Chart 1

Foreign-exchange risk is bearing down on Asia-Pacific corporates. The effects magnify imported inflation, weigh on investor sentiment and constrain funding. While Asia-Pacific corporates have largely managed currency-mismatch effects so far, S&P Global Ratings expects these strains will squeeze entities with substantial dollar debt due in the coming 12-18 months.

Speculative-grade issuers with steep operating and financing currency mismatch are vulnerable. Such entities have been largely priced out of offshore debt markets for some time. Those that can have turned to domestic bond or loan markets. They still need to repay maturing offshore bonds using a devalued domestic currency.

Moreover, Asia-Pacific is in the middle of a set of rapid interest rate rises coming out of the U.S. We expect the macro pressures to build on regional foreign exchange (forex) rates, as apparent in widening current account deficits emerging in many countries. The effects may spread to investment-grade entities, or to sectors that have been largely resilient, should dollar strengthening continue deep into 2023.

Chart 2

Currency effects are part of a set of interrelated risks that include rate increases, a global economic slowdown, and inflation. Indeed, in our conversation with issuers, they typically don't split out forex strains. They describe them in the broader context of these stresses.

Vulnerable sectors include airlines and power utilities in Japan and Korea. Dollar strengthening has magnified the credit hit on these entities stemming from spiking fuel costs. Airlines' financial debt and aircraft leases are typically in dollars. Regulators often impose delays on when utilities can pass through these rising costs to consumers.

Credit quality is likely to be moderately strained for companies with a material operational currency mismatch, such as a net exposure to U.S. dollar input costs. The hit on their margins and operating cash flow will depend on the timeliness and magnitude of cost passthrough to customers. Meanwhile, high inflation may erode consumers' ability to pay for these higher prices.

Asia-Pacific countries are proving more adept at managing forex risk.  Exchange rates are depreciating, but manageably so. Macroeconomic policy has generally been more cautious in recent years. A much larger share of government borrowing is now in domestic currencies, minimizing the hit of currency weakening on debt servicing.

Governments' decision to let flexible exchange rates absorb most of the external pressure has limited the fall in countries' foreign reserves. We don't expect foreign reserves to decline to dangerously low levels any time soon in major Asian emerging markets.

Nevertheless, strains are building, as apparent in diminished forex reserves, especially in energy-importing countries.  Net financial outflows rose by US$106 billion in the first eight months of 2022 in six large emerging market economies in Asia compared with a year earlier (see "Foreign Reserves In Asia's Emerging Markets Are Strained," published Aug. 22, 2022, on RatingsDirect).

For example, India had net inflows of US$16 billion in the first eight months of 2021, compared with net outflows of US$12 billion in the same period in 2022. Depreciation has absorbed much of this strain, especially in Japan, New Zealand, and South Korea (see chart 2). But foreign reserves have fallen in some countries; in some cases even after adjusting for large valuation changes. In China, foreign reserves declined by US$203 billion in the year through August, compared with a drag of valuation changes of US$211 billion.

A Sector-By-Sector Breakdown

Local-currency devaluation has so far had a moderate impact on the operating revenues and profits for most Asia-Pacific corporate sectors.

Asia-Pacific issuers have become more experienced in managing currency volatilities using natural and financial hedges such as currency swaps and options over the past decade. That said, financial hedges that cover a certain currency range could become ineffective, should the local currency depreciate beyond the protection level. Moreover, currencies volatility has increased the cost of hedging, adding to already swollen funding costs.

Given the magnitude of local-currency depreciation, most dollar debt obligations for corporates will translate into higher debt balances and leverage in their local reporting currency.

The strong dollar has been favorable for exporters receiving U.S. dollars that have a high share of local currency operating costs; otherwise it's neutral. These include upstream commodities producers, capital goods makers, pharmaceutical firms, carmakers, and service providers, particularly Indian IT entities. Their dollar-based revenue provides a natural hedge against their dollar debt-servicing obligations. The overall credit effect varies according to the proportion of cost base and discretionary spending in local currency.

