries remained low. Among other (non-capital importing) developing countries, two Middle Eastern countries significantly increased their borrowing, largely in the form of syndicated bank credits.
|Capital importing developing countries||23.5||28.0||30.4|
|Other developing countries||—||0.1||10.4|
|Offshore banking centers||2.3||3.3||2.8|
Re-entrant Countries’ Access to Bond and Equity Financing
International bond issues by developing countries rose sharply in 1991 to $10.7 billion, in large part reflecting the gathering momentum of market reentry by a number of countries that have experienced debt-servicing difficulties (Table A23). Bond issues by the five main re-entrants—Argentina, Brazil, Chile, Mexico, and Venezuela—amounted to $5.8 billion in 1991, compared with $2.6 billion in 1990 and $0.8 billion in 1989.82 Mexico and Venezuela continued to deepen and diversify their access to international bond markets, while Argentina, Brazil, and Chile returned to these markets for significant amounts for the first time since 1982. Mexico remained at the forefront of the re-entry process, but its share in voluntary bond financing for the five re-entrant Latin American countries fell from an estimated 84 percent in 1989-90 to 52 percent in 1991. Borrowing by these countries continued at a heavy pace in early 1992, with issues of $0.9 billion in January alone.
Argentine and Brazilian borrowers raised the equivalent of $2.3 billion on international bond markets in 1991 and a further $1 billion in early 1992. Recent issues by public borrowers from these two countries have included two Eurodollar offerings by Argentina in an amount of $500 million, and eight Eurodollar and one ECU issues by three Brazilian public sector corporations and one state-owned bank in an amount equivalent to $1.3 billion. As is the case with Mexico and Venezuela, the renewed access by public sector entities from these countries has facilitated issues by private companies. Five Argentine and five Brazilian private sector companies have raised $480 million and $1,045 million, respectively, in the international bond market since September 1991.
The increased availability of bond financing has generally been accompanied by an improvement in market terms. This is most apparent in Mexico, the re-entrant with the longest experience in this market. Yield spreads at issue on unsecured Mexican public sector bonds fell further during the course of 1991, to an average of 228 basis points during the second half of the year, a reduction of 40 percent compared with the spread of 1990.83 More recently, in February 1992, Pemex (the state-owned oil company) sold five-year bonds that carried a spread of 215 basis points. At the same time, the initial maturity of public unsecured bond issues lengthened from an average of 3.8 years during the second half of 1990 to an average of 5.7 years during the second half of 1991, while Nafinsa and Pemex were able to issue 10-year bonds in late 1991. Terms for Mexican private sector borrowers were generally harder than those for the public sector, but they have improved over time.
Terms on new issues by more recent re-entrants have not been as favorable as those achieved by Mexico, although yield spreads on issues by Argentina dropped from 510 basis points for the September issue to 375 basis points for the November issue. In contrast, yield spreads for Brazilian borrowers remained high, averaging 525 basis points for the public sector and 650 basis points for private sector borrowers. The maturity of the bonds recently issued by Argentine and Brazilian public sector borrowers has generally been in the range of two to three years.
Initially, re-entrant borrowers tapped primarily the U.S. dollar sector of the Eurobond markets, which has accounted for an estimated 87 percent of issues since 1989. More recently, borrowers have placed bonds in a wider range of currencies—including pound sterling, deutsche mark, ECUs, pesetas, Austrian schillings, and Canadian dollars—to diversify the currency composition of their liabilities.
Recent bond issues by re-entrant developing country borrowers, particularly in Mexico, have contained a number of special features to make them attractive to investors. Early issues were often backed by collateral or asset pledges in order to reduce the extent of transfer risk faced by investors. Early redemption options have also been common. More recently, as yields have declined, equity-linked debt instruments have been used by Mexican issuers to provide investors with greater potential for capital gains. In early 1991, Cemex launched the first convertible Euromarket issue by a Mexican entity. Since then, two other Mexican companies, Tamsa and Apasco, have issued equity-linked debt instruments, and in December 1991, Nafinsa placed the first stock exchange index-linked bond for a Latin American borrower.
