EVIDENCE ON BONDS AND SYNDICATED LOANS

The Use of Markets for Long-Term Finance

The global fi nancial crisis of 2008–09 tem-porarily halted the fast expansion in debt is-suance activity in both high-income and de-veloping economies.²⁰The total amounts of corporate bonds and syndicated loans issued by nonfi nancial fi rms grew at an average an-nual rate of about 10 percent in high-income economies and 23 percent in developing econ-omies during 2000–07. In 2008 total debt is-sued decreased by 40 percent and 33 percent, respectively.

Corporate bond issues began to grow again in 2009, but the collapse in syndicated loan fi -nancing was larger and longer lasting. Corpo-rate bond markets quickly rebounded in 2009 and continued increasing during the postcrisis period, especially in developing economies. In contrast, syndicated loan fi nancing by high-income (developing) economies declined 63

BOX 3.4 Building Blocks for Domestic Corporate Bond Market Development (continued)

related markets (IMF 2013b):

First, well-functioning money markets are a pre-condition for the development of well-functioning longer-term debt markets because they anchor the short-end pricing of debt instruments. Money mar-kets provide investors with instruments to manage risks and maturities and are also important for sec-ondary market liquidity. In this sense, an effectively functioning money market provides key market pric-ing at the short end of the yield curve, infl uencpric-ing the rate of longer-term corporate bonds.

Second, government debt markets are the corner-stone of domestic corporate bond markets. Sound sovereign debt management with regular issues of benchmark bonds at different maturities is central to building a yield curve, which is necessary to price corporate bonds effi ciently (especially in the longer term). Additionally, the fi nancing needs of the cen-tral government determine the scope for corporate bonds, especially in relatively small markets where the government and private entities typically compete for limited long-term funding.

As some studies report, however, it is important to also take into account the possibility of crowding-out effects between government and corporate bond markets through competition for investors’ funds (Friedman 1986). For example, Graham, Leary, and Roberts (forthcoming) documented a negative association between government borrowing and corporate debt issuance, which is consistent with a crowding-out effect on the demand curve for corpo-rate debt.

Third, the banking system also plays an impor-tant role as a supplier, underwriter, and buyer of cor-porate bonds (for itself or for its clients). This role will evolve as countries develop, the fi nancial system deepens, and the domestic investor base becomes diversified. At the same time, the banking system provides fi nancial services to households that can-not access securities markets and, as a result, helps enhance market liquidity and lengthens the maturity of fi nancial securities because the banking system can hold securities on behalf of those households.

corporate bonds to fund operations previously funded by syndicated loans.

During the crisis, the average maturity of newly issued corporate bonds declined in both economy groupings, while the average matu-rity of newly issued syndicated loans declined only in highincome economies. More specifi -cally, between 2007 and 2009, the average ma-turity of corporate bonds declined by almost 3 years in high-income economies and by more than 2 years in developing economies.²¹ The average maturity of syndicated loans conceded to high-income economy fi rms decreased by 1.6 years during the same period, while in developing economies it actually increased by more than 2 years (fi gure 3.7). This increase increased 170 percent from 2008 to 2013,

whereas syndicated lending declined 42 per-cent. The acceleration in the corporate bond issuance was partially prompted by global in-vestors searching for higher yields in an over-all low interest rate environment driven by low government yields. The shift away from bank fi nancing to bond fi nancing has affected some sectors more than others. The infrastruc-ture sector was hard hit because syndicated loan fi nancing plays a very important role at the early stages of the projects. Moreover, al-though the data were silent on substitution be-tween markets, it is possible that some of the increase in bond issue could be attributable to the refi nancing of bank loans or to using

Corporate bonds Syndicated loans

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Maturity, years

a. High-income countries

0 4 6 8

2 10 12

1 5 7 9

3 11 13 14 0 4 6 8

2 10 12

1 5 7 9

3 11 13 14

Maturity, years

b. Developing countries

FIGURE 3.7 Average Maturity of Corporate Bond and Syndicated Loan Issuances, 2000–13

Source: Cortina, Didier, and Schmukler 2015.

the increasing exposure of developing econo-mies to currency mismatches and to potential changes in international investor sentiment (Chui, Fender, and Sushko 2014; The Econo-mist 2014a, 2014c; IDB 2014; Turner 2014).

The volume of domestic corporate bonds issued by developing economies during and after the crisis also accelerated. That expan-sion was heavily concentrated in a few coun-tries, however. Overall, fi rms in developing economies more than doubled the domestic issuance of corporate bonds during 2008–13 (see fi gure 3.8).²² Chinese fi rms accounted for 58 percent of that total, followed by Bra-zil (12 percent), the Russian Federation (8 percent), and India (6 percent).²³ These four economies plus six others captured 99 per-cent of the total amount raised domestically was driven by a decline in shorter-term loans,

however, rather than by an increase in longer-term fi nancing (longer-longer-term loans also col-lapsed during the crisis).

