Non-financial corporations in emerging market countries in Asia are faced with the prospect of stressed balance sheets argues the latest Quarterly Review of the Bank of International Settlements (BIS). Two factors seem to explain this call for caution. First is a huge increase in corporate debt in emerging market economeis. Encouraged by access to large volumes of cheap liquidity in international markets, resulting from the post-crisis policy of monetary easing adopted by developed country central banks, firms in emerging markets worldwide, and in Asia in particular, have reportedly gone on a borrowing spree.
Despite some contraction in bank lending around 2013 resulting from the “taper tantrum”, outstanding cross-border claims of major international banks reporting to the BIS on non-bank borrowers in the rest of the world totalled $12.3 trillion at the end of June 2014. That figure was close to its pre-crisis peak in 2008. Emerging market economies (EMEs) were important contributors to this increase. The top ten EME borrowers saw an increase in international bank claims on them rising from $1.33 trillion in the last quarter of 2008 to $2.69 trillion in the second quarter of 2014 (Chart 1).
But even within the emerging markets there were substantial divergences (Chart 2). The share of Asian emerging markets in total emerging market issuance rose from 30.4 per cent in Q4 of 2008 to 52.5 per cent in Q2 of 2014. And within emerging Asia, the share of China rose from 20.8 per cent of the total to a huge 53.4 per cent between those quarters. China clearly dominates emerging market borrowing in recent years, leaving behind Brazil, India and Korea, who were also important borrowers in that order. Cross-border international claims on China rose from $153.5 billion in the fourth quarter of 2008 to $1.1 trillion in the second quarter of 2014, or more than seven times in less that six years.
Parallel to these banking developments is the evidence that non-financial corporates from emerging markets have ramped up their issuance of debt securities, resulting in a total issue of such securities of $554 billion between 2009 and 2013. Of that $252 billion, or 45 per cent was mobilised by the issue of debt securities by offshore affiliates of these corporations. This points to the fact that non-financial corporations in the EMEs were using their foreign subsidiaries as financing vehicles. Capital mobilised in the overseas market by these subsidiaries was being transferred to their parents, for local currency investments in parent-country markets. Such investment could also be financial, involving loans to other corporates or deposits with banks or non-bank financial entities at interest rates that offer a premium above the low rates prevalent in some international debt markets. The urge to exploit interest rate differentials, ignoring currency risk, is an important driver of debt growth.
These trends point to two kinds of vulnerability in Asia. The first is the sheer volume of exposure to debt in forms that provide foreign lenders not just the right but the possibility of quick exit. The second, is the massive foreign currency exposure implied. In the event of any significant depreciation of the domestic currency relative to the hard currencies in which the original capital was borrowed, local currency commitments of corporates in the form of interest and amortisation can increase hugely, leading to stressed balance sheets.
The latter possibility is already turning real. The Financial Times (December 9, 2014) reported that on December 8, 2014 the JP Morgan Emerging Market Currency Index fell to its lowest level since it first began to be computed 14 years earlier. The problem here is not just the weakening of some of these economies that affects the values of their currencies, but the persistent rise of the dollar driven by both improved economic performance in the US and the expansion of its shale based oil industry that has brought oil prices closer to $60 a barrel. EMEs in the Asian region are bound to be badly hit.
The rest of the world cannot, however, be indifferent to Asia’s potential woes. Not least because of the country-concentration of the incidence of the debt problem in the region noted earlier. China’s more than 50 per cent share in Asia’s exposure to international banks is telling. According to the BIS, even after taking account of foreign banks' claims booked via their affiliates in China, BIS reporting banks' exposure to China was almost twice as large as that to any other emerging market economy. This is remarkable given the fact that, even as recently as 2009, China was not even among BIS reporting banks' top five foreign EME exposures.
This external exposure of China seems associated with the post-crisis stimulus manoeuvred by the government through the banking system. At the end of 2008, on an unconsolidated basis, China accounted for 6 per cent of cross-border claims on all EMEs and for 21 per cent of those on emerging Asia. By mid-2014, those two shares had risen to 28 per cent and 53 per cent, respectively. With evidence of a growth slow down in the country and some evidence of declining export competitiveness, some at least of this lending will not be rolled over.
That could feedback to growth, and pull back an economy which has been an important contributor to global growth in recent years.