Our heat map (chart 3) assesses the impact of a strong U.S. dollar on Asia-Pacific corporate sectors. The matrix covers currency mismatch across operating cash flows (operational risks), and funding currency mismatch, net of any currency hedges (financial risks). Corporates with a similar risk profile from different countries are aggregated within their respective sectors. The list is not exhaustive.

Chart 3

Sectors in the:

• Low-risk buckets are net neutral or benefit from the strong U.S. dollar and weak local currency.
• Moderate-risk buckets face moderate currency mismatch across operating cash flows or funding currency mismatch. Their credit quality could come under pressure if local currency devaluation accelerates or stretches late into 2023.
• The stand-alone credit profiles of firms in the high-risk bucket are under immediate strain because of material currency mismatch and unmitigated exposure. For example, a company may be unable to pass through higher input costs to its customers.

Recent forex drops by themselves have not tipped corporates into default, as seen during previous rounds of dollar strengthening, particularly in 1997. Indeed, we have taken no rating action on Asia-Pacific firm in 2022 solely because of currency effects.

However, the inflation and interest rate stresses emanating from the U.S. are still playing out. Outflows and currency depreciation, triggered by unfavorable benchmark yield differentials, will turn investor sentiment away from emerging-market issuers. This will keep funding availability selective and likely more expensive.

Asian dollar bond yields have risen by over 260 basis points (bps) for investment-grade in the year to date, and by over 500 bps for speculative-grade. This makes access to financing or refinancing more difficult with offshore speculative-grade markets effectively closed.

Should Asia-Pacific currencies continue to devalue against the dollar in 2023, more companies will come under operational strain, and more firms will be priced out of dollar-based debt markets. This will add to escalating refinancing risks with entities already facing high interest costs and a steep maturity wall in 2024. We give a sector-by-sector breakdown of these strains in Asia-Pacific markets that have seen large forex drops in 2022, to get a sense of what's in store.

South Korea

South Korea's open, globally focused economy always gets an amplified version of whatever is playing out in the world. The country is bearing the brunt of macro stresses: inflation, rate rises, and currency swings. The South Korean won has slipped 16.6% against the dollar in the year to date, one of the biggest drops in Asia-Pacific.

FX swings of this magnitude have punished Korea in the recent past (2008, 2013) and practically levelled the country's economy in 1997. This time around, however, Korea is taking its won moves in stride. Several large corporates benefit from won weakening: export-focused entities that price their goods in dollars but incur much of their costs in won. We are thinking here of Hyundai Motor Co., Kia Corp., and LG Energy Solution Ltd.

Many Korean firms are benefiting from these translation effects. Some are losing, but the impact is broadly low to moderate. Many firms can transfer additional costs by raising prices owing to their strong market positions. Examples include Kia, which has raised its average selling price 18.3% year on year in the third quarter of 2022.

Corporate Korea has become much more careful about its hedging. For example, when a rated Korean firm issues bonds in U.S. dollars these days, it routinely enters currency swaps for the full amount.

Some unrated names may not hedge as carefully. This includes the airlines, which is why we classify this sector as having moderate financial risk stemming from won weakening.

Korea Electric Power Corp. and Korea Gas Corp., and transport firms such as Korean Air Lines Co. Ltd. have steep operational exposure to won weakening. The entities import a lot of energy (liquefied natural gas, coal, jet fuel, etc.) and it's mostly denominated in dollars. While these companies are prudent in their currency hedging, the cost of this hedging is rising.

Conditions in Korea's domestic bond market have deteriorated recently, following the default of a property developer in October 2022. Liquidity is tight. Spreads have risen 200 bps-400 bps. The Korean government has acted to support the domestic market by forming a capital market stabilization fund, and by expanding the collateral accepted by the central bank. The measures have yet to change the mood of investors.

Speculative-grade Korean corporates have a small quantum of dollar bonds maturing through 2024, reducing their immediate refinancing risk.

Japan

The yen has fallen the furthest among Asia-Pacific currencies, sinking 22.3% against the dollar so far in 2022. And yet, as with the case of Korea, we see moderate direct currency effects for most of corporate Japan over the next six to 12 months.

