IT MAY SEEM LIKE A GOOD IDEA TODAY… If anyone needs more evidence that focusing on short-term corporate performance can be detrimental to longer-term outcomes, look no further than the effect of the strengthening U.S. dollar on companies outside the United States that issued debt denominated in U.S. dollars. The Economist explained:
“Dollar borrowing is everywhere, but the biggest growth has been in emerging markets. Between 2009 and 2014 the dollar-denominated debts of the developing world, in the form of both bank loans and bonds, more than doubled, from around $2 trillion to some $4.5 trillion, according to the Bank for International Settlements (BIS)… Recent months have seen… an Indian property developer… a South African power generator, and… a Turkish firm that makes TV dinners, sell dollar-denominated bonds. By borrowing dollars at several percentage points below the prevailing interest rate in their domestic currency, CEOs have pepped up profits in the short term.”
As it turns out, dollar-denominated debt may not work out so well in the long run. In recent weeks, the value of currency in many countries has declined relative to the U.S. dollar which has been strengthening. As a result, the amount of interest owed on bonds issued and loans taken in U.S. dollars has increased significantly when measured in local currency terms. Unless a company has U.S. dollar earnings to help offset the expense, the higher cost of its debt can hurt the company.
The New York Times cited a leading electric utility in India that is selling facilities and renegotiating debt after its debts increased thirty-fold in just a few years. In Brazil, some sugar producers have declared bankruptcy, in part, because of U.S. dollar debt and falling sugar prices.
The Times also pointed out, “…the rising dollar and falling emerging-market currencies cut both ways for the economies in question. Even as companies that gorged on dollar debt run into trouble, falling currency values make exporters more competitive on global markets.” In January, the International Monetary Fund projected economic growth in emerging countries will increase from 4.3 percent in 2015 to 4.7 percent in 2016.