A closer look at corporate bond activity during and after the crisis shows that interna-tional bond issues rapidly rebounded after the crisis, particularly in developing regions (fi gure 3.8). For example, the international issuance of bonds in Latin America and the Caribbean increased almost 8-fold between 2008 and 2009 and has remained high since then. The issuance in international markets of some spe-cialized local securities such as Islamic bonds (sukuk) has also been on the rise (box 3.5).

Because bonds issued in international markets are almost exclusively denominated in foreign currency, some studies have warned about

Domestic markets International markets Domestic markets (excluding China) 0

0.2 0.3 0.4

0.1

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0.5 0.6 0.7

2011 U.S. dollars, trillions

a. High-income countries

0 0.10 0.15 0.20

0.05 0.25

2011 U.S. dollars, trillions

b. Developing countries

FIGURE 3.8 Total Amount Raised in Domestic and International Corporate Bond Markets by Nonfi nancial Firms, 2000–13

Source: Cortina, Didier, and Schmukler 2015.

share of developing economies, government bond markets also expanded during and af-ter the crisis; see box 3.6. As noted, these markets constitute a cornerstone of domestic debt markets and are central to building a yield curve that will allow private bonds to be priced at long maturities.)

The largest decline in corporate bond ac-tivity occurred in the fi nancial sector of high-within developing economies during the

pe-riod (fi gure 3.9). Although the experience of these 10 countries indicates how these domes-tic bond markets can play a “spare tire” role (Chan and others 2012), local bond markets did not develop at all for most developing economies. Domestic bond markets remained completely untapped for 14 of the 33 devel-oping economies in the sample. (For a large

BOX 3.5 Sukuk: An Alternative Financing Source

The recent growth of Islamic fi nance, based on the principles of risk sharing and participatory fi nance, offers potential alternatives for long-term fi nancing.

The total size of fi nancial assets under management in this growing industry was estimated to exceed

$2 trillion by the end of 2014. For instance, the African region is embracing large-scale Islamic finance to finance large infrastructure programs.

Although the banking sector dominates the mar-ket, asset-based capital market instruments are a growing source of fi nancing for both Muslim and non-Muslim countries in domestic and international markets.

A sukuk is an asset-backed security representing a right of ownership for the holders to the underlying assets and the income they generate. In particular, a sukuk is commonly used as the Islamic equivalent of bonds. In contrast to conventional bonds, however, which merely confer ownership of a debt, sukuk grants the investor a share of an asset, as well as the associated cash fl ows and risk. Therefore, sukuk securities adhere to Islamic laws that prohibit the charging or payment of interest. The total outstand-ing amount of sukuk stood close to $300 billion by the end of 2014.

Because of the asset-based nature of the security, sukuk are attractive to a diverse group of borrowers and investors in both Muslim and non-Muslim coun-tries. The utilization of sukuk as a fi nancing vehicle by several leading high-income economies includ-ing Hong Kong SAR, China; Luxembourg; South Africa; and the United Kingdom during 2014 is testi-mony to the wider acceptance of the instrument and emergence of a new asset class. Strong demand for

securities with high-quality credit ratings that con-form to principles of Islamic finance is evident by the fact that the U.K. issuance was oversubscribed by approximately 12 times. Tapping into this emerg-ing instrument, the World Bank successfully raised

$500 million through sukuk issuance in 2014 to help with the funding of an immunization program in Africa. The Islamic Development Bank (IsDB) has been the leading multilateral institution mobilizing fi nancing for development through sukuk. IsDB’s lat-est public offering of sukuk in 2014 raised $1.5 bil-lion for development in its member countries. Malay-sia has been the leader in issuing domestic sukuk and represents the largest share of the global market.

Moreover, sukuk has been used successfully for the fi nancing of long-term infrastructure projects.

Sadara Company, a joint venture between Saudi Aramco and the Dow Chemical Company, origi-nated a $2-billion sukuk with a maturity of 16 years to fi nance the construction of a petrochemical plant (planned to cost around $12.5 billion). Tenaga Nasi-onal Berhad from Malaysia issued a $1.09 billion sukuk with a maturity of 27 years to fi nance con-struction of a 1,000 megawatt ultra-supercritical coal-fi red power plant.

