VII Recent Developments in Private Market Financing for Developing Countries
- International Monetary Fund
- Published Date:
- January 1993
The resurgence of private market financing to developing countries continued in 1992. As in previous years, the volume and form of private flows varied markedly across groups of countries. Capital flows to developing countries that had experienced debt-servicing difficulties during the 1980s were mainly through securities markets, whereas financing to countries that had maintained market access consisted of both banking and—increasingly—securitized flows. The growth in scale of portfolio flows has been paralleled by increasing market maturity, by a broadening range of instruments, by rising market liquidity, and by growing availability of information. Nevertheless, developments in this market were far from smooth, with several important sectors experiencing setbacks. Most notably, Latin American entities experienced a significant tightening of their market access during the second half of 1992.
The first part of this section reviews recent experience with securitized capital flows (international bonds, short-term debt instruments, and equities) and with bank lending. The second part discusses several issues raised by the recent patterns of private market financing to developing countries. It looks in turn at the progress toward the broadening of the investor base; the causes, modalities, and implications of the recent market correction; the special role played by regional financial centers in East and Southeast Asia; and the systemic implications of the evolving pattern of developing country financing.
Issuance activity by developing country borrowers in the international bond markets surged in 1992 to a historical high of $23 billion, about double the level in 1991. This amount represented 7 percent of global issuance activity, compared with 4 percent in 1991 (Table 11).
|Taiwan Province of China||100||—||160||60||—||60||—||—|
|Former Czech and Slovak Federal Republic||—||375||277||129||—||15||—||114|
|Trinidad and Tobago||—||—||—||100||—||—||—||100|
|Issues under EMTN programs||—||—||375||1,165||450||100||10||605|
|Total bond issues in international bond markets||255,785||229,915||297,588||333,693||92,670||78,839||77,588||84,596|
|Share of developing countries in global issuance||1.9||2.7||4.0||7.0||6.4||6.1||7.8||7.7|
Including note issues under European medium-term notes (EMTN) programs.
Including note issues under European medium-term notes (EMTN) programs.
The rise in issuance reflected increased activity across various regions of the developing world. Western Hemisphere borrowers raised some $12 billion during 1992, notwithstanding the market correction during the last quarter that forced several Latin American borrowers to curtail or postpone planned issues. Mexico was again the leading borrower in the international bond market, raising close to $6 billion. Among Mexican issuers, the United Mexican States (UMS) raised $250 million in the domestic U.S. bond market (“Yankee” market), the first Latin American and first subinvestment grade issue in the Yankee market. Argentine issuers almost doubled their borrowing in the international bond market, while international bond offerings by Brazilian and Venezuelan entities also increased, although issuance activity dropped sharply in the second half of 1992 in the wake of mounting political uncertainties and, in Brazil, with the adoption of new regulations by the central bank. The range of Western Hemisphere borrowers with access to the international bond market broadened further in 1992, as both Uruguay and Trinidad and Tobago raised $100 million.
Asian borrowers expanded their bond issuance activity during 1992, raising some $6 billion. Entities in China and the Republic of Korea were particularly active borrowers, accounting for the bulk of Asian issues. Hungary and Turkey—the only active European developing country issuers—significantly stepped up their borrowing and accounted for one-fifth of developing country issues during 1992. After two years of minimal activity, Turkey became in 1992 the fourth largest developing country borrower in the international bond market, after obtaining an investment grade rating in April 1992 (Table A7). South Africa, the only African country that had regained access to the international bond markets, saw its access to capital markets curtailed during the second half of 1992 owing to domestic political difficulties.
The increased availability of bond financing was accompanied by a gradual broadening of the range of borrowers. Private sector issuers accounted for an increasing share of developing country bond issues in 1992, representing 42 percent of total issuance activity, compared with 31 percent in 1991 and 8 percent in 1989. This trend reflects, on the supply side, the implications of privatization programs and high domestic interest rates in most Latin American countries, and on the demand side, increased interest by international investors in high-yielding bonds issued by private sector companies, partly because yields on public sector issues from most countries had declined significantly. In most cases, private sector issuers were either large export-oriented industrial companies or banks. Conversely, the share of sovereign borrowers continued to decline, with Hungary and Turkey accounting for about three-fourths of total borrowing by developing country sovereign issuers.
Terms on primary issues continued to improve for a number of developing country borrowers through midyear. The yield differential between public and private sector issuers also narrowed, particularly in Argentina and Mexico. However, the differential between yields on primary issues by developing country issuers and yields on government bonds of industrial countries increased considerably during the last quarter of 1992, particularly for Latin American borrowers, pushing spreads back to 1991 levels. Pressures on spreads in the primary market mirrored a widening of yield spreads in the secondary market, where spreads on Mexican public sector issues widened by some 100–150 basis points (Chart 22). Moreover, in the face of domestic political developments, yield spreads in the secondary markets widened markedly for several other countries, including the former Czech and Slovak Federal Republic and South Africa.