Many of our rated Japanese companies are exporters with solid geographical business diversification. As such, yen weakening is generally a credit support.

Many major exporters will be winners from yen depreciation over the next six to 12 months. Most of their export sales are in dollars, while the firms report in yen. Likewise a weak yen boosts the results of general trading and investment companies, which have sizable overseas assets.

For example, export-led auto firms such as Toyota Motor Corp. and Honda Motor Co. Ltd. will likely benefit from a weak yen. While strategically expanding overseas factories, these companies still have a solid domestic production base, particularly for high-grade vehicles.

Positive forex effects should support the earnings of Japanese carmakers amid a tough sector outlook. Their captive finance operations are heavy issuers of U.S. dollar debt. However, the finance operations are naturally hedged with much of their sales-finance income in dollars.

Some Japanese firms are vulnerable. The airlines face stiff operational strains in that their major operating costs, including fuel, are in dollars. Regulated power utilities such as Tokyo Electric Power Co. Holdings Inc. are seeing the cost of key inputs such as coal and liquefied natural gas (LNG) spike due to surging dollar prices, and a tumbling yen.

Regulations allow utilities to pass on rising costs to consumers, but only after a lag of four to six months, and within a cap.

Although importing almost all of their oil, the weak yen is slightly positive for the earnings of Japan's downstream oil companies. This is due to favorable inventory reevaluation and gains from the export of some products.

Our rated Japanese firms are careful with risk hedging. About 90% of the entities are investment grade. They tend to be blue chips with sophisticated treasury desks. Their global financial operations also generate natural hedging opportunities.

Finally, these entities have ample access to Japan's deep and liquid domestic debt markets, and have strong relationships with Japanese lender banks. They are unlikely to experience a liquidity crunch, in our view.

Indonesia

Indonesia's corporate issuers have historically been sensitive to rupiah depreciation. This stems from currency mismatch, a high reliance on dollar debt, and the negative effect that a depreciating currency has on investor sentiment and foreign funding availability. Firms with little dollar revenue tend to partially hedge their forex within a band, due to the high cost of these instruments.

The sharp rise in U.S. dollar interest rates and credit spreads have made it prohibitively expensive for Indonesian firms to issue new bonds in dollars so far this year. This means that companies will have to repay maturing offshore bonds using depreciated rupiah.

The country's domestic corporate bond market provides little back-up. According to AsianBondsOnline, only US$29.5 billion-equivalent of domestic corporate bonds are outstanding, or less than 5% of GDP. We see signs that local banks have stepped up when offshore liquidity evaporates, but very selectively.

For example, Alam Sutera Realty Tbk. PT recently raised Indonesian rupiah (IDR) 1.75 trillion through a syndicated loan to part refinance its dollar bonds, according to the trade publication REDD. The township developer Kawasan Industri Jababeka Tbk. PT has obtained a domestic bank debt to partially refinance US$300 million notes maturing in October 2023. Moreover, in July, Sawit Sumbermas Sarana Tbk. PT raised a syndicated term loan with Indonesian domestic banks to fund its below-par cash tender for about US$260 million of its guaranteed secured notes.

About 60% of the raw material costs of auto supplier Gajah Tunggal Tbk. PT are dollar-linked. As only about one-quarter of its revenues are exports in dollars, the firm faces currency risk. We estimate that close to 40% of its annual debt servicing is denominated in dollars. Its exports should generate sufficient forex to cover this expense. Timely cash conversion of such earnings remains key to the smooth operation of this natural hedge.

There are winners and losers from rupiah depreciation.  Rated Indonesian homebuilders have the highest currency mismatch with about 90% of debt raised in dollars, while their assets and cash flow are all in rupiah. Rated entities hedged about two-thirds of their dollar debt. However, the effectiveness of the hedge falls away the more the rupiah depreciates against the dollar.