Although still in its infancy, with its asset-based structure and risk-sharing aspects, sukuk bonds seem to have signifi cant potential to be used in infrastruc-ture and fi nancing for small and medium-size fi rms not just for the Middle East and North Africa region (estimated to need $75 billion–$100 billion infra-structure investments annually over the next 10–15 years), but also for both high-income and developing markets around the globe.

Sources: Bank Negara Malaysia 2014; IIFM 2014; Standard & Poor’s 2014; http://www.zawya.com/islamic-fi nance.

income economies, which experienced a sharp and sustained fall in issuance volumes after 2007 (fi nancial fi rms were studied separately from nonfi nancial fi rms). The total amount fi -nancial fi rms raised through corporate bonds in 2013 was about 58 percent the amount raised in 2007 (fi gure 3.10). In contrast, fi -nancial companies in developing economies have quickly recovered the upward trend in corporate bonds activity since 2009. In 2013 the total amount raised doubled that of 2007.

In syndicated loan markets, both domestic and international lending collapsed for high-income economies, while only international lending collapsed for developing economies.

The aggregate amount raised by high-income economies in both domestic and international markets decreased 60 percent between 2007

0 20 30 40

China Brazil Russian Federation 50

60 70

India

Mexico Malaysia Thailand Chile

PhilippinesIndonesia

Share of total raised, %

FIGURE 3.9 Share Raised by the 10 Most Active Developing Countries in Domestic Corporate Bond Markets, 2008–13

Source: Cortina, Didier, and Schmukler 2015.

BOX 3.6 Macroeconomic Factors and Government Bond Markets in Developing Countries

The experience of developing countries in the 2000s shows that improvements in macroeconomic funda-mentals created a momentum to build local bond markets and helped them weather the global fi nan-cial crisis.

In the years preceding the crisis, developing countries achieved signifi cant improvement in their macro economic environments.

Governments’ primary balances, as a percent-age of GDP, were overwhelmingly positive or were becoming positive during this period, and overall budget balances, as a percent of GDP, were improv-ing steadily across all regions.

Greater price stability and positive expectations in developing countries were favorable ingredients boosting confi dence in longer-term bonds, includ-ing government bonds. In many countries, especially those that had been historically plagued by volatile and high infl ation levels, this scenario paved the way for interest rate cuts, the development of local cur-rency yield curves, and the lengthening of the average time to maturity of the domestic government debt.

Buoyant growth, together with sounder fiscal policy, contributed to a downward trend in ratios

of debt to GDP. Fiscal indicators, interest rates, and GDP growth represent the key determinants in the dynamics of these ratios. Most developing countries enjoyed a long period where this positive combina-tion was in place.

Improvements in developing countries’ external accounts provided solid foundations to reduce vul-nerability to shocks and to reversals in capital fl ows.

While external accounts improvements were driven by cyclical factors that led to extremely high inter-national liquidity conditions, proactive policies to reduce debt vulnerabilities (buybacks of external debt and a shift to funding in local markets) were highly instrumental in the rapid pace of change witnessed in external debt vulnerability indicators.

On the back of healthier macroeconomic fun-damentals, developing countries were able to trans-form their government debt portfolios and to grow domestic bond markets. The average ratio of exter-nal to domestic debt for selected developing coun-tries dropped steadily from 0.75 in 2000 to 0.22 in 2009. Currency composition of the government debt port folio moved drastically in favor of local currency, reducing the exposure to changes in exchange rates.

(box continued next page)

tional lending to developing-economy fi rms declined from $256 billion to $64 billion dur-ing the two-year period. The largest fraction of syndicated loans to developing economies and 2009 (fi gure 3.11). This collapse was

es-pecially hard for developing-economy fi rms that received most of their syndicated loan fi nancing in the international market.

Interna-BOX 3.6 Macroeconomic Factors and Government Bond Markets in Developing Countries (continued)

The structure of the domestic debt experienced a signifi cant transformation as debt managers were able to reduce risk exposures through the issue of long-term fi xed-rate instruments. The ratio of fl oat-ing and short-term to fi xed-rate debt contracted from 2.0 in 2000 to 0.7 in 2009.

The extension of the average life of debt was sup-ported by increased credibility of monetary policy and diversifi cation of the investor base. More stable and sounder macroeconomic policies, together with reforms in the pension and insurance industries, changed the investor base that previously comprised almost exclusively commercial banks. Holdings of domestic institutional investors (pension and insur-ance) grew steadily. Foreign investors showed appe-tite for local currency, long-term fi xed-rate instru-ments in countries like Mexico and Brazil.

Although developing countries were initially hit by the global crisis as much as developed countries, the

progress achieved during the precrisis period made developing countries more resilient to the global cri-sis, allowing them to experience a faster rebound (Didier, Hevia, and Schmukler 2012). That is, sound macroeconomic policies seem to have been critical in creating a buffer and in positioning developing coun-tries for quicker recovery from the crisis. Developing countries arrived at the global fi nancial crisis with government debt portfolios that were more resilient to shifts in the economic cycle and market sentiment.