Chart 22.Secondary Market Yield Spreads on Bond Issues by Selected Developing Countries
Sources: Reuters and Wall Street Journal.
Bond issuance by developing countries was increasingly concentrated in three currency sectors, with the share of issues denominated in U.S. dollars, Japanese yen, or deutsche mark rising from 91 percent in 1991 to 95 percent in 1992 (these three currency sectors accounted for about half of global bond issuance in 1992). The U.S. dollar sector continued to be the major funding source for developing country borrowers. Relatively low U.S. interest rates together with greater receptiveness by U.S.-based investors to higher-risk issuers helped attract developing country borrowers into this currency sector. Greater openness of the domestic Japanese bond market (“Samurai” market) to developing country borrowers resulting from recent regulatory changes and stepped-up issuance by Chinese and Turkish entities helped the yen sector become the second largest currency sector tapped by developing country borrowers. Issues in the ECU sector dried up after May 1992, reflecting the general state of the ECU bond market.
Developing country issuers continued to use a broad range of enhancement techniques in 1992 to reduce borrowing costs, but the pattern of enhancement differed among regions and changed in comparison with that used in 1991. Asian borrowers enhanced half of their issues in 1991 and 1992, but use of equity conversion options dropped from 45 percent of issues to 28 percent in 1992, reflecting poor stock market performance in Korea and Taiwan Province of China; instead, an increasing number of issuers offered early redemption options. In contrast, Latin American borrowers enhanced only 21 percent of their bond issues in 1992 (down from 24 percent in 1991), essentially by a range of collateralization techniques or early redemption options.
After emerging in April 1990, the market for Latin American U.S. dollar-denominated short-term securities has developed rapidly, offering attractive funding opportunities to Latin American bank and corporate borrowers. Mexican banks were in the vanguard in developing the market for Euro-certificates of deposits (Euro-CDs), but the range of borrowers in this market broadened in 1992 to include borrowers from Argentina, Bolivia, Brazil, Mexico, Peru, and Venezuela. It is estimated that by April 1992, outstanding Euro-CDs issued by Latin American banks amounted to some $13 billion. Subsequently, the amount of outstanding Euro-CDs appears to have stabilized, partly as a result of the regulations introduced in April 1992 by Banco de México that imposed limits on short-term external borrowing by commercial banks. In contrast, the pace of issuance in the Euro-commercial paper (Euro-CP) sector picked up markedly after April 1992. Whereas only 9 Euro-CP programs had been established in 1991 with a total issuance ceiling of about $1.1 billion, 20 programs were set up in 1992, with a total issuance ceiling of $3.2 billion; issuers were mainly Mexican corporates but also included the UMS and several private sector Argentine and Brazilian companies.
Terms at launch generally improved through end-October 1992, when Euro-CDs issued by prime Mexican banks yielded some 185 basis points above the London interbank offered rate (LIBOR), compared with yield spreads of some 235 basis points a year earlier. However, yield spreads widened to some 230 basis points for prime Mexican banks during the last two months of 1992.111 Yield spreads on Argentine and Brazilian bank Euro-CDs were generally higher (between 280 and 470 basis points depending on the bank). Pricing of Euro-CPs reflected the same credit tiering, with yield spreads on Euro-CPs issued by Mexican corporates in November 1992 varying between 280 and 380 basis points over LIBOR, while spreads were about 480 basis points for Euro-CPs issued by Argentine borrowers.
International investors have also shown interest in certain domestic-currency-denominated short-term debt instruments. In 1992, $5.9 billion was invested by foreigners in Mexican Government papers, mainly in Cetes—Mexico’s federal government treasury bills. This brought holdings of Mexican Government paper by international investors to $8.9 billion by end-year. The internationalization of the investor base for Cetes was further encouraged by Standard and Poor’s assignment of a AA + rating in November 1992.
International Equity Placements
Although the international equity market played only a marginal role in developing country financing in the 1980s, the recent interest of international investors in emerging markets and the wave of privatizations in several countries have led to a surge in international equity placements by developing country companies. Since 1990, these companies have issued a cumulative $16.1 billion in international equity markets (Table 12). In 1992 alone, companies from 21 developing countries raised $9.4 billion in this market (some 41 percent of total international primary equity issuance), despite the setbacks experienced by Latin American and some Asian issuers during the second half of the year.
|Taiwan Province of China||—||—||543||—||461||—||83|
|Global equity issues in international equity market||8,152||15,546||22,632||5,007||4,672||9,291||3,662|
|Share of developing countries in global issuance||15.5||35.0||41.5||39.5||94.9||9.9||56.2|
Through mid-1992, Latin American companies were at the forefront of the new issue boom and accounted for over 60 percent of all international equity issues by developing countries. This expansion took place against the backdrop of a sharp appreciation of prices in the local stock exchanges (Chart 23) and the privatization of numerous large companies. During the second half of 1992, however, equity issues by Latin American corporations dropped abruptly, reflecting the sharp decline in share prices in most of the main Latin American stock markets.
