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Rising Latin American Corporate Risk: Walking a Tightrope

Versions in Português (Portuguese) and Español (Spanish)

The rapid increase in Latin American corporate debt—fueled by an abundance of cheap foreign money during the past decade—has contributed to an increase in corporate risk. Total debt of nonfinancial firms in Latin America increased from US$170 billion in 2010 to US$383 billion in 2015. With potential growth across countries in the region slowing, in line with the end of the commodity supercycle, it will now be more difficult for firms to operate under increased debt burdens and reduced safety margins.

In this environment, Latin American firms are walking a tightrope. With external financial conditions tightening, the walk towards the other side—notably through adjustment and deleveraging—while necessary, has become riskier. After making good progress, the crossing has also become more perilous due to strong headwinds—including slower global demand and bouts of heightened market volatility.

In our most recent regional report, and in a companion working paper, we take a deeper look at the factors driving corporate risk in Latin America over the last decade. We use company-specific financial information for close to 500 publicly listed nonfinancial firms between 2005–15 in 7 major economies—Argentina, Brazil, Chile, Colombia, Mexico, Panama, and Peru. We then gauge the main factors driving corporate risk dynamics in the region. We analyze company-specific, country-specific, and global conditions and the factors contributing the most to the recent rise in corporate risk.

Warning signs

The data shows that corporate risk, as reflected in higher credit default swaps (CDS) spreads, has indeed been rising in 2014–15 (Figure 1), though only in the cases of Argentina and Brazil has it approached the levels observed during the global financial crisis. Interestingly, but not surprisingly, the peak year in most commodity prices (2011) marks the beginning of risk differences across countries, which have further widened since late 2014.


Our results show the following:

Rev Slide 2

Rev 3 chart 3

Minimizing risk

The soundness of policy frameworks matters for corporate risk. Indeed, given the important link between corporate and sovereign spreads, macroeconomic stability and credible policies are an important defense against additional upward pressures on corporate spreads. For instance, reining in risks to fiscal sustainability as well as curbing inflation, particularly in Argentina and Brazil, is crucial to contain corporate risk.

Recognizing the importance of global factors in driving corporate risk at home, solid macroeconomic policies alone, however, may not be enough and supporting underlying microeconomic adjustments are also imperative. This means promoting firms’ capacity to push through needed adjustments. In particular, orderly deleveraging through market-based solutions should be the first line of defense in highly indebted companies. Public sector equity should not be used to stave off needed adjustments in the corporate sector. In the case of insolvent companies, restructuring and bankruptcy legislation should minimize both administrative costs and economic losses related to default.

Finally, enhanced monitoring and supervision and well-targeted macroprudential policies are key to alleviate risks and spillovers, particularly to the financial system. Policymakers should monitor closely corporate balance sheets and income flows, particularly in systemically important nonfinancial firms. Financial regulators also have a critical role to play. Adequate consolidated supervision, particularly in cases where financial and nonfinancial firms are highly interlinked, remains an important risk-mitigating tool.