The increase in the share of domestic debt reduced the exposure to exchange rate shocks and the vulner-ability to sudden stops in capital fl ows. The lengthen-ing of maturities in local currency fi xed-rate instru-ments reduced rollover and interest-rate risk in the time of crisis. During the crisis, debt managers had room to maneuver and were able to adapt quickly, absorbing some risk from the market.

Source: Anderson, Caputo Silva, and Velandia-Rubiano 2010.

(fi gure continued next page) 0

1.0 1.5 2.0

0.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

2.5 3.0

2011 U.S. dollars, trillions

a. High-income countries

FIGURE 3.10 Total Amount Raised in Corporate Bond Markets by Financial and Nonfi nancial Companies, 2000–13

Financial companies Nonfinancial companies

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

2011 U.S. dollars, trillions

b. Developing countries

0 0.10 0.15 0.20

0.05 0.25 0.30 0.35 0.40

FIGURE 3.10 Total Amount Raised in Corporate Bond Markets by Financial and Nonfi nancial Companies, 2000–13 (continued)

Source: Cortina, Didier, and Schmukler 2015.

Domestic borrowing International borrowing Domestic borrowing (excluding China and India)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

2011 U.S. dollars, trillions

a. High-income countries

2011 U.S. dollars, trillions

b. Developing countries 0

1.0 1.5 2.0

0.5 2.5

0 0.10 0.15

0.05 0.20 0.25 0.30

FIGURE 3.11 Total Amount Raised by Nonfi nancial Firms in Domestic and International Syndicated Loan Markets, 2000–13

Source: Cortina, Didier, and Schmukler 2015.

loans are not perfect substitutes, particularly at the construction phase of these projects. Syn-dicated loans are most suited to the complex-ity and higher risks associated with the initial phases of the projects (planning and construc-tion) whereas bonds are more appropriate for more consolidated stages (operational).²⁶ The bank retrenchment that followed the crisis se-verely constrained syndicated loans and thus the fi nancing of infrastructure projects in de-veloping countries, which had few alternatives for fi nancing these operations at their initial phases. Lending originated in high-income economies to fi nance infrastructure in devel-oping ones declined 62 percent between 2007 and 2009, threatening the long-term growth associated with these projects (Calderón and Servén 2014). See fi gure 3.13.

Cyclical and structural reasons seem to be behind the collapse and the weak recovery of syndicated loan fi nancing. Part of this decline may refl ect a drop in demand as fi rms scaled back expansion plans during the recession (Ivashina and Scharfstein 2010). Neverthe-less, the fall in syndicated loans was greater than in a typical recession because the de-mand drop was reinforced by a drop in sup-ply caused largely by deleveraging pressures originated in Western European banks, the

major source of syndicated funding for fi rms in the developing world, fell 80 percent be-tween 2007 and 2009, and has remained very weak since then (fi gure 3.12).²⁴

Although the overall volume of domestic syndicated lending in developing economies rapidly increased during and after the crisis years, China and India alone fully absorbed three-quarters of it. More specifi cally, the ag-gregate amount raised in domestic markets by developing-economy fi rms was $51 billion in 2007, $76 billion in 2009, and $116 billion in 2013 (see fi gure 3.11). Domestic lending in China and in India accounted for 23 percent and 53 percent of the total amount lent, re-spectively.²⁵ Most developing economies did not see any increase in domestic syndicated lending during 2008–13. This lack of growth, together with the collapse in international lending, meant that fi rms from most develop-ing economies have been struggldevelop-ing in recent years to tap long-term funding through the use of syndicated loans.

Because syndicated loans are key at the early stages of infrastructure projects, these projects have been severely affected by the lack of syndicated funding. Bonds and syndicated

Western Europe United States High-income Asia Others

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

2011 U.S. dollars, trillions

0 40 60

20 80 100 120 140 160 180 200

FIGURE 3.12 Total Amount Lent to Developing Countries through Syndicated Loan Markets by Lender Region, 2000–13

Source: Cortina, Didier, and Schmukler 2015.

use these fi nancial markets, and only the larg-est and oldlarg-est ones issue at the long end of the maturity spectrum. For the set of fi rms that do use long-term markets, those in developing economies do not issue at shorter maturities than those in high-income economies.

Because developing-economy fi rms tend to be smaller in size, a smaller proportion of fi rms is able to access equity, bond, and syndicated loan markets. Therefore, the larger proportion of SMEs in these countries has

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