Chart 23.Share Price Indices for Selected Emerging Markets in Latin America
Source: International Finance Corporation (IFC), Emerging Markets Data Base.
Most equity issues during the second half of 1992 came from Asia, and for the entire year Asian companies accounted for about half of total equity issuance by developing countries (up from less than one-fifth in 1991). Companies based in Hong Kong and China were at the forefront of this trend. As share prices on the Hong Kong Stock Exchange recovered in 1992, Hong Kong-based companies raised an estimated $1.2 billion through international placement shares listed in the local stock market. Chinese companies raised the equivalent of $1.0 billion from international investors in 1992, mainly through offerings of “B” shares listed on the Shanghai and Shenzhen exchanges.112 However, issuance activity in these two markets has declined since August 1992, as buying interest by international investors has been dampened by a general market reappraisal in the face of high price/earning ratios and investor concerns about the regulatory environment, custodianship problems, and the segmentation of the “A” and “B” share markets. At the same time, increased interest has occurred in offshore issues. Most notably, Brilliance China Automotive sold $80 million worth of shares in the United States, becoming the first Chinese company to be listed on the New York Stock Exchange. In addition, several Chinese companies launched issues in Hong Kong through subsidiaries based there.
Elsewhere in Asia, companies also stepped up their equity issuance activity, although domestic stock markets performed unevenly during 1992 (Chart 24). Companies from India and Taiwan Province of China tapped the international capital markets through offerings of global depository receipts (GDRs) marking the first-ever international equity offerings from these countries, while companies from the Philippines stepped up their issuance activity, including in the GDR sector. In contrast, companies located in European and Middle Eastern developing countries raised only $194 million in the international equity market in 1992, with small deals originating in Hungary, Israel, and Turkey.113 After a 15-year absence from the market, South African companies had regained access in late 1991–early 1992, raising a total of $393 million, but issuance activity was subsequently interrupted by domestic political events.
Chart 24.Share Price Indices for Selected Emerging Markets in Asia
Source: International Finance Corporation (IFC), Emerging Markets Data Base.
As developing country corporates have striven to internationalize their financing base, the number of developing country shares traded on industrial country stock markets has increased. For instance, at end-1992 the common shares or American depository receipts (ADRs) of 75 developing country companies were traded on the New York Stock Exchange, the American Stock Exchange, or the NASDAQ. Companies from Latin America, India, Korea, Taiwan Province of China, and Turkey relied to a large extent on ADRs or GDRs to raise funds abroad and to facilitate secondary market trading of their shares internationally. In 1992, developing country issuers raised $5.4 billion through issuance of depository receipts, representing some 58 percent of total ADR/GDR issues.
For a number of developing countries, cross-border equity flows have also occurred through direct purchases on local exchanges. Although comprehensive statistics across countries are not available, recent estimates suggest that secondary market purchases in emerging markets by international investors amounted to some $14 billion in 1991.114 Moreover, country-specific information indicates that portfolio investment increased substantially in a number of developing countries in 1992. Foreign investment in the Brazilian stock exchanges amounted to $0.6 billion in 1991 and $1.7 billion in 1992. A similar phenomenon was observed in Korea, where after having been allowed limited direct access to the stock market in January 1992, foreigners invested some $2.1 billion in Korean equities in 1992.
The issuance of bonds and equities by developing country corporates has been facilitated by the creation over the last few years of a number of emerging market mutual funds in industrial countries. After having dropped significantly in 1991 to $1.2 billion, new issues of closed-end mutual funds targeting emerging markets edged up in 1992 to $1.4 billion (Table A8). At the end of 1992, country funds targeting emerging markets in developing countries included 161 closed-end country funds, with total assets of $15 billion, and 227 open-end funds with $8.6 billion in total net assets.115 In contrast with 1991, when a sharp increase in issuance of mutual funds targeting Latin America was observed, funds issued in 1992 targeted mainly emerging markets in Asia. In addition, managers of existing global funds reportedly reallocated their assets away from Latin American markets toward Asian markets, while managers of Latin American funds substantially increased cash holdings. Only two new closed-end funds targeting Eastern Europe were established, reflecting continued difficulties in finding suitable investment opportunities in the region’s fledgling financial markets.
