LOCAL DEBT MARKETS
LOCAL DEBT MARKETS
As corporations expand across foreign frontiers, they must adjust to local debt markets, both short term and long term. Since each country has different business customs, firms need to abandon strict operating procedures developed in other countries. When Caterpillar Tractor went to Brazil for the first time, it was accustomed to operating through one bank for all of its transactions. Very quickly, however, it became clear that the tight credit market in Brazil required different operating procedures. So Caterpillar opened accounts in several banks, allowing it to tap several different credit sources. Caterpillar liked this so much that it exported its Brazilian policy back to the United States, which allowed it to gain access to funds from many different banks.
In the United States it is customary for U.S. companies needing cash to sell commercial paper, a form of IOU backed up by standby lines of bank, credit, which are the lines of credit that the companies can gain access to if they need to use them to settle their IOUs. When U.S. subsidiaries of foreign corporations began to issue such paper, the market required that the paper be guaranteed by the parent company. Some giants, like Shell Oil, did not need to rely on their parent, because they were large enough and had a good enough reputation to gain access to capital on their own, but most companies did.
Even though domestic and international markets are becoming more and more like a single market—at least in the case of the industrial countries—
local markets still depend a great deal on internal political and economic pres- Sures. In Latin America, for example, high inflation has created problems for
, . - , „ , . „ . ,
a number ot firms. In some countries, efforts to control inflation have curtailed the money supply and thus the availability of funds.
In Italy, foreign banks entered the market to provide financing for local firms, and most experts consider the foreign banks more efficient, competitive, and innovative than their Italian counterparts. However, they lack the branch network of the Italian banks and the strong banker-customer relationships that are necessary in the highly regulated Italian market. As a result, many of the large foreign banks, such as Lloyds, Chemical Bank, and Hongkong and Shanghai Bank, are leaving the local market to the local banks.1
Spain's preparations for entry into the European Community (EC) revolutionized the local credit market. Before 1981 the only source of medium-term financing was from capital markets outside of Spain. When loans were denominated in currencies other than the Spanish peseta, the borrowers were exposed to a foreign-exchange risk when they had to pay off their loans. However, several changes in Spanish banking laws in 1981 opened up the local peseta financial market. The major source of influence was the international banks, long accustomed to creative financing.2
Foreign companies sometimes are treated differently from domestic companies when it comes to access to the credit markets. In Brazil in the early 1980s, for example, subsidiaries of foreign-owned companies were excluded from local credit markets, because they wanted those subsidiaries to bring in hard currency from abroad.3
Sometimes, however, foreign companies can get access to credit differ-
ently than local firms because of their access to hard currency. Firms can enter
into back-to-back loans during periods when interest rates are high or credit
is frozen. A back-to-back loan is one that involves a_ company in Country A
with a subsidiary in Country B, and a bank in Country B with its branch in
Country A. The example below of a U.S. food company operating in Italy
shows how the Italian subsidiary can gain access to Italian loans by having its U.S. parent provide dollars for the U.S. subsidiary of an Italian bank. Under that condition, the Italian bank will lend money to the Italian subsidiary of the U.S. parent. An example of a back-to-back loan by a U.S. food company operating in Italy is as follows:
A dollar deposit is made in the U.S. with a branch of a leading Italian bank. At the same time, the equivalent amount in lira is lent by the bank to the company's Italian sub as a seven-year loan. The loan will be repaid in full to the bank at the end of the loan period. Once the loan is terminated, the parent will withdraw its deposit plus interest. The subsidiary pays Italian prime. Every six months, the exchange rate is adjusted if it varies more than 5 percent from the contracted rate. Thus, the subsidiary shoulders the exchange risk.4
If a U.S.-based MNE decides to use foreign credit markets to finance foreign operations, it must take into consideration interest-rate differentials and exchange-rate risks. As noted in Chapter 8, interest rates differ from country to country, primarily because of inflation differentials. In Brazil in 1989, the consumer price index rose by more than 1000 percent, which was reflected in high interest rates and a rapidly devaluing currency. If the Brazilian subsidiary of a U.S. company decided to borrow in dollars at lower interest rates rather than pay the high interest rates on Brazilian currency loans—if they were even available—it would be exposed to an exchange-rate risk. If the Brazilian currency were to devalue against the dollar (which it certainly did during the period of high inflation), the Brazilian subsidiary would have to come up with more Brazilian currency to purchase dollars to pay the principal and interest.
From these illustrations it is obvious that MNEs need to weigh several factors as they look at the local credit markets: (1) availability of funds, (2) cost due to interest rates and foreign-exchange risk, and (3) local customs and institutions. Because situations and events are dynamic, corporate treasurers must be able to react quickly.
