IFC Research Note By John Gandolfo and Paolo Mauro1 How Emerging Market Companies Are Withstanding Global Interest Despite swings in global interest rates during the past five years, emerging market corporate borrowers have proven resilient— Rate Shifts faring better than in previous crises.2 Global interest rates have gyrated since 2019, driven by large-scale economic shocks that have shifted the macroeconomic outlook and provoked a series of monetary policy responses. Prior to the COVID-19 pandemic, policy rates in most advanced economies were low or near zero, and nominal government bond yields were often negative. In March 2020, a sharp rise in uncertainty prompted the largest central banks to flood global markets with liquidity. Policy rates remained near zero until a surge in inflation worldwide sparked a tightening cycle. Although inflationary pressures have lessened, and central banks have begun easing—notably with a 50-basis point rate cut by the U.S. Federal Reserve in late September 2024—key global interest rates are projected to remain well above pre-pandemic levels in real terms.3 OCTOBER 2024 IFC Research Note | 1 IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 2 How have emerging market companies fared? This IFC Research Note analyzes the cost of borrowing for firms in emerging and developing economies, changes in their debt structure, and indicators of indebtedness and profitability. It finds reasons for optimism on their resilience, while noting that vulnerabilities remain. In contrast to earlier periods of heightened macro volatility and Fed hiking cycles, emerging market corporate yields rose significantly but spreads over U.S. Treasuries remained stable. Moreover, there was a noticeable shift by emerging market firms toward local currency borrowing to eschew vulnerabilities from foreign currency denominated debt. As a result, interest coverage ratios for emerging market companies are still healthier than on the eve of the pandemic. Nevertheless, borrowing costs warrant monitoring because corporate debt levels remain high and, despite recent policy rate cuts in the United States and elsewhere, global real interest rates are projected well above pre-pandemic levels in the next few years. Impact of Global Interest Rates on Borrowing Costs for Emerging Market Companies Spreads between emerging market corporate yields and U.S. Treasuries have remained relatively stable, even as global interest rates fluctuated. Since 2019, U.S. dollar-denominated bond yields for these firms have largely mirrored movements in U.S. 10-year Treasury yields (Figure 1). One key deviation occurred in March 2020, at the onset of the pandemic, when uncertainty and risk aversion caused emerging market yields to spike even as U.S. Treasury yields fell in response to the U.S. Federal Reserve’s rate cuts. However, this divergence proved short-lived, with emerging market yields swiftly falling back in line with U.S. Treasury yields—a stark contrast to the more prolonged disruptions experienced during previous emerging market crises, such as those originating in Latin America (1980s), Asia (1997), and the Russian Federation (1998), or the 2013 “taper tantrum,” during which spreads for emerging market corporate debt rose in response to a drop in global risk appetite.4 During the past five years, borrowing costs for emerging market firms have tracked global interest rates more closely than in more distant historical episodes. FIGURE 1 Emerging Markets: Corporate and Sovereign Yields on U.S. Dollar Denominated Bonds In percent CEMBI Yield EMBI Yield US 10YR Fed Funds Rate (Avg.) US High Yield EMBI, CEMBI, US 10 Yr Treasury and High Income Upper Middle Income Lower Middle Income 15% Fed Funds Rate Emerging Markets Emerging Markets Emerging Markets 10% 5% 0% 9 0 1 2 3 4 9 0 1 2 3 4 9 0 1 2 3 4 9 0 1 2 3 4 01 02 02 02 02 02 01 02 02 02 02 02 01 02 02 02 02 02 01 02 02 02 02 02 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 r2 Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Ap Sources: JP Morgan, Haver, St Louis Federal Bank and IFC Note: For these charts, the Sovereign Emerging Markets Bond Index (EMBI) and the Corporate Emerging Markets Bond Index (CEMBI), which tracks the performance of the bonds, are recomputed using the same sample of countries, with a common set of countries for each income group, weighted by market capitalization (as of February 2024). The countries are grouped by income level and include high-income emerging economies (Bahrain, Chile, Oman, Panama, Poland), upper-middle-income countries (Argentina, Brazil, Colombia, Dominican