Research & Policy Briefs From the World Bank Chile Center and Malaysia Hub No. 42 February 18, 2021 The Boom in Corporate Borrowing after the Global Financial Crisis: Different Tales from East Asia and Latin America Facundo Abraham Juan J. Cortina Sergio L. Schmukler Firms from emerging economies increased their bond financing significantly after the 2008–09 global financial crisis. The patterns of corporate borrowing in East Asia and Latin America offer very different lessons. In East Asia, the main component behind the overall growth in bond financing was an expansion in domestic bond issuances, in domestic currency, by more and smaller firms. This expansion seems to be explained by a higher supply of funds by domestic investors, which lowered issuance costs. In Latin America, relatively larger firms tended to borrow from international markets issuing foreign currency bonds. These contrasting patterns have resulted in exposures to different types of risks. Risks in East Asia have been more related to the increasing debt accumulation by smaller firms, issuing debt at shorter maturities. Latin American firms have been more exposed to external factors and currency depreciations. The Role of Domestic and International Bond Markets in the East Asian and Latin American economies. Between 2010 and 2019, the ratio Two Regions of corporate debt to GDP in the median economy increased from 119 percent to 144 percent in East Asia and from 34 percent to 42 percent in Latin America During the 1990s and 2000s, emerging market firms greatly expanded the (figure 1, panel a). An increase in bond issuances by firms accompanied this amount of financing raised in bond markets. As a result of increased financial growth in corporate debt. In the median East Asian and Latin American liberalization in emerging economies, international issuances were a key economy, the annual amount raised in corporate bonds during 2010–19 was component of this expansion (World Bank 2005). International issuances about twice the amount raised during 2000–07. However, bond financing accelerated after the 2008–09 global financial crisis. The literature associates produced different patterns in each region. In Latin America, the annual the increase in international bond issuances after the global financial crisis amount of bond financing followed an inverted U-shape, peaking in 2013 and with an expansion in the supply of capital by foreign investors, which lowered declining afterward. Still, the annual amount of bond financing during the cost of raising capital in international markets (Shin 2014; Turner 2014; 2014–19 was typically larger than that during 2000–07. In contrast, in East McCauley, McGuire, and Sushko 2015). The expansion in international bond Asia the annual amount of bond financing consistently increased throughout issuances led to a surge in corporate debt and corporate vulnerability across 2010–19 (figure 1, panel b). emerging economies (IMF 2019). The rise of corporate bond financing in East Asia and Latin America is Whereas many studies have documented the growth in international bond consistent with the so-called “second phase of global liquidity” that started issuances after the global financial crisis, not much is known about the after the global financial crisis (Shin 2014; Turner 2014). Before the crisis, the issuance of domestic bonds by emerging market firms. The distinction banking sector (mainly international banking) was at the center of firm between international and domestic bond markets is not trivial. It is ex ante financing in emerging economies. This pattern changed after the global unclear to what extent emerging market firms used domestic bond markets as financial crisis, when institutional investors through purchases of corporate they increased their issuances abroad. On the one hand, in an increasingly bonds replaced banks as key liquidity providers of financing to emerging globalized world where financial transactions can take place anywhere, market firms. In fact, the growth of corporate debt over GDP in emerging preference for deeper and more liquid international bond markets could have economies turned flat when the issuance of bond securities is excluded made domestic markets less relevant (Levine and Schmukler 2006). On the (Abraham, Cortina, and Schmukler 2020). This development resulted in global other hand, even when barriers to financial transactions are removed, frictions financing conditions becoming more sensitive to changes in bond markets. (such as information asymmetries, fixed transactions costs, or tax barriers) can still cause market segmentation across international and domestic bond Although firms in both East Asia and Latin America increased their bond markets to persist (Bekaert et