In contrast to the increase in capital flows to developing countries through the international securities markets, syndicated bank lending to developing countries remained subdued in 1992. As banks strove to improve the quality and profitability of their portfolios, they remained reluctant to take on new exposure to developing countries, particularly to restructuring countries. New lending was largely limited to short-term credits (typically trade credit), project finance, and loans structured using a variety of risk-mitigating techniques, including asset securitization. Medium- and long-term bank loan commitments to capital importing developing countries declined from $16.7 billion in 1991 to $14.1 billion in 1992 (Table 13).
|Capital importing developing countries1||20.9||16.7||14.1||2.7||4.1||3.3||4.0|
|Papua New Guinea||0.1||0.3||—||—||—||—||—|
|Taiwan Province of China||0.8||0.7||0.8||0.3||—||—||0.4|
|Former Czech and Slovak Federal Republic||—||—||—||—||—||—||—|
|Other developing countries||0.1||10.0||2.9||—||—||—||—|
|Offshore banking centers||3.7||1.5||1.5||0.4||0.3||0.2||0.6|
|International organizations and unallocated||4.4||6.6||7.1||0.1||1.9||1.5||3.7|
Excludes offshore banking centers.
Excludes offshore banking centers.
Tighter international credit conditions were reflected in a further increase in lending spreads to their highest level since the early 1980s and a shortening of maturities for countries of the Organization for Economic Cooperation and Development (OECD) and developing countries alike. The average spreads on voluntary loans to developing country borrowers rose from 75 basis points in 1991 to 86 basis points in 1992. Also, facility fees remained high. Overall, the differentiation of margins and fees according to creditworthiness widened. Average maturities for developing countries shortened from 7.6 years in 1991 to 6.7 years in 1992.
Asian borrowers accounted for 74 percent of new syndicated bank credit commitments to capital importing developing countries in 1992. Indonesian residents reduced their foreign borrowing following the imposition in November 1991 of measures to curtail foreign borrowing, while China and Malaysia stepped up their borrowing, including that to finance large property, infrastructure, and manufacturing projects.
Elsewhere, some renewed interest emerged in lending to selected Latin American borrowers (including Chilean corporates and Mexican and Venezuelan public sector oil exporters), although banks generally remained cautious about new exposure to the region. In Europe, Turkish borrowers were very active, accounting for 13 percent of total new commitments to capital importing developing countries, whereas except for Hungary, East European countries had little access to nonguaranteed medium- and long-term bank lending during 1992. Bank lending to the Middle East dropped from the historically high level reached in 1991, reflecting lower borrowing activity by Kuwait and Saudi Arabia; the $2.9 billion committed by banks to the region in 1992 went to Saudi Arabia. Bank lending activity in Africa continued to be limited, for the most part, to short-term trade lending or project financing, and generally featured wide interest margins.
In contrast to the primary market for bank loans, activity in the secondary market for bank claims on developing countries was buoyant, and the market for derivative instruments on developing country debt grew rapidly. Market turnover was estimated at some $450–500 billion in 1992, including $323 billion of transactions in the 10 most traded bonds issued in the context of debt-restructuring operations.116 The volume of transactions in this market was spurred by the securitization of an increasing portion of bank claims. By end-1992, securitized bank debt in developing countries had increased to some $65 billion, comprising $58 billion of “Brady bonds” and $7 billion of bonds issued by Brazil in November 1992 securitizing interest arrears accumulated in 1989 and 1990 (interest due and unpaid (IDU) bonds). Together with an improvement in the perception of Latin American countries’ fundamental credit quality, securitization attracted an increasing number of nonbank investors to the market, who are estimated to hold about $10 billion of such claims.
The growing use of derivative instruments in the secondary markets for bank claims on developing countries has been propelled by the entry of new investors and the persistence of high price volatility in the cash market. The largest segment of the derivatives market is the OTC market, where volumes surged from less than $1 billion in 1991 to an estimated $15–20 billion in 1992. Although the market for OTC warrants is still in the early stages of its development, liquidity has improved and several major market players now quote two-way prices on OTC options with relatively narrow bid-offer spreads. The OTC market was increasingly supplemented in 1992 by publicly issued warrants on a series of debt instruments.
Issues in Market Access
The Investor Base: Globalization of Investment Strategies
Against the background of continued globalization of investment portfolios, industrial country investors have shown increased interest in diversifying their assets into a maturing market for developing country securities.
The investor base varies significantly across capital importing developing countries.117 Asian countries that maintained access to the international markets have continued to attract significant portfolio investments from mainstream institutional investors such as pension funds and insurance companies from industrial countries, particularly from the United States and the United Kingdom. In contrast, the rediscovery of Latin American securities was spearheaded by capital flight and global investment funds, and these investor types apparently still account for the bulk of capital flows toward Latin America. However, it appears that the investor base for Latin American securities has begun to broaden over the past year with increased participation by mainstream institutional investors.
