interest rates | Trump policies, higher rates may spark emerging market debt crisis
Could the policies of US President Donald Trump (unwittingly) spark an emerging market debt crisis?
AFP photo/ Mandel Ngan
Could the policies of US President Donald Trump (unwittingly) spark an emerging market debt crisis? AFP photo/ Mandel Ngan

Trump policies, higher rates may spark emerging market debt crisis

The toxic mix of massive debt built up over a decade of record low interest rates and the start of higher rates suggest a crisis might be brewing

February 6, 2017 9:14 AM (UTC+8)

US President Donald Trump has been accused of courting international trade friction and even currency wars by his proposed policies, but there is another danger that he could be risking (maybe unwittingly): A new international debt crisis.

There were already signs a crisis might be brewing given the toxic mix of huge debt built up over a decade of record low interest rates, and that rates had begun rising.

Trump’s fiscal spree of big spending and tax cuts could push US rates higher and faster, while his plan to gut Wall Street rules has raised concerns about a new financial free for all.

Global debt has reached US$217 trillion, equal to a record 325% of global gross domestic product with the build-up particularly marked among business corporations in the world’s leading emerging economies as well as among some governments in mature economies

International debt crises have increased in frequency and intensity in recent decades, from the Latin American debt crisis of 1982 to the Asian financial crisis of 1997 and the Global Financial Crisis of 2008. Each is said to be the “crisis to end all crises” until the next one comes.

The next one in this case isn’t a sovereign debt crisis or a banking/financial system crisis, the epicenter of the eruption could well be in the emerging market corporate sector.

Global debt has reached US$217 trillion, equal to a record 325% of global gross domestic product with the build-up particularly marked among business corporations in the world’s leading emerging economies as well as among some governments in mature economies.

“The sheer size of global debt raises the risk of unprecedented [debt] deleveraging that could hamper growth worldwide,” said Tim Adams, former US Treasury Under-Secretary for International Affairs and now head of the Institute of International Finance (IIF) in Washington.

In similar vein, the IMF suggested that “the sheer size of global debt raises the risk of unprecedented deleveraging that could hamper growth worldwide.”  At the World Economic Forum in January, David Rubenstein, co-chief executive officer of The Carlyle Group, warned of a repeat of the 1990s emerging-market crisis.

In absolute money terms, debt is largest in advanced or “mature’ economies where the figure across the household, central government, financial, and non-financial corporate sectors has reached $165 trillion or 390 per cent of GDP. Government debt has risen especially sharply.

Meanwhile, total emerging market debt has reached around $53 trillion or 217 per cent of GDP and nearly a half of this or $25 trillion is concentrated in the non-financial corporate sector.

According to the IIF’s Global Debt Monitor, the highest ratios of non-financial sector corporate debt to GDP among emerging markets are found in Hong Kong, China, Singapore, Thailand, Chile, Saudi Arabia, Turkey, Indonesia, Mexico. Malaysia. Czech and South Korea.

High levels of debt do not in themselves indicate an impending crisis. But when a dramatic surge in borrowing is followed by a quite sudden and sustained rise in interest rates, the cost of servicing the debt can outrun the ability of borrowers to repay.

The potential crisis that is building now is not really like past events.  It is very much a “monetary” phenomenon where borrowers have succumbed to the lure of ultra-cheap (even free) credit made available in vast quantities by the world’s leading central banks.

The so-called “Great Recession” that followed the 2008 Global Finance Crisis was prevented from developing into a Great Depression by a massive official bailout, mostly from US financial institutions, with only Lehman Brothers directly “going to the wall.”

The bail-out funds were supplied largely by central banks (notably the US Federal Reserve”) but it was really the follow-up action of the banks — in particular the Bank of Japan and the European Central Bank as well as the Bank of England — that sparked the big debt build-up.

Under the so-called quantitative easing (QE) programmes, central banks bought trillions of dollars worth of financial assets from governments and from the private sector to drive down the cost of money and so avert bankruptcies, repair balance sheets, and restore credit creation.

Not only did credit become historically cheap in “real” or inflation adjusted as well as nominal terms, but also capital began to be re-routed globally.

Funds fled the US where yields on government bonds and Treasury Bills fell to derisory low levels under the impact of the Fed’s assaults. The “hunt for yield” was on and it was to be had in emerging markets.

Funds fled the US where yields on government bonds and Treasury Bills fell to derisory low levels under the impact of the Fed’s assaults. The “hunt for yield” was on and it was to be had in emerging markets.

Emerging market companies took advantage of this and many borrowed up to the hilt.  Not only that, but some have borrowed in dollars while their revenues are in local currencies — creating a classic “currency mismatch” situation.

Global investors have been eager to snap up corporate bonds issued by emerging market companies during the era of low, zero and even negative interest rates. This despite the fact that credit ratings were often very low on such bonds.

Investors in Brazil, South Korea, Thailand, Chile, Czech and Malaysia especially have been big borrowers. While most of this has been in local currencies, corporates in India, Saudi Arabia, Turkey and Russia as well as Hong Kong and Singapore have borrowed heavily in foreign currency.

Companies need to renew or roll over their debt and if banks raise lending rates or even deny fresh loans — borrowers are going to be in trouble. If bond market borrowing rates rise or credit dries up, we’ll have the elements needed for the next crisis.

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