al. 2011; Colla, Ippolito, and Li 2013). issuances during 2010–19, there is an important difference between the two regions. Whereas in East Asia most of the growth in bond issuances occurred This Research & Policy Brief discusses corporate bond financing in East through bonds denominated in domestic currency, most of the bonds issued Asia and Latin America. In doing so, it sheds light on the role of domestic and by firms in Latin America were denominated in foreign currency. In the foreign bond markets in emerging economies since the global financial crisis. median East Asian economy, 72 percent of the total amount of bonds raised The Brief focuses on these two regions because together they accounted for per year during 2010–19 (which includes domestic and foreign currency about 90 percent of the total amount raised in corporate bond markets by issuances) was denominated in domestic currency. This represented an emerging economies between 2010 and 2019. At the same time, the two increase of 7 percentage points relative to the annual share of domestic regions exhibited contrasting patterns in terms of use of domestic and currency bond issuances in 2000–07. This pattern still holds when China is international markets, the driving forces behind their issuance activity, and excluded from the sample. In contrast, the share of domestic currency bonds the various risks their increased borrowing has entailed. over the total bonds raised per year in the median Latin American economy was 33 percent in 2010–19 (figure 2). Importantly, this share indicates a The Brief devotes more attention to East Asia because this region decrease in the proportion of domestic currency bonds raised in Latin accounts for most of the corporate bond issuance activity in emerging America with respect to the period before the global financial crisis. In economies as a whole; it weighs heavily in international portfolios; and policy 2000–07, domestic currency bond issuances captured about 57 percent of makers in the region made a conscious effort to develop domestic bond the total capital raised in bond markets per year. markets following the 1997–98 Asian financial crisis. Moreover, the patterns from this region challenge many of the predictions in the academic literature Given the high correlation between currency denomination and issuance and the messages in policy reports. The experiences of East Asia and Latin market, these trends mean that most of the bonds raised after the global America offer different lessons on how financial markets have evolved in financial crisis in East Asia (Latin America) were issued in domestic (foreign) emerging economies and what that means for corporate debt and bond markets. Moreover, the growth in domestic bond financing in East Asia vulnerability across regions. was accompanied by an increasing number of firms using those markets. In the median East Asian economy, the number of firms issuing domestic bonds The Rise in Bond Issuance per year doubled after the global financial crisis. This trend contrasts with that in international markets, where the annual number of issuers slightly declined Following the global financial crisis, corporate debt steadily increased among after the global financial crisis. Affiliations: Development Research Group, World Bank. E-mail addresses: fabraham@worldbank.org, jcortinalorente@worldbank.org, sschmukler@worldbank.org. Acknowledgements: This Research & Policy Brief summarizes the arguments in Abraham, Cortina, and Schmukler (2020; 2021a; 2021b). We received very useful comments from Norman Loayza and helpful edits from Nancy Morrison. The World Bank Chile Research and Development Center, East Asia & Pacific Chief Economist Research Center, the Knowledge for Change Program (KCP), and the Research Support Budget (RSB) provided financial support for this brief. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. The Boom in Corporate Borrowing after the Global Financial Crisis: Different Tales from East Asia and Latin America Figure 1. Growth of Corporate Debt after the Global Financial Crisis The ratio of corporate debt to GDP and bond issuances by firms increased in both regions. a. Outstanding debt as a share of GDP, 2005–19 East Asia Latin America 150 50 145 45 140 Percent of GDP Percent of GDP 135 40 130 125 35 120 115 30 110 25 105 100 20 5 7 9 1 3 5 7 9 5 7 9 1 3 5 7 9 200 200 200 201 201 201 201 201 200 200 200 201 201 201 201 201 b. Bond issuance, 2000–19 East Asia Latin America 400 1,400 140 350 1,200 120 300 US$, billion US$, billion 1,000 100 250 800 80 200 600 60 150 400 40 100 50 200 20 0 0 0 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 200 200 200 200 200 201 201 201 201 201 200 200 200 200 200 201 201 201 201 201 East Asia exc. China (left axis) China (right axis) Source: Abraham, Cortina, and Schmukler 2021a. Note: This figure shows the evolution of corporate debt and bond issuances in East Asia and Latin America. Panel a shows, for each region, the amount of corporate debt outstanding as a share of GDP for the median economy per year. Panel b shows, for each region, the aggregate amount of corporate bonds issued per year. East Asia includes: China, Hong Kong SAR, China, Indonesia, Malaysia, Philippines, Republic of Korea, Singapore, Taiwan, China, Thailand, and Vietnam. Latin America includes: Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico, Panama, Peru, and Venezuela. East Asia is split into China and the rest. Values are in constant 2011 U.S. dollars. Firms borrowing in international markets are typically larger than those comparing all firms (listed and unlisted) using the size of bond issuances. The borrowing in domestic markets. In East Asia and Latin America, the size of the median issuance size in Latin America was US$118 million in 2016, more than median international issuer during 2008–16 was more than three times the four times higher than in East Asia (US$28 million). size of the median domestic issuer. Therefore, the observed trends also imply that the growth in bond market activity in East Asia comprised the What Drove the Rise in Domestic Bond Issuances? participation of smaller issuing firms than in Latin America. The size of the median firm issuing bonds decreased (increased) in East Asia (Latin America) The patterns of issuance activity in Latin America are in line with the argument as the use of domestic (international) markets expanded after the global in the literature that an expansion in the supply side of capital by foreign financial crisis (figure 3). In 2016, the median asset size of publicly listed investors lowered the cost of issuing bonds in international markets, boosting issuing firms in Latin America was US$10 billion, more than ten times higher foreign bond issuances after the global financial crisis. But what caused the, than that in East Asia (US$1 billion). The differences are also substantial when mostly overlooked, acceleration in domestic bond issuances in East Asia? Was Figure 2. Domestic Currency versus Foreign Currency Bond Issuances, 2005–19 Domestic currency bonds dominate in East Asia, whereas foreign currency bonds dominate in Latin America. a. East Asia b. Latin America 100 100 90 90 Share of bonds raised Share of bonds raised 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 5 7 9 1 3 5 7 9 5 7 9 1 3 5 7 9 200 200 200 201 201 201 201 201 200 200 200 201 201 201 201 201 Domestic currency Foreign currency Source: Abraham, Cortina, and Schmukler 2021a. Note: This figure shows, for each region, the share of corporate bond financing raised in domestic currency or foreign currency as a percentage of the total bonds raised for the median economy in each year. 2 Research & Policy Brief No.42 Figure 3. Size of Firms Issuing Bonds, 2007–16 Figure 4. Cost of Corporate Bond Issuances by East Asian Firms, 2000–16 The size of the median firm issuing bonds decreased in East Asia and increased in Latin America after the global financial crisis. The cost of issuing corporate bonds declined after the global 23.5 financial crisis, and yields declined more for domestic than for international bonds. 23.0 8 22.5 Yield to maturity, percent Issuer size, log scale 22.0 7 21.5 6 21.0 5 20.5 20.0 4 19.5 3 19.0 2 7 8 9 0 1 2 3 4 5 6 200 200 200 201 201 201 201 201 201 201 0 2 4 6 8 0 2 4 6 200 200 200 200 200 201 201 201 201 East Asia Latin America International bonds Domestic bonds Source: Abraham, Cortina, and Schmukler 2021a. Note: This figure shows, for each region, the size of the median firm in the median Source: Abraham, Cortina, and Schmukler 2021b. economy issuing bonds each year. Firm size is measured as the end-of-year value Note: This figure shows, for the median economy in East Asia, the median bond of total assets. yield to maturity per year. The figure only includes domestic currency issuances. the acceleration in domestic bond issuances driven by an increased appetite increasing demand for capital by firms was the main driver behind the for domestic bonds by investors (supply-side expansion) or by a higher acceleration in bond issuances, domestic bond yields would be expected to demand of capital by firms (demand-side expansion)? Overall, the evidence is increase (other things equal). The evidence shows that the cost of issuing consistent with a supply-side expansion by domestic investors being the main domestic bonds declined after the global financial crisis in East Asia. East Asian force driving the rise of domestic bond markets in East Asia since the global firms issued