A recent survey of institutional fund managers active in emerging markets indicates that these managers quadrupled the share of their international portfolios allocated to emerging markets, from 2.5 percent of global international portfolios in 1989 to 10 percent in 1992.118 These investments are heavily concentrated in Asian and Latin American emerging markets. Latin America accounts for 39 percent of institutional investors’ emerging markets portfolios, while investments in the Pacific Rim account for 49 percent. Only about 10 percent of these institutional fund managers have ventured into the new East European exchanges, notably Hungary.
Mainstream institutional investors (for example, insurance companies and pension funds) appear to have followed a more conservative investment strategy and have invested in emerging market equities typically less than 5 percent of total foreign equity holdings, representing about 0.2 percent of total assets.119 Nevertheless, a broadening range of institutional investors reportedly invest at least a small share of their assets in Asian and Latin American securities, including bonds issued in the context of debt and debt service reduction operations, Eurobonds, ADRs, and domestic-currency-denominated government papers.
Investors in different source regions have shown markedly different attitudes toward developing country securities. Whereas U.S.-based investors, including flight capital and investment funds, have shown the most interest in Latin American market re-entrants, the investor base for developing country securities in Europe has remained more narrow. German investors continue to focus mainly on securities issued by developing countries that avoided debt-servicing problems during the 1980s, including the former Czech and Slovak Federal Republic, Hungary, South Africa, and Turkey. The investor base reportedly consists mainly of high net worth individuals; flight capital played only a minimal role, while institutional investors have generally invested very limited amounts in developing country securities. Some placement activity, including for Latin American borrowers, also took place in Switzerland and the United Kingdom. Demand for Latin American securities in the latter countries was reported to be largely based on flight capital (possibly 80 percent), while domestic investors in both countries showed more interest in Asian securities. Even in the United Kingdom, where institutional investors’ equity portfolio has long been internationalized and included a significant stake in Asian equities, the share of assets invested in emerging market equities remained small. In France, developing country securities remained a negligible share of investors’ portfolios; specialized mutual funds are reportedly the largest holders of such securities in France.
Japanese investors have invested a small share of their assets in securities issued by the fast-growing economies of East and Southeast Asia, and other developing countries that maintained a good debt-servicing record during the 1980s, such as Hungary and Turkey. Emerging market equities reportedly comprise less than 2 percent of foreign equities held by Japanese institutional investors.
These differences among international financial centers reflect a range of factors. The receptivity of the U.S. investor base to Latin American borrowers reflects the substantial presence of flight capital as well as other investors familiar with high-yielding, if risky, subinvestment grade securities. Financing within the region has also been encouraged by close business links and the importance of U.S. dollar-denominated trade flows in Latin America. Moreover, the weakness of the U.S. economy and the decline in U.S. dollar short-term interest rates boosted investors’ interest in emerging market opportunities, while increasing the attractiveness of fund raising in this market for Latin American borrowers.
Regarding European financial centers, generally conservative investment strategies, the availability of high-yielding investment alternatives in Europe (including government paper denominated in escudos, lire, and pesetas), the aversion for foreign exchange risk, and the preference for liquid financial instruments have all contributed to the limited involvement of European institutional investors in securitized flows to developing countries. In addition, attitudes toward re-entrant countries are still dominated by the traumatic experience with bank credit of the 1980s, and European investors appear less willing than U.S. investors to make a distinction between bank credit and securitized financing. Banks, particularly in Germany and Japan, have continued to concentrate on traditional borrowers and have been reluctant to break open new and riskier markets, partly because they generally feel that their involvement in the underwriting and distribution of securities is seen as an implicit credit judgment on the underlying quality of the issue and are concerned to maintain long-standing customer relationships. Finally, the availability of developing country financing from Japan has been curtailed by the impact of the recent sharp declines in domestic equity and property values on commercial bank and insurance company balance sheets.
In sum, although the investor base has broadened recently, involvement by mainstream institutional investors in developing country securities remains limited. Against this background, it is not surprising that there have been reports of investor portfolios becoming saturated. Looking ahead, it will be important that the investor base for developing country securities continues to broaden to underpin the sustainability of private flows to developing countries.
The main constraints to investment in developing country securities, including portfolio investment in emerging markets, have been investor concerns about economic and political fundamentals. The consolidation of economic and political stability would justify investment grade credit ratings—already obtained by a number of East and Southeast Asian countries, Chile, the Czech Republic, Israel, and Turkey—and encourage the involvement of new institutional investor groups facing limits on subinvestment grade holdings in the form of internal or mandated credit quality requirements.
In addition, although some progress has been made on this front, factors such as limited information and the poor liquidity of emerging market assets remain important impediments to portfolio investments into emerging countries.
Cross-border flows can be facilitated by a deepening of the domestic investor base in developing countries. A broader local investor base helps generate adequate liquidity, provides an informed investor base capable of providing an assessment of value, and could afford some insulation from the impact of shifts in international market conditions.120 Reforms of social security systems and pension funds, as well as privatization, have proved instrumental in encouraging increasing depth of the domestic investor base.
