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Problem: Fixed Debt Service FX Denominated Debt Mismatched Revenues/Expenses FX Impact on Demand Short-Maturity Debt Inability to Roll-over Interest rate volatility Demand Declines Interest Coverage
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Debt & Firm VulnerabilityJack GlenIFCMarch 2004
Why Do Firms Get into Trouble? Poor Management Technological Innovation Market Competition Demand Declines
Business Cycle Crisis
Problem: Fixed Debt Service FX Denominated Debt
• Mismatched Revenues/Expenses• FX Impact on Demand
Short-Maturity Debt• Inability to Roll-over• Interest rate volatility
Demand Declines• Interest Coverage
How to Measure Leverage? Aggregate Measures
External Debt Ratios Consumer Debt Component
Firm-Level Measures Accurate, but what to Count? Reveals Distribution of Exposure Ability to Service Debt Varies
Excess Leverage?
0
20
40
60
80
100
120
140
East Asia andPacific
Europe andCentral Asia
Latin America andCaribbean
1995 1997 2001
Percentage of GDP
Domestic Bank Credit
Excess Leverage?Spot the Emerging Market CountryMedian, Total Liabilities/Total Assets
00.10.20.30.40.50.60.70.8
1994 1995 1996 1997 1998 1999 2000 2001
IrelandMalaysia
Declining East Asian Debt LevelsTotal Liabilities/Total Assets, Median
0.40
0.45
0.50
0.55
0.60
0.65
0.70
0.75
1995 1996 1997 1998 1999 2000 2001
KoreaThailandNetherlands
Korea: Total Liabilities/Total Assets% of Companies
0%5%
10%15%20%25%30%35%
TL/TA %
20001995
Short-term Debt Vulnerability?Current Liabilities
0
10
20
30
40
50
60
70
80
East Asia Latin America Europe and CentralAsia
1995
1997
2001
Percentage of Total Liabilities
Too Much Short-Term Debt?Median Current Liabilities/Total AssetsOECD, Low Middle & Upper Middle Income Countries
0.200.220.240.260.280.300.320.340.36
1994 1995 1996 1997 1998 1999 2000 2001
LMIUMIOECD
Too Much Short-Term Debt?Spot the Emerging Market CountryMedian, Total Current Liabilities/Total Assets
0.000.050.100.150.200.250.300.350.400.45
1994 1995 1996 1997 1998 1999 2000 2001
ArgentinaJapan
Excess External Leverage?Corporate foreign debt
0
5
10
15
20
25
30
35
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Percentage of GDP
Latin America and the Caribbean
East Asia and Pacific
Europe and Central Asia
Private Flows to Emerging Markets$ Billions
-50
0
50
100
150
200FDI
Portfolio
Debt
East Asian Corporate BorrowersLT Debt/Total Debt,Firms with FX Debt & with no FX Debt
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
No FX DebtFX Debt
Allayanis, Brown & Klapper (2003)
How Does Foreign Debt Impact Results?Allayanis, Brown & Klapper (2003)
Foreign debt no worse than local debt for stock prices & interest coverage
FX debt is used because it is longer tenor FX debt is used most when FX sales are
available
Cash Flow and Interest CoverageGlen (2004)
Cash Flow Volatility Business Cycle Currency Depreciation Interest Rate Increases
ICR=EBITDA/Interest Expense What is impact of these factors on
ICR?
The Data
Osiris 41 Countries 1994-2001 Manufacturing
7 Sectors 44,424 Firm Years
Interest Coverage RatioAll Countries & Firms, EBITDA/Interest Expense, 2000
0.0
2.0
4.0
6.0
8D
ensi
ty
-50 -40 -30 -20 -10 0 10 20 30 40 50ICR
Interest Collection RateBrazil, All Firms (149), 2000
0.0
5.1
.15
.2.2
5D
ensi
ty
0 5 10 15ICR
ThailandInterest Coverage Ratio (Median),GDP Growth (%) & Interest Rates (%)
-15
-10
-5
0
5
10
15
20
1994 1995 1996 1997 1998 1999 2000 2001
ICRGDPInt Rate
The Findings Significant Business Cycle Effect
• -5% ΔGDP –1 Δ ICR Significant Sector Differences
• General Manufacturing Hit Hardest Significant Interest & Inflation
Effects• Both Negative & Economically Large
Developed and Emerging Markets Better fit for Emerging Markets GDP impact same DM sensitive to Inflation EM sensitive to Interest Rates
Impact of a 5% Decline in GDPAll Countries & Firms, EBITDA/Interest Expense, 2000
0.0
2.0
4.0
6.0
8D
ensi
ty
-50 -40 -30 -20 -10 0 10 20 30 40 50ICR
Turnover & Margins
Returns correlated with Business Cycle
Margin Effects Hard to Discern Turnover Effects Strongly Negative
sTotalAssetSalesx
SalesEBITDA
sTotalAssetEBITDA
Conclusions Debt Service a major source of
Vulnerability Business Cycle Impacts Significant Measuring Vulnerability
Product Market Volatility Sensitivity to Business Cycle Does Market Structure Permit a
Management Response?