Republic, Georgia, Guatemala, Indonesia, Kazakhstan, Malaysia, Mexico, Paraguay, Peru, South Africa, Türkiye, Ukraine), and lower-middle-income countries (Egypt, Ghana, India, Morocco, Nigeria, Philippines, Zambia). IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 3 U.S. dollar-denominated corporate bond yields in emerging markets at all income levels are higher today than pre-pandemic, but the rise was similar or less pronounced than in advanced economy comparators. On average, yields rose from 4.8 percent in December 2019 to 6.4 percent in September 2024.5 Although this is a significant increase, it is less prominent than for investment- grade companies in advanced economies, which on the eve of the pandemic were benefiting from exceptionally low interest rates, whereas emerging market corporations had been contending all along with perceptions of greater risks.6 For example, yields rose from 2.7 percent in December 2019 to 4.7 percent in September 2024, for U.S. investment grade companies. The percentage point increase was about the same or smaller for emerging market firms in all income groups, and smaller as a share of yields pre-pandemic (Figure 2). As expected, borrowing costs vary across income levels, with corporate borrowers in lower-middle income countries typically facing higher yields than their upper-middle income or high-income counterparts. Interestingly, in the lower-middle-income group, some corporate bonds were perceived as less risky than sovereign bonds, highlighting the nuanced risk perceptions of investors.7 FIGURE 2 Corporate Bond Yields Pre-Pandemic and Today U.S.dollar denominated, in percent Source: JP Morgan, Bloomberg and IFC The United States Note: U.S. high yield refers to all corporates below investment grade. For US High Yield= BarCap US Corp US Investment Grade US High Yield HY YTW, For US Investment Grade 6.9% = Bloomberg US IG Corporate YTW Index. Emerging market (EM) groups as in Figure 1. 68% +1. 5.22% 4.67% % .01 +2 2.66% Dec 2019 Sept 2024 Dec 2019 Sept 2024 Emerging Markets High Income Upper Middle Income Lower Middle Income 7.3% 6.9% 6.4% .3% +1 % .3 +2 .7% 5.6% +1 5% 4.7% Dec 2019 Sept 2024 Dec 2019 Sept 2024 Dec 2019 Sept 2024 IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 4 As interest rates on U.S. dollar denominated debt rose, there was a noticeable shift by emerging market companies toward borrowing in local currencies,8 especially in countries with relatively deep domestic capital markets. India, in particular, saw a pronounced shift toward local-currency bond issuance (Figure 3).9 Borrowing in local currencies offers several advantages, including lower exposure to exchange-rate fluctuations and currency mismatches, which create vulnerabilities especially in periods of global financial volatility or high and volatile inflation. Although nominal interest rates also increased on domestic currency instruments, many corporate borrowers found them preferable to incurring the risk of depreciation or costly hedging, on top of rising foreign currency rates. However, not all firms had the option to shift toward domestic currency borrowing. In many lower-income and smaller countries with less developed capital markets, companies remain dependent on foreign currency denominated debt.10 Emerging Market Corporates Show Resilience Despite the rise in interest payments, emerging market firms have managed to maintain relatively healthy financial positions, as reflected in their interest coverage ratios (measured as earnings before interest and taxes, divided by interest payments). Analysis of the balance sheets and income statements of publicly traded companies in emerging markets shows that although interest payments as a share of total debt have increased since 2021, profits have comfortably kept pace (Figure 4). As a result, interest rate coverage ratios are currently similar to pre-pandemic levels. In lower-middle-income countries, where the impact of higher interest rates has been most pronounced, interest payment ratios rose from 6 percent of total debt in 2021 to 9 percent in 2024. Nevertheless, after peaking in 2021-22, interest coverage ratios have returned to levels comparable to those seen before the pandemic (Figure 5). FIGURE 3 Bond Issuance by Emerging Market Companies Local currency versus U.S. dollars, annual data Other Emerging Market India and Developing Economies $ Billion 200 Local currency 150 Local currency 100 US dollar 50 US dollar 0 13 14 15 16 17 18 19 20 21 22 23 24 13 14 15 16 17 18 19 20 21 22 23 24 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: Bloomberg and IFC Note: Data for 2024 refer to the first 8 months of the year and were multiplied by 1.5 to preserve comparability. IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 5 Although emerging market corporate borrowers maintain relatively healthy balance sheets, several factors point to potential future vulnerabilities. First, global interest rates are projected to remain above pre-pandemic levels in the coming years, increasing the cost of refinancing debt incurred prior to 2022. Second, corporate leverage is higher today than a decade ago in most emerging markets, especially in high-income emerging economies and lower-middle income countries (Figure 6), and corporate debt as a share of GDP has risen over the past two decades.11 These developments tend to make both companies and emerging economies more sensitive to shifts in global financial conditions. Third, higher interest payments might ultimately erode firms’ ability to invest. Considering how emerging market corporate borrowers have withstood major shifts in global interest rates, there are grounds for optimism. Beyond the cost of borrowing and related vulnerabilities, however, corporate resilience will hinge on profitability, which in turn will be heavily influenced by global, regional, sectoral, and country-specific shocks against a backdrop of high global uncertainty. FIGURE 4 FIGURE 5 Interest Payments as a Percentage of Total Debt Interest Coverage Ratio for Non-Financial Companies By income group, in percent By income group 10% 12 Lower Middle Income Countries Lower Middle Income Countries Upper Middle Income Countries Upper Middle Income Countries 10 High Income Emerging Markets High Income Emerging Markets 8% 8 6% 6 4% 4 2% 2 0% 0 14 15 16 17 18 19 20 21 22 23 24 14 15 16 17 18 19 20 21 22 23 24 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: Refinitiv and IFC Source: Refinitiv and IFC Note: Data for around 9,000 listed companies. For these charts, the sample consists of countries Note: Data for around 9,000 listed companies. The Interest coverage ratio evaluates a firm’s ability with enough representative company data (more than 30) for the whole analyzed period. These to cover its interest expenses from its earnings before interest and taxes (EBIT), with a ratio countries are high-income emerging markets (Bulgaria, Croatia, Chile, Oman, Poland, Romania), below 1 signaling that a company cannot meet its interest obligations from operational income upper-middle-income countries (Argentina, Brazil, Colombia, Indonesia, Malaysia, Mexico, Peru, alone. For these charts, the sample consists of countries with enough representative company South Africa, Thailand, Türkiye), and lower-middle-income countries (Bangladesh, Egypt, India, data (more than 30) for the analyzed period. These countries are high-income emerging markets Jordan, Kenya, Morocco, Nigeria, Pakistan, Philippines, Sri Lanka, Viet Nam). (Bulgaria, Croatia, Chile, Oman, Poland, Romania), upper-middle-income countries (Argentina, Brazil, Colombia, Indonesia, Malaysia, Mexico, Peru, South Africa, Thailand, Türkiye), and lower-middle- income countries (Bangladesh, Egypt, India, Jordan, Kenya, Morocco, Nigeria, Pakistan, Philippines, Sri Lanka, Viet Nam). IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 6 FIGURE 6 TABLE 1 Financial Leverage for Non-Financial Companies List of Countries Used in This Note By income group High Income Upper-Middle- Lower-Middle- 3.5 Lower Middle Income Countries Emerging Markets Income Countries Income Countries Upper Middle Income Countries Bahrain Argentina Bangladesh High Income Emerging Markets Bulgaria Brazil Egypt 3 Chile Colombia Ghana Croatia Dominican Republic India Oman Georgia Jordan 2.5 Panama Guatemala Kenya Poland Indonesia Morocco Romania Kazakhstan Nigeria Malaysia Pakistan 2 Mexico Philippines Paraguay Sri Lanka Peru Viet Nam 1.5 South Africa Zambia 14 15 16 17 18 19 20 21 22 23 24 20 20 20 20 20 20 20 20 20 20 20 Thailand Source: Refinitiv and IFC Note: Financial leverage is defined as total assets divided by the common shareholder equity. Data Türkiye for around 9,000 listed companies. For these charts, the sample consists of countries with enough representative company data (more than 30) for the whole analyzed period. These countries are Ukraine high-income emerging markets (Bulgaria, Croatia, Chile, Oman, Poland, Romania), upper-middle- income countries (Argentina, Brazil, Colombia, Indonesia, Malaysia, Mexico, Peru, South Africa, Thailand, Türkiye), and lower-middle-income countries (Bangladesh, Egypt, India, Jordan, Kenya, Morocco, Nigeria, Pakistan, Philippines, Sri Lanka, Viet