Market regulation in source countries may also affect portfolio flows to developing countries. Restrictions are applied in some industrial countries to subinvestment grade issues, and, more generally, the relevant regulatory authority places limits on institutional investors’ holdings of foreign securities as well as subinvestment grade paper. However, only a few of these regulatory restrictions are presently binding, and recent steps taken in some countries (including Japan and the United States) have eased potential impediments to greater capital flows toward developing countries. As regards bank provisioning against claims on rescheduling countries, regulatory regimes in Canada, France, Germany, the United Kingdom, and the United States provide scope for recognizing progress in improving creditworthiness and/or the lower risks involved in short-term trade or structured credits.121 Provisioning systems in other countries provide less flexibility, but in a number of countries the authorities are now looking at means to amend these regimes to facilitate graduation where consistent with maintaining prudential standards.
Developing country efforts at improving the flow of financial information have been usefully complemented by market authorities and market participants in industrialized countries. The London Stock Exchange established in September 1992 a new developing market sector that trades equities from Asia, Latin America, and Eastern Europe, which could help developing country companies gain exposure to the international capital market and may appeal to new investors. The International Primary Market Association issued in November 1992 a new set of guidelines for the issuance of international equity offerings that distinguishes between equity issues from industrial countries and emerging markets, calling for greater disclosure by lead managers for emerging market issues.122 Also, the Emerging Market Traders Association issued in September 1992 a draft code of conduct for emerging market trading activities aimed at ensuring that the market functions fairly and efficiently. Finally, financial information on developing country issuers is increasingly available. Several indices tracking price developments in developing country bonds were recently introduced, providing investors with new benchmarks to evaluate the performance of fund managers.
The 1992 Market Correction
As indicated above, the market re-entry by Latin American issuers was subject to a correction from June 1992 on the equity side and during the last quarter of 1992 on the bond side. International equity issues from the region almost completely dried up during the second half of 1992, while yields on Latin American bond issues increased sharply during the last quarter. Nevertheless, interest in the region has remained high in the investor community, and in early 1993 pressures on the markets were relieved to some extent by the continuing decline in U.S. long-term interest rates and the recovery in some local stock exchanges. Yield spreads narrowed somewhat in the bond market, particularly for prime Mexican borrowers, while the volume of bond placements continued to increase and equity issuance resumed, albeit at a much lower level.
A series of factors contributed to the reversal in 1992 of the gradual improvement in terms that had been observed since the beginning of the re-entry process. Over the previous two years, terms both at launch and on the secondary market had improved rapidly as investors’ enthusiasm for Latin American securities may have taken precedence over proper risk assessment. The change in investor attitudes toward Latin American securities may have been prompted by the political developments in Brazil and Venezuela, the wide external current account deficits in Argentina and Mexico, and anticipation of an increase in U.S. interest rates. Terms at launch and in the secondary market stopped improving in May-June when heavy issuance activity by Latin American entities, particularly in the equity market, started exerting pressures on the absorptive capacity of the market. This coincided with a sharp decline in prices on most Latin American stock markets from their peaks, starting in June 1992, which discouraged new equity issues while making international investors more aware of the volatility of these markets. In the event, international equity issues by Latin American companies dropped to minimal levels for the rest of the year.
This led a number of potential issuers to shift away from equities toward debt, adding to an already heavy bond issuance calendar. In October 1992, it was reported that Mexican borrowers planned to issue some $4–5 billion worth of bonds before year-end, and that some $20 billion of bonds were to be issued over the next year by Latin American borrowers. The issuance of $7.1 billion of IDU bonds by Brazil in November may have added to the perceived imbalance. Concerns over perceived oversupply contributed to a widening of yields on Latin American issues by some 100–150 basis points in October, both in the primary and secondary markets. Although issuance activity reached historically high levels during the fourth quarter, several Latin American borrowers either scaled down or postponed planned issues. Also, a number of deals remained partially unplaced, leaving underwriters with large inventories. As a related development, a sharp reduction occurred in the liquidity of the secondary market for a number of issues. Much wider spreads in the bond sector led a number of borrowers increasingly to tap the shorter-term Euro-CD and Euro-CP markets, where spreads were initially lower.
The market correction seems to have led to a general reappraisal of the market for Latin American securities as investors and investment banks realized that progress toward expanding the investor base beyond flight capital and high net worth investors was more limited than many had wanted to believe. Investors reportedly became more discriminating, looking more rigorously at the specifics of country risk and the credit of the issuer. This could make it more difficult for lesser known companies to raise funds in the international securities markets. However, although the recent market correction highlights the fragility of the re-entry process, it does not seem to have scared away new investors (as illustrated by the historically high level of issuance during the first months of 1993), and the more careful pricing of deals should eventually make the market re-entry more durable.
