Equipment financing in emerging markets

Business America, Oct, 1997 by Jerrold B. Rosen, Donald G. Becker

Has competition driven down your company's yields? Are you developing a strategy for long-term growth? Or, have you been asked to finance a deal in Latin America as part of a vendor program? In today's global economy, it is inevitable that a leasing company at least consider providing equipment financing in an emerging market.

The best way to describe an "emerging market" is to describe what a country in an emerging market lacks. An emerging market country lacks a history of economic and political stability. The country may have suffered from high inflation, or large parts of the economy may have been decentralized or privatized not long ago. Politically the country may have recently migrated from autocratic military rule to a more democratic form of government. An emerging market country lacks a "hard," or stable, currency with an established foreign exchange market. The user of the equipment (or the funding source) may find it difficult or very expensive to convert the local currency into U.S. dollars during the term of a transaction. An emerging market country also does not have a long history of equipment financing, which means that laws, accounting standards, business customs, and local taxes may be less than accommodating to providers of equipment financing. An emerging market country may have less competition, larger profits, and more potential for growth, but it also may bring an increased level of risk.

In order to be successful, lessors must first examine the opportunities that exist in providing equipment financing in emerging markets and the factors that have led to successful penetration by other companies and then analyze the risks of doing business in an emerging market country, such as credit, legal, and tax issues the leasing company is expected to face. Although this article is limited to emerging markets, as opposed to the broader topic of international transactions, many of the issues lessors face in emerging markets must also be addressed to a lesser degree in more established international markets.

Opportunity

Growing Importance of Emerging Markets. The emerging markets are becoming increasingly important to the global economy. With the growth in international trade and the globalization of equipment manufacturers, the emerging markets have generated and should continue to generate more opportunities for providers of equipment financing. These opportunities, however, will not be without risk. While many emerging market regions have recently demonstrated positive economic trends, a significant amount of volatility in their domestic economies is expected in the short run.

Financing in emerging markets is comprising a greater percentage of the world's financing volumes. A 1994 Citibank study (see Chart I) showed that while financing in emerging markets accounted for less than one-fifth of the total worldwide financing volume, the growth rate (15 percent) was three times that of the developed markets (5 percent). The same Citibank study also estimates (and our experience agrees) that 35 to 40 percent of the deal volume in the global capital markets is in the emerging markets.

CHART 1
ANNUAL WORLDWIDE FINANCING VOLUME

Developed Markets         $ Billion   Growth   Rate

United States               $300
Western Europe              $200
Japan/Australia              $100
Total                       $600       (82%)    5%

Emerging Markets

Eastern Asia                 $60
Eastern Europe/CIS           $30
Latin America/Caribbean      $20
Middle East/Africa           $20

Total                       $130       (18%)    15%

Total Global                $730      (100%)     7%

Source: Citibank

Political Risk. Even if your lessees are financially strong, political events in the emerging market country where you are doing business may affect your transactions. For example, the sale or export of U.S. dollars could be prohibited. There could be a war or a revolution. Your equipment could be requisitioned. Or, your import license could be revoked. The degree of political risk will, of course, vary from one country to the next, but it can be mitigated by purchasing political risk insurance (PRI) which will insure a leasing company against these risks. PRI, although expensive, is available both in the private insurance market and from government agencies such as the Export-import Bank of the United States.

Import and Export Issues. How do you get your equipment in and, if necessary, out of an emerging market country? All countries view the importation of foreign manufactured goods as an opportunity to generate tax revenue, so there will probably be an import duty to pay. Depending on the country and the equipment, the duty could be as high as 50 percent of the equipment cost. There may also be a significant delay while your equipment clears customs, which could affect the commencement date of the lease term. Be sure to determine whether the equipment is exempt from import duties under GATT, NAFTA, or some other treaty or statute. (Medical equipment, for example, is frequently exempt.) Import duties are often based upon die invoice price of the equipment, so there may be some scope to restructure a transaction to reduce the invoice price of the equipment in exchange for an up-front or back-end payment, which would reduce the amount of import duty.