Nam). IFC RESEARCH NOTE How Emerging Market Companies Are Withstanding Global Interest Rate Shifts | 7 Endnotes 1 International Finance taper-tantrum episode in May 9 Three countries—India, Corporation. John Gandolfo is Vice 2013. Credit ratings also play an Brazil, and Thailand—accounted President & Treasurer, Treasury important role in determining for more than two thirds of all and Mobilization. Paolo Mauro is funding costs (Jaramillo and Tejada local-currency corporate bond Director, Economic and Market 2011; Goel and Ghosh 2011), even issuances. Other significant Research. Helpful comments by after accounting for fundamentals, local currency markets include Susan Lund, IFC’s Vice President as they alter investor behavior and Indonesia, Malaysia, Mexico, for Economics and Private Sector eligibility. On sovereign borrowing Philippines, South Africa, and Development and inputs by Dilek costs, see also Adrian, Natalucci, Türkiye. Aykut, Samed Hysa, Cesaire Meh, and Wu, January 2024, “Emerging 10 A well-functioning domestic Florian Moelders, Nimarjit Singh, Markets Navigate Global Interest capital market for local currency Issei Takahashi, Imtiaz Ul Haq, and Rate Volatility,” IMF Blog. issuance usually requires a strong Rey Zhangrui Wang are gratefully 5 Interest costs also rose on track record of macroeconomic acknowledged. other U.S. dollar-denominated stability and a large domestic 2 This note focuses on a set borrowing—notably, syndicated investor base—conditions often of 37 emerging market and loans, which usually have floating lacking in many lower-income developing economies, defined by rates that depend on U.S. rates. emerging markets. Tyson the World Bank Global Economic A similar pattern is observed (2023) provides an overview of Prospects report (see Table 1 for for non-listed companies over capital market development in the list). The sample does not the same period, based on EMDEs, highlighting the role of include China owing to its large central bank surveys from India, institutional and macroeconomic size and different economic Indonesia, Pakistan, Thailand, and factors for local currency bond dynamics during the period under Zambia. issuances. In an analysis of consideration. Additionally, there international bond issuances by 6 In late 2019, more than half of is no low-income country in the firms between 1995 and 2013, advanced economy governments sample. The countries are grouped Hale et al. (2016) emphasize that were able to issue bonds at following the World Bank country economic fundamentals, such negative interest rates. classification by income level. as inflation and government 7 In the sample under debt, are associated with lower 3 For example, in the United consideration, this occurred in probabilities of issuing in home States, real rates are projected Egypt and Ghana. Firms that currencies. In the context between one or two percentage operate internationally with of the COVID-19 pandemic, points above pre-2019 levels. receipts in foreign currency are Papageorgiou and Goel (2021) This statement is consistent more likely to retain low funding note that local currency bonds with various sources, such as costs during episodes when the were more sensitive to domestic the Treasury Inflation-Protected sovereign is perceived as risky. fundamentals, while hard currency Securities market, the Fed’s dot- See also Jaramillo and Tejada bonds depended more on global plots minus projected inflation, or 2011; Goel and Ghosh 2011; and risk sentiment. the Federal Reserve Bank of St. Bevilaqua et al. (2020). In general, Louis (FRED) ex-ante real rates 11 For example, debt of non- however, sovereign bond yields at https://fredblog.stlouisfed. financial corporates rose from are a crucial driver of corporate org/2022/05/constructing-ex- about 30 percent of GDP in 2008 bond yields (Li, Magud, Werner ante-real-interest-rates-on-fred/. to about 40 percent at present and Witte 2021; Bevilaqua, Hale, in the sample of 47 countries 4 Global risk appetite becomes and Tallman 2020). considered, based on data from especially relevant during periods 8 See also Bruno et al. (2024) the Institute for International of stress because it can interact for analysis of corporate bond Finance. The increase was much with domestic vulnerabilities issuance in various country steeper for China, which is not to amplify the impact on groupings, and Avdjiev et al. included in the sample. (For data borrowers, especially those (2024), who highlight the role of on non-financial corporate, other with weaker fundamentals. 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