Role of Hong Kong and Singapore as Regional Financial Centers
In this discussion of private financing flows to developing countries, the focus has been on industrial financial markets as the primary source of funding and the center of intermediary activity. It should not be overlooked, however, that an increasingly important role has been played by other developing countries in both these areas. This is particularly true in the East and Southeast Asia region, reflecting, inter alia, the high rates of saving and relative wealth of a number of countries in the region, the close network of interrelationships of the overseas Chinese community, and the increasing importance of intraregional trade and investment flows. The presence of two major full-service offshore centers—Hong Kong and Singapore—has also played an important role, which will be examined below. In other parts of the developing world, intraregional financial flows are probably less important, and are mainly confined to short-term money market flows (for example, between Argentina and Uruguay) or within currency zones. However, it seems likely that over time these intraregional flows will grow in importance, particularly in Latin America, as incomes increase, local financial centers become more sophisticated and capable, and progress is made toward regional integration and cooperation.
Hong Kong and Singapore have played important roles in intermediating financing flows in the East and Southeast Asian region. Both centers have achieved a critical mass of technical expertise and professional skills, combined with a stable macro-economic environment, strong communications, and attractive tax regimes to succeed as full-service offshore centers.
Although there is much overlap, there is also complementarity in the roles of the two centers, both geographical and functional. Geographical specialization reflects location and political relationships. Hong Kong institutions have increasingly focused on opportunities in mainland China whereas Singapore has particularly close ties with other countries within the Association of South East Asian Nations (ASEAN). Regarding functional complementarity, Hong Kong has a larger role in originating new issues and in fund management, whereas Singapore specializes more as an offshore banking center and in regional equity trading, as well as being the world’s fourth largest foreign exchange market. This pattern seems to reflect in part the different regulatory characters of the two centers: Hong Kong has a more hands-off regulatory style, while the closer regulatory oversight in Singapore has contributed to confidence in the center for offshore deposit taking and foreign exchange activities. International financing out of Hong Kong has also been encouraged by its relatively larger role as a source for foreign direct investment, particularly in South China.
Both the Hong Kong and Singapore stock exchanges play important regional roles in international equity trading, although neither has been able to establish a dominance comparable to that of London in the European market. Growth of market share has been limited on both the supply and the demand side, as the exchanges have been reluctant to introduce new listings unless local standards can be satisfied, given the desire to maintain the integrity of the market. Moreover, neighboring countries have been eager to establish their own local markets.
Until 1990, the Singapore Stock Exchange (SES) had cross-listings of shares with the Kuala Lumpur Stock Exchange (KLSE) and accounted for 60 percent of transactions in Malaysian shares. However, Malaysia ended this arrangement to encourage local trading. In January 1990, the SES introduced an OTC market for trading in internationally listed equities—CLOB International—which includes stocks from Malaysia, Hong Kong, and the Philippines. Trading on this market still accounts for about 30 percent of transactions in Malaysian stocks but is limited to existing issues, and the share is declining as liquidity on the KLSE has gradually increased. Moreover, this business could be affected further when the KLSE introduces a scrip-less (that is, a no paper documentation) trading system. Thereafter, trading on the SES could only be carried out through the introduction of depository receipts. The SES has also established a custodial linkage with the Japanese Securities Clearing Corporation (JSCC) that allows Japanese securities to be traded on a scripless basis on the SES, with the shares held in custody at the JSCC. Transactions to date have, however, been extremely limited.
As for Hong Kong, consideration is now being given to the appropriate modalities for listing of Chinese companies. One possibility would be to establish a separate section on the Hong Kong Stock Exchange (HKSE) for such listings, with less stringent disclosure standards, open only to professional investors.
Regarding debt-related flows to regional borrowers, Hong Kong and to an increasing extent Singapore institutions have played an important intermediary role, particularly as Japanese banks have pulled back. Commercial banks located in these centers were not heavily exposed to syndicated lending to countries affected by the debt problems of the 1980s and have relatively strong capital bases. Hong Kong traditionally has been more active in this area, reflecting its more open regulatory system and the more innovative character of its financial markets. It also has a larger investor base—in terms of both the size of the local pool of funds available for international investments and its greater role in international fund management. Nevertheless, Singapore has recently taken an increased share, with total offshore borrowing arranged out of Singapore in the first half of 1992 rising 30 percent to $4.2 billion. Tight pricing has been facilitated by tax benefits—company income tax is only 10 percent on offshore transactions and is reduced to zero if more than 50 percent of the issue is accounted for by local arrangers—compared with a tax rate of 17.5 percent in Hong Kong.
