EM debt levels a worry but Asia crash fears seen overdone
A new financial crisis in Asia's emerging markets is not imminent say market observers and investors, despite warnings from the Bank for International Settlements (BIS) about heightened levels of corporate and household debt in some countries.
In its annual report this week, the BIS warns that with the region's debt levels so high there is the potential for rising interest rates to trigger the kind of market shocks not seen since the 2008 global financial crisis.
In his notes attached to the report, Claudio Borio, head of the BIS monetary and economic department, said that in the past year “gloom gave way to confidence" but then suggested that “one may legitimately ask whether sentiment has [now] swung too far?”
Borio highlighted some of the fragilities in the global economy and considered what might provoke economic weakness. He largely discounted inflation risks and focused more on the financial sector, where the risks “may come to resemble more closely a financial boom gone wrong, just as the latest recession showed with a vengeance".
Debt questions
Some Asian debt levels are now far above their long-term averages, BIS data shows. In China, corporate debt has almost doubled since 2007 to reach 166% of GDP, while household debt jumped last year to 44% of GDP. Debt levels in Hong Kong and Thailand are also abnormally elevated, BIS said.
The bank's contagion concerns are shared by Gonzalo Pángaro, portfolio manager for emerging markets equity at US-based fund manager T. Rowe Price, not least in China, where the economy is slowing and the authorities are trying to clear bad debts.
“Beijing has taken steps to crack down on leverage, and there are fears that more moves in that direction could create unforeseen problems," he said. "If that happens, the effects will be felt not just in Asia, but across the world.”
Connie Bolland, chief economist at Economic Research Analysis in Hong Kong, was more sanguine about the issue. “While the doubling of China's corporate debts in a decade poses rising risks to financial stability, the overall debt level as a share of GDP is lower than those of the US and UK before the [global financial crisis],” she told AsianInvestor.
Central to her argument are the region's still-benign economic fundamentals, which suggest there is no great rush to hike rates. “It is consoling to note that inflation remains fairly low in China and Thailand and has been declining in India to hit a record low of about 2.2% in May," she said.
At Thailand’s Government Pension Fund, investment strategy head Arsa Indaravijaya corroborated this view. “For Thailand, raising the policy rate will not happen this year in light of falling inflation and the moderate pace in GDP growth," he told AsianInvestor.
While the household debt level in Thailand is growing, Indaravijaya also said the pace had slowed and was under control.
Soft landing?
China remains a major long-term concern for global financial markets, according to Northern Trust, but the firm’s chief economist, Carl Tannenbaum, said: "While we think the current economic and financial structure is unsustainable, it is important not to exaggerate the risks of a hard landing.”
He added: "China’s aggregate debt (both private and public) remains manageable at around 250% of GDP, and the government balance sheet is strong enough to deal with non-performing assets and [the] recapitalisation of banks."
And in contrast to the Asian financial crisis 20 years ago, much of this debt is denominated in local currency and owed to domestic public entities.
“This means the [Chinese] government faces few hard constraints on its ability to deal with the situation," Tannenbaum said. "A large positive net foreign asset position and the world’s largest foreign currency reserve should buffer the financial system against capital flight in the case of a financial panic.
"In addition, policy makers have displayed a strong preference for capital account restrictions and a tightly controlled currency, which should provide stability to the financial system during a crisis."
Another fund manager to have taken a sober look at the BIS report is Michael Biggs, investment manager in the EM fixed income team at Swiss fund house GAM.
“We shouldn’t over-state the BIS’s position,” Biggs told AsianInvestor. “I am not sure he [Borio] suggests a major crash is imminent in [emerging markets]. He merely highlights the risks and urges policymakers to ‘take advantage of the current tailwinds to put the expansion on a sounder footing’. This seems reasonable and prudent.”
Without disagreeing with the BIS’s actual conclusions, Biggs said GAM disagreed with its analysis. “The BIS are basing their vulnerabilities of certain markets on their levels of debt," he noted. "In our view, what is far more important is whether the level of new borrowing is high. The higher the current level of new borrowing, the greater the risk of a recession."
Take Thailand. In 1995/96 it was borrowing 25% of GDP, so when it was forced to abandon the baht peg and found itself unable to pay off many of its debts, it suffered a severe recession and triggered the 1997/1998 Asian financial crisis.
"[But] right now, Thailand’s levels of new borrowing are not particularly high, even though the debt levels might be high," said Biggs. "As a result, we do not see it as being particularly vulnerable to a recession."