corporate bonds in 2008–16 at a cost 39 percent lower financial crisis. (measured as the yield to maturity) than in 2000–07 (figure 4). Moreover, yields declined more for domestic than for international issuances. Yields of Movements in the cost of issuances are informative to study this issue domestic and international bonds declined by about 42 percent and 29 because a decline in the cost of capital would suggest that the liquidity percent, respectively, between 2000–07 and 2008–16, at the same time that provided by investors grew faster than firms’ demand for new financing. If an domestic issuances increased more than international ones. The decline in Figure 5. Financial Status of East Asian Firms, 2000–16 New, smaller firms that started issuing bonds in domestic markets in 2008–16 accumulated more debt and cash, and their financial performance worsened relative to their position before 2008. Leverage, debt to asset ratio b. Cash position 1.3 3.5 Value over 2000–07 average Value over 2000–07 average 1.2 3.0 1.1 2.5 1.0 2.0 0.9 1.5 0.8 1.0 0.7 0.5 0.6 0.0 0 2 4 6 8 0 2 4 6 0 2 4 6 8 0 2 4 6 200 200 200 200 200 201 201 201 201 200 200 200 200 200 201 201 201 201 c. Interest coverage ratio (ICR) d. Return on equity (ROE) 1.6 1.2 Value over 2000–07 average Value over 2000–07 average 1.4 1.0 1.2 0.8 1.0 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0 0 2 4 6 8 0 2 4 6 0 2 4 6 8 0 2 4 6 200 200 200 200 200 201 201 201 201 200 200 200 200 200 201 201 201 201 Recurrent bond issuers New bond issuers Non-issuers Source: Abraham, Cortina, and Schmukler 2021b. Note: This figure shows the trends in financial statement variables for recurrent issuers (issued bonds before 2008), new issuers (began issuing bonds after 2008), and non-issuers in East Asia. All variables are normalized by their average value during 2000–07. For each variable, the figure shows the results for the median firm in the median economy per year. 3 The Boom in Corporate Borrowing after the Global Financial Crisis: Different Tales from East Asia and Latin America the issuance cost of international bonds is consistent with the argument in the case that the financing directed to new investments was geared toward literature that an increase in the supply of bond financing by foreign investors projects with relatively low rates of return. Moreover, the new issuers drove international bond issuances after the global financial crisis. raised bonds at relatively shorter maturities than in the past, which could Importantly, the larger decline in the issuance cost of domestic bonds implies have amplified rollover risks. The maturity of bond issuances by East Asian that the supply side of funds (investors’ demand) for domestic bonds grew firms declined from 4.3 years in 2004–07 to 3.7 years in 2010–19. On the even faster than that for international bonds. The patterns in corporate bond bright side, higher amount of cash savings (which could be used during markets contrast with those in syndicated loans, where the cost of issuances negative shocks) and the domestic currency nature of the bonds raised increased for East Asian firms during 2008–16. could have lowered debt-related risks. Domestic investors, with substantial and growing funds, were the main buyers of domestic securities, contributing to the decline in the cost of capital Conclusion in those markets. For example, the holdings of East Asian corporate bonds by Although international bond markets were an important contributor to East Asian mutual funds increased five-fold between 2008 and 2016, and 93 the corporate financing boom in East Asia during the 1990s, domestic percent of these bond holdings were in domestic issuances. On the other markets have played an even more important role in the new millennium, hand, foreign investors were the main buyers of securities issued in especially since 2008. As the amount raised domestically grew faster than international markets. Out of the total East Asian corporate bonds held by U.S. that raised internationally, the share of domestic currency debt increased, investors and foreign mutual funds during 2008–16, 96 percent and 99 the number of firms issuing in domestic markets expanded, and the size of percent were issued in international markets, respectively (Abraham, Cortina, issuing firms declined. The evidence is consistent with the notion that a and Schmukler 2021b). This evidence is consistent with the view that higher supply of funds by domestic investors is an important driver behind institutional investors tend to buy securities issued in their own markets documented in the literature (Maggiori, Neiman, and Schreger 2020). the rise in domestic bond financing. Evidence on firm performance provides additional support to the The patterns of