Emerging Economy Corporate Debt: The Threat to Financial Stability

By Viral Acharya, Stephen Cecchetti, José De Gregorio, Sebnem Kalemli-Ozcan, Philip R. Lane and Ugo Panizza

...the risks arising from non-financial corporate issuance of foreign currency-denominated bonds are very real...so long as the authorities use their existing prudential tools wisely, they appear manageable.

A major question facing the world’s central bankers is whether a tightening of US monetary policy portends another round of financial stress or even a wave of crises in emerging economies.

During earlier decades, emerging economies borrowed heavily in international markets, while at the same time operating under fixed exchange rate regimes. Since these debts were unhedged, the result was exposure to both sovereign risk and exchange rate risk. In such an environment, any change in the willingness of global investors to bear risk quickly led to a capital flow reversal, occasionally triggering a full-blown crisis. This narrative played out over and over again in Latin America and Asia during the 1980s and 1990s.

Policymakers in emerging economies learned their lesson, improving macroeconomic management and financial regulation, allowing for greater exchange rate flexibility and reducing unhedged debt burdens. During the first decade of this century, through a combination of current account surpluses, rising foreign exchange reserves and a shift from debt to equity financing, both public and private sector balance sheets grew stronger.

Read full article as published in VoxEU.

Viral Acharya is the C.V. Starr Professor of Economics and the Director of the NSE-NYU Stern Initiative on the Study of Indian Capital Markets.