Emerging markets’ impending risks: private sector debt and dollar liabilities

19 July, 2016


The Great Recession held a silver lining for EM where cheap dollar loans financed investments. Unfortunately, that silver lining could actually be clouds gathering for the next storm. As the global economy enters a new period of uncertainty and as the Fed is expected to slowly raise interest rates, dollar liabilities of struggling EM corporations may hint at bigger troubles to come.


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.

Figure1 - Emerging markets total debt by sector (% of GDP)
Source: BIS, National Central Banks, IMF

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.

Figure 2 - Non-financial corporations' international debt securities by currency, billions USD
Source: BIS

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.

[1] IMF Working Paper 14/232, Corporate Vulnerabilities in India and Banks' Loan Performance, 2014.
[2] Bloomberg, "Petrobras's Dangerous Debt Math: $24 Billion Owed in 24 Months,” 19 November 2015.
[3] Financial Times, “China bankruptcies surge as government targets zombie enterprises,” 23 June 2016.
[4] IMF Working Paper 14/232, Corporate Vulnerabilities in India and Banks' Loan Performance, 2014.
[5] Financial Times, “Indonesia Inc faces tough time rolling over debts,” 4 October 2015.
[6] Financial Times, “Turkish corporate debt: ‘a few shocks away’ from a crisis,” 13 June 2016.

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