Indonesian commodity exporters, such as coal producers Bumi Resources Tbk. PT and Bayan Resources Tbk. PT. have benefited from buoyant prices, lifting their U.S. dollar-based revenue against their cost base, which is partially in rupiah. Their U.S. dollar-based EBITDA also provides a natural hedge against their dollar liability.

Perusahaan Perseroan (Persero) PT Perusahaan Listrik Negara (PLN) and Cikarang Listrindo Tbk. PT benefit from the passthrough of rising coal prices under regulatory frameworks and contracts. A large portion of PLN's power purchase obligations are payable in dollars, but the government will need to provide subsidies under public-service margins that are set at cost plus 7%.

Both entities have substantial borrowings in foreign-currency debt. PLN has significant funding needs in dollars to repay upcoming maturities, and for capital expenditure. If offshore debt markets remain fickle and the rupiah stays weak, its financial metrics will take a small hit.

Cikarang has a bullet bond due in 2026, which may be ample time for the rupiah to stabilize. PLN's debt maturities are spread out, which will keep the hit on credit metrics manageable. These entities also generally enjoy better access to capital markets due to their credit standing.

India

Infrastructure entities are most exposed to currency risk among Indian corporates.

Renewable players in particular have high capex spending and a heavy reliance on dollar debt. Over the next 12 months, rated Indian renewable companies will likely have to raise funds equal to nearly one-third of their existing debt. They will need this capital to meet capex targets, and for refinancing. These companies should be able to raise funds domestically, rather than using high-cost offshore debt.

Rated airports have largely raised sufficient funds to meet ongoing capex and have limited refinancing needs over the next 12-24 months. Regulated utilities will benefit from cost passthrough mechanisms, which account for hedging costs and currency movement.

Most rated Indian companies adopt a full hedge for principal and interest; however the hedge is often imperfect. They adopt a call-spread structure to reduce their cost of hedging the principal, which exposes them to currency risk in case of sharper than expected depreciation.

Much of our rated India corporate portfolio has sizable U.S.-dollar linked revenue and, therefore, is not exposed to rupee depreciation. This encompasses entities in the IT, metals, and chemicals sectors. About half of the firms we rate are getting an EBITDA boost from currency weakening.

Indeed, there is only one publicly rated firm for which there is a large mismatch between revenues and balance sheet exposure: ANI Technologies Pte. Ltd. The firm operates the ride-hailing platform OLA Cabs. OLA's revenues are largely rupee denominated while it has unhedged dollar debt. However, the risk for ANI Technologies is mitigated as the company holds dollar reserves of a similar size to its dollar debt.

Other domestically driven sectors, such as telecoms, are also well placed to withstand the rupee depreciation due to their hedging policies. For example, Summit Digitel Infrastructure Ltd. fully hedges all offshore debt. Bharti Airtel Ltd. has swapped half the principal of outstanding dollar debt--and all its interest expense--on this debt over at least the next 12 months.

Elsewhere, the information technology firms that export services denominated in dollars, but whose costs are largely in rupee, are clear winners. These include Wipro Ltd., Infosys Ltd., and HCL Technologies Ltd.

Local metals firms such as Vedanta Resources Ltd. are also getting an earnings gain. The company has guided that annual EBITDA will rise by about US$50 million every time the Indian rupee (INR) drops INR1 against the dollar.

Still supportive onshore funding environment has also helped Indian companies manage the weaker offshore funding markets. Key onshore benchmark rates have risen about 200 bps in the year to date, less than that seen in many offshore markets. This has made local markets an attractive alternate source of capital. This will give rated issuers a funding option to repay offshore bonds coming due through 2024.

China

Most rated Chinese corporates have found renminbi depreciation to be managable so far. Most rely on domestic markets for funding, and domestic financing conditions have been accommodative. The average loan rate for corporates dropped to a record low of 4.05% in August.

Renminbi depreciation has also had a relatively modest effect on entities' operations. The businesses of most of our rated firms are domestically focused. The risk of currency mismatch between revenue and costs is largely manageable.

Weak privately owned enterprises (POEs) are more exposed to currency risk as the entities often have large dollar debt outstanding, and few refinancing options. Record defaults among developers have largely cut off POEs from offshore bond markets, for example.

