BT : Who's going to blow next?

Business Times - 02 Dec 2009

AFTER THE BINGE
Who's going to blow next?

Dubai's travails have some economists wondering if another debt bomb may be lurking dangerously

(NEW YORK) LIKE overstretched American homeowners, governments and companies across the globe are groaning under the weight of debts that, some fear, might never be fully paid back.

As Dubai, that one-time wonderland in the desert, struggles to pay its bills, a troubling question hangs over the financial world: Is this latest financial crisis an isolated event, or a harbinger of still more debt shocks?

For the moment, at least, global investors seem to be taking Dubai's sinking fortunes in their stride. On Monday, the American stock market rose modestly, even as share prices plunged throughout the Persian Gulf.

But the travails of Dubai, a boomtown that, with its palm-shaped islands and indoor ski slope became a potent symbol of hyperwealth, nonetheless have some economists wondering where other debt bombs might be lurking - and just how dangerous they might turn out to be.

Big banks that have only just begun to recover from the financial shocks of last year are now nervously eyeing their potential exposure to highly indebted corporations and governments.

From the Baltics to the Mediterranean, the bills for an unprecedented borrowing binge are starting to fall due. In Russia and the former Soviet bloc, where high oil prices helped fuel blistering growth, a mountain of debt must be refinanced as short-term IOUs come due.

The numbers are startling

Even in rich nations such as the United States and Japan, which are increasing government spending to shore up slack economies, mounting budget deficits are raising concern about governments' ability to shoulder their debts, especially once interest rates start to rise again.

The numbers are startling. In Germany, long the bastion of fiscal rectitude in Europe, government debt is on the rise. There, the government debt outstanding is expected to increase to the equivalent of 77 per cent of the nation's economic output next year, from 60 per cent in 2002. In Britain, that figure is expected to more than double over the same period, to more than 80 per cent.

The burdens are even greater in Ireland and Latvia, where economic booms fuelled by easy credit and soaring property values have given way to precipitous busts. Public debt in Ireland is expected to soar to 83 per cent of gross domestic product (GDP) next year, from just 25 per cent in 2007. Latvia is sinking into debt even faster. Its borrowings will reach the equivalent of nearly half the economy next year, up from 9 per cent a mere two years ago.

Like Latvia, the Baltic states of Lithuania and Estonia remain worryingly exposed, as do Bulgaria and Hungary. All of these nations carry foreign debt that exceeds 100 per cent of their GDPs, said Ivan Tchakarov, chief economist for Russia and the former Soviet states at Nomura bank.

External debt is often held in a foreign currency, which means that governments cannot use devaluation of their own currencies as a tool to reduce their debt when they run into trouble, according to Maurice Obstfeld, an economics professor at the University of California, Berkeley.

Few analysts predict that a major nation will default on its government debts in the immediate future. Indeed, many maintain that rich nations and the International Monetary Fund (IMF) would intervene in the event that a government needs to be bailed out.

But there are no assurances that companies in these nations, which, like governments, gorged on debt in good times, will be rescued.

Precedent for withdrawing state backing

Dubai's refusal to guarantee the debts of its investment arm, Dubai World, may set a precedent for other indebted governments to abandon companies that investors had in the past assumed enjoyed full state backing.

'I see very good reasons to be worried that at some point in 2010, we are going to see more cases of ring- fencing because governments realise they can't afford to guarantee the debts of these companies,' said Pierre Cailleteau, managing director of the global sovereign risk group and chief economist of Moody's.

Kenneth Rogoff, a Harvard economist whose recent book, This Time Is Different, chronicles 800 years of financial crises, said: 'I think right now, every vulnerable country has one or two deep-pocketed backers that pretty much rule out a sudden run.' But Mr Rogoff said that he expected a wave of defaults about two years from now, when the countries now serving as implicit guarantors turn their focus to economic problems at home.

One feature of the financial crisis is that some governments have taken on increasingly short-term debt. In the US, for example, Treasury debt maturing within one year has risen from around 33 per cent of total debt two years ago to around 44 per cent this summer, while falling slightly since then, according to Wrightson ICAP. The US will soon have debt problems of its own.

'In another couple years, as industrialised countries' own debts - in places like Germany, Japan and the United States - get worse, they will become more reluctant to open up their wallets to spendthrift emerging markets, or at least countries they view that way,' Mr Rogoff said.

This might spell trouble for cash-tight nations. Facing a need to roll over their maturing debts, emerging markets may have to borrow around US$65 billion in 2010 alone, according to Gary N Kleiman of Kleiman International. But while government indebtedness may be a problem for the future, corporate debt may set off a crisis that, in some ways, is already unfolding.

Corporate borrowing surged over the last five years. According to Mr Kleiman, US$200 billion of corporate debt is coming due this year or next year. He estimated that companies in Russia and the United Arab Emirates account for about half of that borrowing. 'This is where the Achilles' heel is,' he said.

Companies in several countries, beyond Russia and the emirates, face immediate tests in raising new money. Companies in China will have to borrow US$8.8 billion in 2010; companies in Mexico US$11 billion.

According to an analysis by JPMorgan Chase, Russian companies borrowed US$220 billion from banks or by selling bonds between 2006 and 2008. That is the equivalent of 13 per cent of Russia's GDP. In the emirates, that figure was US$135.6 billion, or 53 per cent of GDP; in Turkey, it was US$72 billion, or 10 per cent of GDP; and in Kazakhstan, it was US$44 billion, or 44 per cent of GDP.

In the past, if companies could not meet those obligations, governments might have stepped in. But already some companies have defaulted on payments after assumed government guarantees failed to materialise.

In Russia, for instance, the foreign debt totals more than US$470 billion. But only a tiny fraction of that - about US$29 billion - is sovereign debt. The rest is owed by Russian companies, including state giants such as Gazprom. The most troubling case in Russia is Rusal, the world's largest aluminium company, which owes a total of US$16 billion and has been in a standstill on repayment this year while renegotiating with a group of creditors.

A subsidiary of a Russian state aircraft manufacturing company defaulted on bonds last autumn despite a presumed sovereign guarantee.

In Ukraine, the state energy company, Naftogaz, and a state railroad, have restructured or asked to restructure their debt.

'This was a trail that was blazed in this part of the world,' said Rory MacFarquhar, an economist at Goldman Sachs in Moscow, referring to governments retreating from implied guarantees of state company debt as in the case of Dubai World.

The Dubai World debt restructuring is already lifting borrowing costs for Russian companies that must repay a total of US$20 billion in December, according to Vladimir Tikhomirov, chief economist of UralSib bank in Moscow. -- NYT

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Big burden: Newly built houses in Loughrea, County Galway, Ireland; public debt in Ireland is expected to soar to 83 per cent of gross domestic product next year, from just 25 per cent in 2007