Market re-entrant countries have also used various types of borrowing facilities, such as commercial paper programs, in order to expand their range of borrowing options and gain flexibility in approaching the markets. As in bond markets, Mexico has been the most active country in this area. Seven Mexican companies reportedly arranged Euro-commercial paper programs with financial intermediaries in 1991, raising some $550 million (Table A24). In addition, Petrobras (the Brazilian state-owned oil company) set up a $200 million Euro-commercial paper facility in December 1991. Mexican borrowers have also established several Euro-medium-term note (EMTN) programs, including programs featuring multicurrency options, while Bariven (a wholly owned subsidiary of the Venezuelan state oil company) established an EMTN program for $1 billion in February 1992. While institutional investors reportedly account for a growing share of the market for these instruments, the reflow of flight capital continues to be an important source of funding.
Finally, re-entrant countries have regained access to the international equity market, including through large international share offerings in the context of privatization programs. Mexican companies have raised about $3.6 billion abroad through equity offerings with international tranches, while Telefónica de Argentina raised the equivalent of some $850 million in a public offering in December 1991. Three Venezuelan companies raised about $200 million in February 1992 through global depository receipts (GDRs). Of particular note, Venprecar (a steel company) recently made the first Latin American equity offering in which all shares sold—including those traded on the Caracas Stock Exchange—will be quoted in U.S. dollars. Following the $100 million raised by the Chilean Telephone Company in 1990, Chilectra, an electric distribution company in Chile, raised $72 million in February 1992 through the placement of ADRs. Finally, shares in Manila Electric Company were sold internationally in December 1991 in the context of the first Filipino privatization to be financed through equity issues.
As the equity cash market has grown, interest in related derivative products has increased. So far, the derivatives introduced have been mainly for Mexican shares; several warrants have been launched outside Mexico by major banks, and in September 1991 the Chicago Board Options Exchange introduced a stock option on Telmex ADRs, the first exchange-traded option on a Latin American equity. Also, call warrants were sold in the context of Venprecar’s share offering.
While the focus of this section is on market reentrants, it is important to note that developing countries that avoided debt-servicing problems have expanded their access to international bond markets during the period under review. Excluding the five re-entrant Latin American countries, the Organization for Economic Cooperation and Development (OECD) data suggest that bond issuance activity by developing countries in 1991 was at its highest level since 1986 at $6.1 billion, compared with $5.6 billion in 1990 (Table A23). Among Eastern European countries, Hungary placed seven bond issues during September 1991-March 1992, including a yen placement totaling ¥ 50 billion; while Czechoslovakia made Eurodollar and Euro-yen bond offerings in November 1991, raising $200 million and ¥ 10 billion, respectively. Nonetheless, compared with 1990, the initial yield spread widened for both Hungary and Czechoslovakia, owing in part to uncertainty caused by economic and political reforms in Eastern Europe and the former Soviet Union. Turkey tapped the Eurodeutsche mark and the Euro-yen markets in 1991 for DM 500 million and ¥ 10 billion, respectively, at a spread of some 230 basis points. Other recent issuers included China, Korea, Thailand, and South Africa; the last of these in particular made a successful return to international capital markets-after an absence of about six years—with three issues in deutsche marks and ECUs.
Developing countries also have made increasing use of the international equity market, particularly the dynamic East Asian economies. In addition, China made its first public equity offerings to foreign investors in 1991, including placements of an estimated $80 million by China Southern Glass Company and Shanghai Vacuum. Also of note, a South African insurance company (Liberty Life) raised $143 million through the first international equity offering from a South African company in nearly 15 years.
In contrast to the experience with bond and other security issues, medium- and long-term bank loan commitments to capital importing developing countries dropped from $20.6 billion in 1990 to $18.0 billion in 1991 (Table A25).84 This decline paralleled a fall in international bank syndication activity for industrial country borrowers. Banks’ reluctance to extend credit to developing countries reflects primarily their own difficult balance sheet situation and their previous experience with nonperforming claims on some of these countries. It has also been influenced in some cases by regulatory factors, including risk weights under the Basle Accord and regulatory provisioning requirements. Under the Basle Accord, loans to developing countries that are not members of the OECD or lenders under the General Arrangements to Borrow (GAB) carry a 100 percent risk factor in the determination of the capital-asset ratio; other sovereign loans carry a zero risk factor. The cost of lending has also increased as a result of regulations that require banks to establish loan-loss provisions against exposure to developing countries with recent debt-servicing problems.85 While it is generally recognized that these regulatory factors result from genuine prudential considerations, authorities from developing countries have expressed concern that they could lead to undue credit rationing if not adjusted in a timely fashion to reflect sustained improvements in developing countries’ debt-servicing capacity.