As corporations expand across foreign frontiers, they must adjust to local debt markets, both short term and long term. Since each country has different business customs, firms need to abandon strict operating procedures developed in other countries. When Caterpillar Tractor went to Brazil for the first time, it was accustomed to operating through one bank for all of its transactions. Very quickly, however, it became clear that the tight credit market in Brazil required different operating procedures. So Caterpillar opened accounts in several banks, allowing it to tap several different credit sources. Caterpillar liked this so much that it exported its Brazilian policy back to the United States, which allowed it to gain access to funds from many different banks.
In the United States it is customary for U.S. companies needing cash to sell commercial paper, a form of IOU backed up by standby lines of bank, credit, which are the lines of credit that the companies can gain access to if they need to use them to settle their IOUs. When U.S. subsidiaries of foreign corporations began to issue such paper, the market required that the paper be guaranteed by the parent company. Some giants, like Shell Oil, did not need to rely on their parent, because they were large enough and had a good enough reputation to gain access to capital on their own, but most companies did.
Even though domestic and international markets are becoming more and more like a single market—at least in the case of the industrial countries—
local markets still depend a great deal on internal political and economic pres- Sures. In Latin America, for example, high inflation has created problems for
, . - , „ , . „ . ,
a number ot firms. In some countries, efforts to control inflation have curtailed the money supply and thus the availability of funds.
In Italy, foreign banks entered the market to provide financing for local firms, and most experts consider the foreign banks more efficient, competitive, and innovative than their Italian counterparts. However, they lack the branch network of the Italian banks and the strong banker-customer relationships that are necessary in the highly regulated Italian market. As a result, many of the large foreign banks, such as Lloyds, Chemical Bank, and Hongkong and Shanghai Bank, are leaving the local market to the local banks.1
Spain's preparations for entry into the European Community (EC) revolutionized the local credit market. Before 1981 the only source of medium-term financing was from capital markets outside of Spain. When loans were denominated in currencies other than the Spanish peseta, the borrowers were exposed to a foreign-exchange risk when they had to pay off their loans. However, several changes in Spanish banking laws in 1981 opened up the local peseta financial market. The major source of influence was the international banks, long accustomed to creative financing.2
Foreign companies sometimes are treated differently from domestic companies when it comes to access to the credit markets. In Brazil in the early 1980s, for example, subsidiaries of foreign-owned companies were excluded from local credit markets, because they wanted those subsidiaries to bring in hard currency from abroad.3
Sometimes, however, foreign companies can get access to credit differ-
ently than local firms because of their access to hard currency. Firms can enter
into back-to-back loans during periods when interest rates are high or credit
is frozen. A back-to-back loan is one that involves a_ company in Country A
with a subsidiary in Country B, and a bank in Country B with its branch in
Country A. The example below of a U.S. food company operating in Italy
shows how the Italian subsidiary can gain access to Italian loans by having its U.S. parent provide dollars for the U.S. subsidiary of an Italian bank. Under that condition, the Italian bank will lend money to the Italian subsidiary of the U.S. parent. An example of a back-to-back loan by a U.S. food company operating in Italy is as follows:
A dollar deposit is made in the U.S. with a branch of a leading Italian bank. At the same time, the equivalent amount in lira is lent by the bank to the company's Italian sub as a seven-year loan. The loan will be repaid in full to the bank at the end of the loan period. Once the loan is terminated, the parent will withdraw its deposit plus interest. The subsidiary pays Italian prime. Every six months, the exchange rate is adjusted if it varies more than 5 percent from the contracted rate. Thus, the subsidiary shoulders the exchange risk.4
If a U.S.-based MNE decides to use foreign credit markets to finance foreign operations, it must take into consideration interest-rate differentials and exchange-rate risks. As noted in Chapter 8, interest rates differ from country to country, primarily because of inflation differentials. In Brazil in 1989, the consumer price index rose by more than 1000 percent, which was reflected in high interest rates and a rapidly devaluing currency. If the Brazilian subsidiary of a U.S. company decided to borrow in dollars at lower interest rates rather than pay the high interest rates on Brazilian currency loans—if they were even available—it would be exposed to an exchange-rate risk. If the Brazilian currency were to devalue against the dollar (which it certainly did during the period of high inflation), the Brazilian subsidiary would have to come up with more Brazilian currency to purchase dollars to pay the principal and interest.
From these illustrations it is obvious that MNEs need to weigh several factors as they look at the local credit markets: (1) availability of funds, (2) cost due to interest rates and foreign-exchange risk, and (3) local customs and institutions. Because situations and events are dynamic, corporate treasurers must be able to react quickly.
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