Following increased borrowing in recent years, some commentators have warned about a looming emerging market (EM) debt crisis. But outside of China, the increase in debt has not been remarkable and ratios remain well below those seen in the advanced economies. Many emerging economies are more resilient than in the past, and concerns of a synchronised default are overdone.
Emerging market debt has increased
Since 2008, central banks in the advanced economies have reduced policy rates to zero or below and conducted large-scale asset purchases. Those policies reduced global interest rates, and have been associated with a large increase in credit in EMs. Much of this increased borrowing has been centred in the corporate sector, prompting warnings by the BIS and IMF. With the Federal Reserve hiking cycle underway, some are concerned about a looming EM debt crisis.
Based on headline credit figures, it is hard not to be alarmed. Since 2008, total outstanding debt in eleven of the largest EMs has increased by over 60 percentage points of GDP and stands at a staggering 176%. Moreover, around two-thirds of this increase has been concentrated in the non-financial corporate sector. The annual debt servicing ratio, relative to income, for private non-financial corporates (NFCs), has increased by four percentage points over that period.
 Brazil, China, India, Indonesia, Mexico, Poland, Russia, Saudi Arabia, South Africa, South Korea, Turkey. Together these account for 41% of global GDP (PPP).
However, this overall increase has been masked by China’s incredible debt binge. If China is excluded, the numbers look less worrying: the increase in total debt as a share of GDP is only 18 percentage points since 2008. Meanwhile, the private NFC debt servicing ratio declined in 2016, and is only modestly higher than in the recent past.
Dollar strength: a potential problem
Reports of severe negative contagion following Federal Reserve hikes have so far proven to be wide of the mark. The FOMC has increased the fed funds rate twice in recent months and looks set to do so again in a couple of weeks. So far, there has not been any major negative impact on EM asset markets or capital flows. One explanation is that the Fed’s policy normalisation is set to be unprecedentedly shallow.
The years 2014 to 2015 were associated with dollar strength and large declines in commodities prices — a toxic combination — which resulted in large falls in many emerging economy assets. The MSCI EM FX index dropped by 11% while its equity counterpart fell by 21%. Against a 20% US dollar appreciation, EM external bank borrowing fell by around US$600 billion, or 12%. It dropped further in 2016, and currently stands at just over US$2.3 trillion. In some ways then, the EM debt adjustment may have run much of its course already.
Lessons learned from past crises
2017 marks the twentieth anniversary of the Asian Financial Crisis. Back then, fast-growing Asian tigers pegged their currencies with the dollar. Amid substantial capital inflows, real effective exchange rates rose, inflating current account deficits. When short-term capital inflows dried up, the result was severe: large drops in GDP and significant exchange rate depreciations.
Since then, many EM economies have introduced floating exchange rates – facilitating adjustment to external shocks, and allowing a buildup of foreign reserves. That, coupled with increased reliance on longer debt maturities, means that emerging economies are now better equipped to deal with short-term refinancing needs.
Public debt burdens in EMs are half their rich world equivalent. An equivalent figure for household borrowing is closer to a third. So in terms of total debt, China is a notable outlier among EMs. For now, most EMs have avoided the rich world’s debt-led malaise.
Contrary to warnings from the BIS and IMF, we find that EM debt does not pose an immediate threat. But that does not mean that EMs are immune to secular headwinds, including a period of weaker Chinese growth and lower commodities prices. Admittedly, we are optimistic about their outlook in the short run, with growth set to rise from a low base. But the expansion will remain modest when compared to the pre-crisis period, with GDP growth set to average 3.7% in 2017 and 2018.
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