In spite of the decline in banks’ loan commitments to developing countries, two Middle Eastern borrowers (not classified as capital importing developing countries) were able to obtain substantial access to international bank credits. In the absence of new money packages, concerted commitments dropped to zero.
Asian and Middle Eastern developing countries accounted for the bulk of new bank credit commitments to developing countries in 1991. New commitments to Asian countries rose by $1.4 billion, mainly on account of increased lending to Indonesia, Korea, and, to a lesser extent, China and Thailand. Regarding Middle Eastern borrowers, the Saudi Arabian Monetary Authority established a $4.5 billion loan facility in May 1991; this was Saudi Arabia’s first significant loan in recent years. The Government of Kuwait signed a $5.5 billion syndicated loan facility in December 1991, its first significant external borrowing since 1984. In contrast, new commitments to European countries dropped by $3.1 billion to $1.7 billion, largely reflecting the halt in lending to the former U.S.S.R. Commitments to Latin America declined to $2.5 billion in 1991, comprising mainly a refinancing loan to Colombia and officially guaranteed trade credits to Mexico.86 African countries received only about $0.4 billion of loans from commercial banks in 1991, down somewhat from the previous year.
OECD data on the terms of international bank lending indicate that the terms of such lending hardened in 1991, including for OECD borrowers. The average spreads on voluntary loans to developing countries rose from 66 basis points in 1990 to 70 basis points in 1991; excluding loans to Kuwait and Saudi Arabia, the spread in 1991 equalled 97 basis points. At the same time, average maturities shortened from 9.8 years in 1990 to 6.2 years in 1991, while facility fees have reportedly remained high.
The secondary market price of bank claims on developing countries tended to rise in 1991. The weighted average price for bank claims on the 15 heavily indebted countries87 increased by some 28 percent during 1991 to 51 cents a dollar at the end of the year (Chart 8). This rise reflected higher prices for claims on Chile, Mexico, and Venezuela, as well as other countries, including some with large arrears to banks. Prices for claims on Argentina and Brazil rose by 94 percent and 32 percent, respectively, during the first three quarters of the year, before dropping by 4 percent and 14 percent, respectively, during the fourth quarter of the year, as the market grew more uncertain about the economic outlook of these countries. These prices began to recover in 1992 against the background of active negotiations with banks on debt packages.
Chart 8.Secondary Market Prices of Bank Claims on Selected Indebted Countries
Sources: Salomon Brothers; and ANZ Grindlays Bank weekly secondary market price report.
1Argentina, Bolivia, Brazil, Chile, Colombia, Côte d’Ivoire, Ecuador, Mexico, Morocco, Nigeria, Peru, the Philippines, Uruguay, Venezuela, and Yugoslavia.
In contrast, the price of claims on Eastern European countries (including the former U.S.S.R.) was broadly unchanged at about 67 cents on the dollar during the first three quarters of 1991, but dropped by about 30 percent in the last quarter of the year (Chart 9). The price for claims on the former U.S.S.R. fell from 75 cents bid/95 cents offer at the end of September 1991 to 45 cents bid/50 cents offer at the end of December 1991, as the former U.S.S.R. had difficulty in servicing its external debt.
Chart 9.Secondary Market Prices of Bank Claims on Selected Eastern European Countries
Sources: Salomon Brothers; and ANZ Grindlays Bank weekly secondary market price report.
1Bulgaria, former U.S.S.R., and Poland.
In contrast to the retrenchment in primary lending activity, there are increasing indications of greater bank involvement in the secondary market for bank claims. Initially, this increased interest reflected banks’ efforts to rationalize their loan portfolios. In the recent past, however, greater emphasis has been placed on trading book operations, per se, which, combined with the expansion in the market participant base to institutional investors, contributed to a further surge in trading volume in 1991 (to an estimated $200 billion).88 Concurrently, standardization of documents and trading practices improved the transparency and liquidity of the market. As in the case of the bond market, the secondary market’s investor base has broadened from specialized institutions and flight capital to include institutional investors. As the market expanded and deepened, the range of market broker-dealers has also expanded, providing for a decline in margins and a further evolution of trading practices and products.89 The expansion in product range is being directed primarily toward derivative products and has started with simple put and call options aimed at reducing effective maturities. The introduction of market-traded derivative instruments, including options on indices, is envisaged for later in 1992. With the significant evolution of the market, financial authorities have devoted greater attention to the adequacy of the regulatory and supervisory structure, which to date is based essentially on self-regulatory mechanisms by individual firms, reinforced by the activities of a traders’ association.
