anne.bernier@prometeia.com, lorena.vincenzi@prometeia.com
Following the
2008 crisis, increased liquidity and the higher risk and lower return
associated with most of the industrialized countries allowed several emerging
market economies, and in particular their private non-financial sector, to borrow
heavily in the international markets, and as a consequence their debt grew
faster than GDP (Fig. 1). China’s total gross debt reached almost 300% of its
massive GDP at the end of 2015, far higher than all the other emerging market
economies, and on a par with more mature economies such as Korea (300%), the
United States (279%), or Italy (337%). In particular, from 2007 to 2015 non-financial
corporations in Brazil, Russia, Turkey and Mexico increased their debt at
nearly twice the pace of GDP growth, this debt also grew in India, Indonesia,
and South Africa, albeit at a lower speed.
According to the
IMF,[1] in India, the leveraging
of the private sector reflected a shift toward cheap debt financing, as equity
became harder to sell to more cautious investors following the 2008 crisis. The
default probability on Indian private sector debt is rising and the risk that
banks cease to roll over debt to the most vulnerable corporations is not
negligible.
China’s real
estate sector and Brazil’s commodities sector also fell into the cheap credit
trap and many corporations are finding themselves struggling to pay back their
debt. In Brazil, Russia, and China, a large part of this “private sector” debt
increase is actually due to massive state-owned enterprises which may be a
ticking time bomb. In Brazil, 17% of the non-financial corporations’ debt is
Petrobras’ $128 billion debt, while the corporation is embroiled in scandal and
has not generated profit in 8 years.[2] Likewise, Mexico’s Pemex and
Russia’s Gazprom and Rosneft represent significant shares of private sector
debt, which are growing as oil and gas prices remain low. Mexico has already
had to rescue Pemex with debt swaps and tax breaks.
China has already
began to address the issues with corporate debt. This year, China has allowed
for easier corporate bankruptcy filings, leading to a 52.5% increase.[3] New policies to increase
debt-for-equity swaps for struggling Chinese businesses will lighten the
corporate debt burden without increasing government debt or loan defaults.
Beyond the risk of unprofitable indebted corporations, all EM countries
hold more debt securities denominated in foreign currencies than before the
2008 crisis (Fig. 2). Their relatively better economic situation than the
industrialized countries in 2009 and 2010 drew the attention of foreign
investors and encouraged EM corporations to issue international debt securities
denominated mostly in US dollars. The strong depreciation of their national
currencies since the turmoil in the international markets in 2013 increased the
burden of the debt in local currency terms. In Brazil, for example, from 2007
to 2015 the real depreciated by roughly 70% with respect to US dollar. The
possible additional depreciation due to the expected increase of the US
interest rate could aggravate this effect making it tougher for corporations to
pay back their debt.
As a percentage
of GDP, the highest corporate dollar debt belongs to Mexico (8.8%), Brazil
(7.5%), Russia (5.8%), and South Africa (5.5%). Chinese corporations hold the
most dollar-denominated securities in absolute terms, although
dollar-denominated bonds represent only 2% of China’s GDP.
Countries
have responded differently to these trends. Since 2007, the Indian government raised
the limit on overseas borrowing, and corporations borrowed dollars at lower
interest rates than were available in India. Indian corporations worry about
unhedged currency risk and, according to the IMF,[4] corporate vulnerability is
at its highest level since the early 2000s. Indonesia’s private sector is particularly
vulnerable to a currency crisis, as 96% of its private sector external debt is
in foreign currency, and two thirds of Indonesian real estate developers’ debt is
in US dollars.[5] In Russia, the government sold foreign currency repurchase agreements to
Russian companies to help prevent a currency crisis. On the other hand, foreign
debt for Turkish corporations seems less dangerous as holding dollar assets is a
common practice in Turkey’s firms. Although individual
Turkish firms may be less
safe from default, this should help to insulate the system from a strengthening
dollar.[6]
All in all, the
dimension of the debt of several emerging market corporations and its currency
denomination seems to be a long term double risk to watch carefully in a
fragile global environment with a potential US interest rate rise waiting in
the wings.