Ruchir Sharma, chief global strategist at Morgan Stanley has been warning of the next global crisis emanating from China due to its rapid build-up of debt, and the Bank for International Settlements (BIS) has now added its heft to that.
As BIS puts it, “the accumulation of debt since the global financial crisis has left EMEs particularly vulnerable to capital outflows … as private sector borrowing has led to overheating in several large EMEs, the unwinding of imbalances may generate destabilizing dynamics”.
The debt of non-financial corporations in major EMEs, BIS says, has risen from less than 60% of GDP in 2006 to over 110% at the end of 2015, well over the 85% level for advanced economies—that for China has risen from 90% to over 150% over the same period. As a result, China’s credit-to-GDP is 30% higher relative to the long-term trend while that for Brazil is around 8.5% and Turkey 11.8%—India is below trend by around 3.2%.
As BIS points out, “two-thirds of banking crises were preceded by credit-to-GDP gaps breaching this threshold (of 10%) during the three years before the event”.
Though BIS does not give the figure for individual countries, it points out the repayments for EMEs add up to around $340 billion over 2016 to 2018, or 40% higher than that during the last three years and, on an annualised basis, equals roughly the net issuance of bonds by EME corporates in 2015—in other words, companies will be borrowing afresh just to repay debt, making this a classic debt-trap.
Normally, any discussion on China’s overseas debt juxtaposes this with the country’s mammoth forex reserves of $3.2 trillion, making the problem look less serious.
For EMEs as a category, however, BIS says this “may provide a false sense of safety … if non-financial corporates face pressure from capital outflows, there may be no easy way for the authorities to deploy their reserves to alleviate this pressure … even though the central bank has large foreign-exchange reserves”.
Apart from the central bank’s forex reserves, there is the issue of a natural hedge that exports provide, but as BIS data shows, the foreign currency debts of the corporate sector in EMEs have been growing much faster than their export revenues.
If all goes well, and China’s corporate sector sees top-lines and bottom-lines grow fast, none of this may matter but once forex outflows starts, as BIS points out—of course, not specifically in the context of China—“a final lesson is that capital flows can generate self-reinforcing asset price dynamics … outflows, by increasing the perceived riskiness of borrowing economies, can generate further outflows … and this may trigger contagion”.
In other words, while the global economy slowly recovers, the threat of a problem emanating from countries like China is looking more serious by the day.