“Original sin” — in an economic context — was coined to help explain how foreign borrowing and weak currencies sent Asia into a full-blown financial crisis in the late 1990s. Now the term has resurfaced to describe the worrisome borrowing practices of such fast-growing Asian countries as Malaysia and Indonesia.
Essentially, governments and companies in the two Asian countries have already borrowed more in foreign currencies in 2015 than in all of 2014 and their currencies are weak. Because of their depreciating currencies, bond yields are higher and domestic-currency bonds are less attractive for foreign lenders.
When countries are unable to borrow abroad in their own currency, the subsequent debt mountain in foreign currency results in a currency mismatch that can cause financial crises. That’s “original sin.”
The problem with foreign borrowing by Malaysia and Indonesia now is that US interest rates are set to rise, which means servicing their foreign-currency-denominated debt will become more difficult. At the very least, borrowing in foreign currency for both governments and corporations complicates domestic policy-making.
An index computed by the Bank of America Merrill Lynch shows how “original sin” is returning. The index takes into account how much of the debt buildup is in foreign currency and how much is domestic. A country that borrows entirely in domestic currency would get a zero, and one that borrows entirely in FX would get a 1. Malaysia’s value has increased from an average of 0.1 during 2009-14 to 0.37 by mid-July 2015, and Indonesia’s is up from 0.3 to 0.67 over the same period.
History has proven that countries that become accustomed to relying on cheap funds find it difficult to stop borrowing. Blaming weak domestic local-bond-market conditions, Indonesia’s Debt Management Office announced plans to increase the FX-denominated portion of government securities to 30% (from 23% planned previously).
Both Malaysia and Indonesia are in a far better situation than they were prior to the Asian crisis — having freely floating exchange rates, among other criteria, is positive. But their relatively high external debt singles them out as especially vulnerable among emerging markets. The cost of insuring the debt of Indonesia and Malaysia is already increasing, according to the Financial Times. Corporations across the developing world are in a similar predicament.
The question for some of these countries is whether the long run will arrive soon enough. Dun and Bradstreet’s analysis of emerging markets’ long-term growth outlook and short-run vulnerabilities signals trouble could be ahead.
Malaysia, for instance, is near the top according to both sets of indicators. Its economy has reformed massively in the last decades, and it has made huge gains in terms of education and infrastructure. But, at the same time, the country has accumulated imbalances that make it one of the most vulnerable nations financially in the region. External debt has increased from 48.1% in 2007 to 68.7% in 2015, and FX reserve coverage is down to 1.1 times the short-term external debt.
Companies currently benefiting from strong consumer demand in emerging markets should be wary of countries growing so rapidly that they are bursting at the seams.
Oana Aristide is a Senior Economist on D&B’s Global Data, Insight and Analytics team. Based in the UK, she covers three Scandinavian countries as well as Romania, Japan, Malaysia, and the Philippines as a contributor to D&B’s Macro Market/Country Insight Products. She has a background in central banking.