Market-making activity in Asian offshore bond issues continues to be largely in London, mainly reflecting the economies of scale and liquidity achieved in the London-based global Eurobond market, while clearance and settlement are handled by specialized clearers in Europe. Both Hong Kong and Singapore have some interest in increasing their roles in this area.
Hong Kong has established a dominant regional role in fund management and is about ten times the size of Singapore in this area. In addition to its larger investor base and its historical expertise, its tax treatment of offshore funds is considered more favorable. In Singapore, the bulk of domestic saving is tied up in the government-administered Central Provident Fund. In addition, seats on the local exchange are expensive relative to those in Hong Kong, and requirements to bring back-office work to Singapore also raise costs.
Although Japan and, to a lesser extent, Hong Kong, Korea, and Taiwan Province of China were important, the bulk of capital market flows to Asian developing countries intermediated through Hong Kong and Singapore were sourced from outside the region rather than from within. The United Kingdom is the traditional source of funding for flows through both Hong Kong and Singapore and still accounts for an important share. Continental European and U.S. investors are showing increasing interest in the region, particularly in China. The majority of large institutions are concentrating on regional investment through Hong Kong until the proper infrastructure in the Southern China stock markets is in place and the markets mature.
Despite their success to date, the future development of Hong Kong and Singapore may be constrained, partly by their relatively limited domestic investor bases and relatively underdeveloped local capital markets. Regional competition is likely to increase as other countries—such as China, Malaysia, and Thailand—seek to develop their own financial markets and even to establish rival offshore centers (such as Malaysia’s Labuan Island and Thailand’s Bangkok International Banking Facility). Also, for Hong Kong uncertainty remains about the consequences of integration with China in 1997.
Systemic Implications of the Evolving Pattern of Developing Country Financing
The changing character of private market financing for developing countries—securitization of flows/disintermediation from the international banking system—carries implications for the resilience of the international financial system. As shown by the recent experience with market correction in Latin America, the modalities and timing of market adjustment may differ in the present circumstances from those in the early 1980s. Specifically, greater scope now exists for price adjustments, which may signal emerging difficulties before the situation deteriorates to where access is cut off. Also, as an increasing proportion of cross-border flows are in the form of securities held by nonbanks, balance of payments difficulties experienced by developing countries would not directly put at risk banks and the international payments system. Instead, adjustment to debt-servicing difficulties would likely involve a drop in the price of securities and result in a decline in the financial wealth of investors, the global macroeconomic consequences of which would be limited, since most large investors hold only a small proportion of their assets in developing country securities. Consequently, the new financing pattern seems to imply lower systemic risks than the bank credit flows of the 1970s and early 1980s.
The implications of greater openness to international portfolio flows for the underlying volatility of emerging markets is unclear. These markets traditionally have had a fairly shallow domestic investor base, a limited range of actively traded shares, and financial asset prices that have been particularly volatile. Greater openness may help broaden the investor base, deepen the market, transfer more sophisticated investment strategies, and ultimately stabilize emerging markets. Nonetheless, there is a concern that at least until a broad domestic investor base has developed, competition among international asset managers, combined with the narrow range of liquid markets in which they can invest, could mean that a concerted move in the same direction might generate a large amount of financial asset price volatility. These risks underline the importance of sustained implementation of sound stabilization and reform policies by developing countries, which would foster a gradual expansion of the investor base and provide sufficient resilience in the face of transient shifts in the availability and terms of international financing.
The discussion of bond and equity developments in this section is based on a comprehensive data base developed by the staff. Based on market information, this data base allows for a disaggregation of these capital flows by country, borrower, term, and currency. See Collyns and others (1992).
In November 1992, the Mexican central bank raised the limit on Euro-CD issuance by Mexican banks, which reportedly resulted in stepped-up issuance activity.
B shares are ordinary shares restricted to foreign investors, denominated in renminbi but settled in foreign currency.
To date, East European developing countries, except Hungary, have remained on the sidelines of the international equity market because of limited or nonexistent stock markets, the use of mass privatization methods for privatizing state-owned companies, and concerns regarding investor protection, disclosure, and macroeconomic prospects.
Lipper Analytical Services.
This estimate is based on information provided by Cedel and Euroclear.
No comprehensive and detailed information is available on the composition of the investor base for developing country securities. The analysis here is based on discussions with market participants and on a number of published surveys and studies.
See Kleiman International Consultants (1992). The study by Howell and others (1992) reports that on average over 1989–91, $21 out of every $100 cross-border equity investment was placed into the emerging stock markets of Latin America or Asia.
The synergy between local and foreign investors can be affected by regulatory segregation between the two groups of investors, such as that resulting from the separation between the “A” and “B” shares market in China.
See Collyns and others (1992) for additional information.
In emerging market issues, additional information is to be disclosed by lead managers on the stock market on which the shares are listed, on transaction costs in this market, and on transfer/settlement procedures.