bond financing in East Asia are not observed in other hypothesis that the expansion of domestic bond markets in East Asia was emerging regions. For example, in Latin America—which also accounted supply driven. Smaller firms typically have access to a limited number of for a significant share of corporate bond issuance activity by emerging (mainly domestic) debt markets and are more financially constrained than economies—the rise in corporate bond issuances was mostly conducted larger firms. Thus, if the supply side of financing drove the rise in domestic through international markets, denominated in foreign currency, and bond issuances, the relatively smaller new issuers would be expected to driven by larger firms. increase their leverage more than the larger firms already issuing bonds, which The much higher use of domestic bond markets in East Asia than in typically have adequate access to funds through multiple domestic and Latin America since the global financial crisis could be related to different international debt markets (Faulkender and Petersen 2006). The evidence factors. The growth of East Asian domestic bond markets might be traced shows that the new, smaller firms that started issuing bonds in domestic back to the Asian financial crisis, after which policy makers implemented markets in 2008–16 (new issuers) indeed accumulated debt faster than assets, a series of reforms that expanded the investor base, improved market increasing their leverage positions more than firms that had already issued infrastructure, and enhanced investor protection. Another key reason bonds prior to 2008 (recurrent issuers) and non-issuers (figure 5, panel a). behind the expansion in domestic financing for the corporate sector Moreover, the supply-side expansion hypothesis would suggest that firms might be related to the growth in public and private savings. Stronger hoarded large shares of the bond proceeds in cash and that the share of cash fiscal discipline and positions by East Asian governments could have savings per bond issuance was higher during 2008–16 than in previous reduced crowding out and, as a result, directed more financing toward the periods (Erel et al. 2012; Acharya, Byoun, and Xu 2020). The alternative corporate sector. Moreover, as households became richer, they might hypothesis that increasing firms’ demand for capital was more important have increased their savings and investments in financial products. Higher would suggest that firms invested or spent most of the bond proceeds raised. demand for investment products, coupled with a home bias, could have The data indicate that the relatively cheaper domestic bond financing was increased the flow of funds toward domestic bond markets through associated with high cash accumulation by bond issuers. Although bond domestic institutional investors. The retrenchment in international capital issuers increased their investments, cash accumulation was the most flows after the global financial crisis could have also contributed to these important use of funds per bond issuance since the global financial crisis and, developments, at least in the immediate years following the crisis when as a result, both new and recurrent bond issuers accumulated a substantial investors worldwide became more risk averse and reduced their share of amount of cash after 2008 (figure 5, panel b). Specifically, during 2008–16, foreign assets. bond issuers held around 40 cents in cash for every dollar raised, and the average amount of cash saved per bond issuance was significantly higher than Differences in the use of domestic and international bond markets in previous years. imply that firms in East Asia and Latin America have been exposed to different types of risks. Firms in East Asia might be less vulnerable to The net effect of the increase in the supply side of financing on East changes in global market conditions, as they have relied less on foreign Asian firms is unclear. On the one hand, financial performance of new currency debt. In turn, the main risks for East Asia have been more related issuers worsened relative to the period before 2008, as measured by the to the higher overall indebtedness and the participation of smaller firms, interest coverage ratio (ICR) (figure 5, panel c) and return on equity (ROE) as these firms tend to issue bonds at shorter maturities and have fewer (figure 5, panel d). Even though new issuers could access cheaper financing options during crises. Latin American firms have been more financing in bond markets, these patterns could imply that the large cash exposed to external factors and currency depreciations because they have holdings yielded returns below the cost of financing. 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