Among developers, Seazen Group Ltd., Central China Real Estate Ltd., and Yanlord Land Group Ltd. are mostly affected by renminbi depreciation based on their high exposure to dollar bonds, relative to total debt.

Like most Chinese firms, the developers generally do not hedge their currency risk. This follows a long period in much the renminbi has stayed largely stable against the dollar.

In the case of the developers, however, renminbi depreciation is just the latest hit in a wave of strains. We are not putting a lot of focus on this currency aspect as it is the smaller part of a set of challenges.

Chart 4

Operational strains loom for those with high dollar costs.   Entities in the oil and gas downstream, metal and mining downstream, chemicals, and agriculture and commodity foods sectors face moderate operational risk.

For example, China Petrochemical Corp. has the largest refining and marketing businesses among all three national oil companies, for which the cost of materials are mostly in U.S. dollars. Jiangsu Shagang Group Co. Ltd. pays for its iron ore in dollars, for example.

Companies in upstream sectors may benefit from renminbi depreciation as part of their revenue comes from overseas, in dollars. Zijin Mining Group Co. Ltd. has around half of its revenue denominated in dollars. Yankuang Energy Group Co. Ltd. derives 30%-40% of its revenue from its Australian subsidiary.

We also label as moderate the financial risk of the property and retail and restaurant sectors due to the high, unhedged exposure of these sectors to foreign debt.

Such sectors largely lack access to domestic debt markets. Investors have been unwilling to back weak POEs in the renminbi bond market since 2018, after the government introduced a batch of policies encouraging deleveraging. Most liquidity now flows exclusively to strong POEs, or state-backed entities.

Australia

Rated Australian corporate and infrastructure entities with either U.S.-dollar denominated debt or revenues generally have minimal exposure to forex risk. Entities' dollar-denominated debt is fully or mostly hedged, or U.S.-dollar revenues provide a natural hedge.

Issuers in the metals and mining, oil and gas, and chemicals sectors fit this description. Examples include Santos Ltd., Fortescue Metals Group Ltd. and Coronado Global Resources Inc. The entities earn at least some portion of revenues in dollars and issue some dollar-denominated debt, with little currency mismatch on the financing side.

Those that are not so naturally hedged, earning revenues wholly or mostly in Australian dollars, typically are fully financially hedged. This includes real estate investment trusts such as Dexus and Scentre Group, infrastructure firms such as Transurban Group and WestConnex Group, and utilities such as AusNet Services Ltd. and Ausgrid Finance Pty Ltd.

Consumer discretionary and packaging sectors are slightly higher on the operating risk spectrum. A proportion of raw material and input costs can be U.S.-dollar based but where revenues and debt are substantially Australian-dollar based. Such entities have some capacity to pass on rising costs to their customers.

Issuers of term loan B facilities in dollars may experience refinancing difficulties. These instruments often run for seven years. It is expensive to hedge the currency for that full term. As U.S. rates rise it will be expensive to refinance in dollars, particularly as these entities are speculative grade. Firms may need refinancing in Australian dollars, and to absorb the hit of a depreciated local currency.

Issuers that have accessed this debt market, and which have predominantly Australian dollar revenues to service U.S. dollar financial obligations, include MYOB Group Co. Pty. Ltd. and Snacking Investments HoldCo Pty Ltd.

Lastly, any businesses buying expensive capital equipment priced in dollars may face pressures on expected project costs. Woodside Energy Ltd. and Santos Ltd. are in the midst of large growth capital projects with a number of prospective projects set to undergo a final investment decision in the next two to three years.

Writer: Jasper Moiseiwitsch

Digital designers: Halie Mustow, Evy Cheung

Related Research

• Momentum On The Rocks, Oct. 19, 2022
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• Foreign Reserves in Asia's Emerging Markets are Strained, Aug. 22, 2022
• Emerging Markets Focus: Where Are The Pockets Of Risk From EM Currency Depreciation?, Nov. 5, 2018