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Emerging Markets

Foreign Currency Debt Troubles Mount

By Carol Matlack and Mark Scott

Foreign-denominated debt is squeezing countries from Romania to South Korea as their local currencies falter.

When Daniel Ion bought his first home last year, his monthly mortgage payment was $704 (€552). Now it's $939 -- and rising. "We wanted so much to have our own house, but now we are really starting to feel the burden," says Ion. Soon, he frets, his salary as a manager at a toy factory may not be sufficient to cover the payments.

Another subprime hard-luck story? Not exactly. Ion lives in Bucharest, and his plight illustrates one reason emerging markets such as Romania are in trouble. Like US subprime borrowers, Ion was lured by a mortgage with easy up-front terms. But a bigger problem is that his loan is in euros while his salary is in lei, the Romanian currency, which is off by 12 percent against the euro in the past year. Foreign-currency loans are popular in developing countries because they offer lower interest rates than those in local currencies. In Romania, for instance, foreign currency loans run as low as 8 percent, vs. 10 percent or more for loans in lei.

All told, borrowers in emerging markets owe some $4.7 trillion in foreign-denominated debt, up 38 percent over the past two years. Many developing countries still look strong on paper, with big foreign reserves and healthy trade surpluses. But the statistics can mask heavy dependence on offshore loans to keep economies buoyant. "It's amazing that people don't pay attention," says Mark Mobius, head of Templeton Emerging Markets Fund (EMF). Borrowers have been taking out "mortgages in yen and Swiss francs because they thought the money was so cheap."

Governments and international lending agencies are scrambling to rescue the hardest-hit countries. The hundreds of billions of dollars the US and Europe are pumping into frozen credit markets also will help. But for some countries, it's already too late to avoid a painful hangover, says Morgan Stanley's (MS) Ronny Rehn in London. "There will be extreme repercussions," he says.

Who could suffer, and how? Romania, Hungary, and Bulgaria -- where more than half of all debt is foreign-denominated -- could be pushed into recession, joining the Baltics, where the economies already are contracting. "The only sector that's doing well is collection agencies," says Tomass Barilo, managing director of WorkingDay, a recruitment company in Riga, Latvia. Barilo says he expects WorkingDay's revenues to shrink 25 percent to 30 percent this year as consumers and businesses struggle to repay foreign-denominated debts. And Ukraine is bracing for draconian cuts in social spending under terms of a $14 billion emergency loan it is negotiating with the International Monetary Fund. Some 49 percent of the country's debt is foreign-denominated, and Ukraine's currency is down nearly 9 percent in the past year.

Lenders are at risk, too -- especially in Central and Eastern Europe, which have gotten some $1.5 trillion in credit from foreign banks. The three biggest foreign lenders -- Italy's UniCredit, and Austria's Erste Bank and Raiffeisen International -- have all had their debt outlooks lowered recently to "negative" by ratings agencies that cite deteriorating economic conditions in the region. And Sweden's SEB and Swedbank have written down more than $100 million on credit losses in the Baltics this year.

Healthy Reserves

In South Korea, the global credit squeeze has sent the won plunging 33 percent against the dollar this year, making it virtually impossible for local banks to borrow from overseas lenders. Some banks, in turn, stopped lending to small and midsize companies -- prompting Seoul to swoop in on Oct. 19 with $100 billion in guarantees on foreign borrowings. But most analysts expect Korea to weather the storm, in large part because of its healthy $240 billion foreign-exchange reserve.

Other countries are vulnerable not so much because of corporate or consumer borrowing in foreign currencies but because their governments are at risk of default. In Argentina, President Cristina Fernández de Kirchner wants to nationalize $30 billion in private pension funds. Although Kirchner says the move will protect retirees from falling stock prices, critics say the real reason is to strengthen state finances as Argentina prepares to make billions of dollars in foreign debt payments next year. In Pakistan, meanwhile, foreign reserves have dropped to $4.3 billion, enough to cover only 45 days of imports. Pakistan's rupee has plunged 22 percent this year as exports have slowed.

To preserve foreign currency, Pakistan's government has ordered companies to pony up, in cash, one-third of any import bill before banks can issue letters of credit. That has forced businesses to slash imports. "My company is in a pretty deep crisis right now," says Muhammad Imran Khan, chief executive of Lahore-based steel products company Conductor & Cables, which has cut its imports of raw steel and cables by half this year.

Slumping stock markets aggravate the problem. More than $20 billion flowed out of emerging-market equities in the third quarter, estimates the Institute of International Finance, a Washington association of financial firms. Ukrainian stocks are off 77 percent this year, shares in Bucharest have plummeted 67 percent, and Sofia's bourse has dropped 66 percent. In Moscow, where the RTS stock index is down by 71 percent, oligarchs who pledged shares in their companies as collateral on loans from Western banks now are having trouble making payments.

Small wonder, then, that businesspeople around the world feel whipsawed. "The value of the [Turkish] lira doesn't depend so much on the performance of the Turkish economy, but on decisions made by people that have invested in Turkey," laments Mahmut Derya Uras, general manager of Transturk Holding, a machine tool company in Istanbul. Uras concedes, though, that the crisis underscores the need for economic restructuring in Turkey. "It can be used," he says, "as an opportunity to change."