Factors Affecting Market Access for Developing Countries
The greater availability of voluntary external financing and the improving terms of this financing can be attributed to five main factors. First, sustained implementation of sound macroeconomic policies has been pivotal in reducing perceptions of country transfer risk. Second, accompanying structural reforms, particularly in the financial sector and in the area of privatization, have made investment opportunities in these countries more attractive. Indeed, the upbeat response of international capital markets—in terms of both volumes and country borrowers—emphasizes the importance of borrowers’ sustaining adjustment and reforms that contribute to a lasting improvement in their economic and financial situation. This is the critical factor for minimizing the risks of renewed disruptions to voluntary market access—disruptions that would also adversely affect the ongoing process of repatriation of flight capital and foreign direct investment inflows.
Third, policy efforts have been accompanied by progress toward the restructuring of existing commercial indebtedness through market-based debt and debt-service reduction operations, thus addressing concerns about the disincentive effects associated with an excessive debt burden. Fourth, market re-entrant countries have established solid records of servicing securitized claims, even during the 1980s when debt service to banks was interrupted or subject to renegotiation. Finally, there has been a fall in certain transaction costs for accessing international capital markets as a result of, inter alia, regulatory changes and increased dissemination of information regarding borrowers’ creditworthiness, including through the actions of credit rating agencies.
As discussed above, some developing countries have regained access to international capital markets through the issuance of securities rather than by bank lending. This fact reflects several factors including changes in securities regulations in industrial countries, industrial country receptivity to risk, and constraints on bank lending.
Changes in Securities Regulations in Industrial Countries
Certain recent regulatory changes in industrial countries have facilitated, or have the potential to promote, developing country access to international bond markets. In particular, the Japanese authorities took steps in June 1991 to ease the credit rating standards for public placement of bonds in the Samurai market.90 These minimum standards were lowered from single-A to triple-B for bonds issued directly or guaranteed by governments.91 These changes were aimed at facilitating access for some countries—such as Hungary and India—which had been downgraded to triple-B status. Hungary took advantage of this change in its abovementioned yen issues in late 1991.
In the United States, regulatory changes were implemented in 1990 to reduce the transactions costs and liquidity problems facing developing country issues in U.S. capital markets.92 Moreover, in June 1991, the SEC issued proposals that would exempt foreign companies from certain disclosure and accounting regulations provided that these countries met equivalent regulations in their home countries. In Canada, the Ontario Securities Commission has already adopted such a measure with respect to Mexican companies.
The minimum rating requirements for foreign bond issues in the Swiss market were abolished in January 1991. Previously, a floor credit rating of triple-B applied. Measures are also under consideration that would remove potential constraints such as the minimum size of issues and business borrowers’ capitalization.
Industrial Country Receptivity to Risk
In recent years, the largest markets in industrial countries for bond issues by developing countries have been those in the United States and, to a lesser extent, Germany. A combination of factors may explain investors’ receptivity in these two markets, including the availability of information on the borrowers’ prospects as well as institutional differences.
The greatest investor interest in developing country bond issues appears to have emerged in two distinct types of markets: first, markets with an established tradition of placement of noninvestment grade, high-yield corporate bonds, supported by the widespread availability of credit assessments by well-established credit-rating agencies; and second, markets with widespread retail networks of universal banks that investors perceived as also providing de facto credit ratings for certain investment instruments.
The U.S. market is the leading example of the first type where credit ratings and market reports are widely available. Under these circumstances, the expected return and risk of bonds issued by developing countries can be gauged by individual investors when forming their portfolio allocation decisions. Moreover, in the case of Latin American reentrants, placement in the U.S. market is facilitated by the familiarity deriving from the issuers’ close geographical proximity and history of relatively close commercial ties.
An important factor in the placement of developing country bonds in the German market is the role played by the universal banks. Traditionally, these banks have maintained close client relations at the retail level and, in the context of legal responsibilities linked to bond prospectuses, have been perceived as providing implicit creditworthiness judgments. This perception has been reinforced by the relative infrequency of foreign bond defaults. Thus, universal banks have been able to combine credit assessment and distribution services for bond issues. It should also be noted that there too, geographical proximity and historical links have facilitated the placement of bonds from certain developing countries (e.g., Hungary, Turkey, and, to a lesser extent, Czechoslovakia).
