ONCE again, two news stories touching on a similar subject sat nearly side by side. The first was about the Philippine government coming back to the global debt market, borrowing a fresh $500 million in a dollar-bond sale. The second story was that loans taken out in foreign currency from local banks were up 4.3 percent in the third quarter 2014 versus the previous quarter.
Prior to 1997, the average person in business never thought about borrowing funds in foreign currency, except when funding imports or the like. But it was foreign currency-denominated debt that caused the 2007 Asian crisis. While some commentators say it was a debt crisis, that is wrong.
The governments of Thailand, showing the infinite economic wisdom that most governments have, encouraged businesses to borrow in dollars from foreign banks to expand their business, particularly in the property sector. The government, in return, “pegged” the Thai baht to the US dollar, so that there would not be a risk to the borrowers from currency exchange-rate changes.
Eventually, the government ran out of dollars to provide to the borrowers to pay back their loans, had to let the currency float and bankrupted the country.
Here is the key to the situation. Foreign debt to gross domestic product (GDP) of the four largest Association of Southeast Asian Nations countries went from 100 percent to 167 percent from 1993 to 1996. In 1997 it was over 180 percent.
The Philippine government and individuals and companies are borrowing in dollars anticipating a US interest-rate increase. The risk is in the peso exchange rate. But foreign just offered to buy over four times as much dollar debt as the Philippine government was offering. They do not see a great currency risk.
The reason is that the Philippines, both the government and private sector, has a low foreign-currency debt. Current foreign debt-to-GDP ratio is only 32 percent. By comparison, Australia is at 95 percent, and Sweden, South Korea and New Zealand, among others, are all higher than the Philippines.
Borrowing in dollars at this moment makes sense as long as done in a prudent amount as the government just did. The interest-rate differential between local and foreign banks and between peso- and dollar-denominated
debt is large enough to warrant the risk of the currency exchange rate.
For both businesses and government, borrowing and debt is a financial tool. As with all tools, you need to know which one to use, and how to use it properly.
Image credits: Jimbo Albano