Constraints on Bank Lending
As discussed in Sections II and IV, the financial performance of banks continues to be affected by substantial nonperforming assets (most recently involving domestic loans) and binding capital requirements. To strengthen their balance sheets, several banks have taken steps to rationalize their portfolios through curbs in new loans, securitization, and direct loan sales. The latter has included the disposal on the secondary markets of claims on developing countries—the pace of which picked up in 1991 as the price of such claims recovered.
Under the capital adequacy standards established by the Basle Accord, exposures to non-OECD/GAB governments carries a 100 percent risk weight in the calculation of the ratio of capital to risk-adjusted assets. Accordingly, in order to maintain the same level of risk-weighted capital, banks in countries that adhere to the Accord would be required to hold a minimum of $8 for every $100 in loans to developing countries outside the OECD/GAB area; a transitional requirement of 7¼ percent has been in effect since the end of 1990. Under certain circumstances, these regulatory requirements could discourage lending to such countries, particularly if banks are capital-constrained and the spread on the loan does not offset the cost of raising the incremental capital required.93
Several industrial country regulatory authorities require, as an element of prudential policy, that banks maintain loan-loss provisions against loans to a wide range of developing countries that have previously defaulted or whose debt has recently been restructured. In making new loans to such borrowers, banks would normally be required to increase their levels of reserves, and this would raise the cost of lending—a requirement that does not apply to nonbank investors. As noted in previous capital market reports, some regulatory jurisdictions (e.g., Canada, the United Kingdom, and the United States) have established procedures for “graduating” borrowers from the provisioning requirements following the demonstration of a sustained improvement in creditworthiness. Others (e.g., Japan) maintain a five-year minimum period since the most recent event of restructuring or default. A third group of countries (e.g., Belgium and France) appears not to have established graduation procedures as yet.
In discussing the impact of regulatory-induced provisions, it must be noted that the actual level of provisioning is mainly the result of market-induced pressures. Markets have tended to interpret a bank’s high provisioning level as the sign of a strong balance sheet and thus an ability to withstand other adverse shocks. In some countries (e.g., Germany), provisioning is also encouraged by favorable tax treatment of provisions. As a result, in practice many banks have actually exceeded their regulatory provisioning requirements.
El-Erian (1992) examines the process of market re-entry for a group of developing countries.
Based on OECD figures, adjusted to include concerted new money commitments in bank financing packages. These data exclude private placements.
These figures are based on issues reported in the International Financing Review, the Financial Times, and Euroweek. Estimates are somewhat higher than those reported by the OECD and shown in Table A23, which do not include private placements.
Yield spreads are measured relative to industrial country government paper of the same currency and maturity.
In view of the sizable impact in recent years of various adjustments to the stock of bank claims on developing countries (e.g., contractual principal reduction resulting from market-based operations, transfer of claims to the official sector owing to the exercise of guarantees, write-offs, and capitalization of interest arrears), the analysis of voluntary bank lending is based on commitment data, rather than estimates of outstanding cross-border bank claims.
It may be noted that, in some cases, market-induced provisioning levels are above the regulatory requirements.
In February 1992, the Mexican state oil company (Petroleos Mexicanos) obtained a $100 million one-year revolving bank credit to finance imports of oil products. This represented the first syndicated bank loan by a Mexican borrower since the early 1980s.
The group includes Argentina, Bolivia, Brazil, Chile, Colombia, Côte d’Ivoire, Ecuador, Mexico, Morocco, Nigeria, Peru, the Philippines, Uruguay, Venezuela, and Yugoslavia.
The face value of the volume of bank claims on developing countries exchanged in the market.
Broker-dealers participating in the secondary market formed the LDC Traders Association in December 1990, with the aim of increasing market efficiency through the standardization of documents and trading practices.
For investments made through country fund vehicles used by retail investors, the Japanese Securities Dealers Association has designated 32 countries, of which 7 are developing economies, where Japanese securities firms may channel individual investors’ funds. The designated developing economies are Hong Kong, Indonesia, Malaysia, Mexico, the Philippines, Singapore, and Thailand.
The rating must be obtained from at least one of the six authorized rating agencies—Fitch Investors Services, Japan Bond Research Institute, Japan Credit Rating Agency, Moody’s Investors Service, Nippon Investors Service, and Standard and Poor’s. International Monetary Fund (1991b) provides information on the credit ratings of selected developing countries.
International Monetary Fund, International Capital Markets (1991) describes the changes in U.S. regulations.
International Monetary Fund (forthcoming) examines in greater detail the impact of the Basle risk weights on bank lending to developing countries.