Emerging market corporate debt levels ballooned in the years following the global financial crisis, jumping from less than 50% of GDP in 2008 to almost 75% today according to data recently published by the IMF. China alone has seen corporate debt levels more than double from below $8 trillion to more than $16 trillion over the same time period.
Since 2009, it has grown at a compounded rate of more than 30%, to see corporate debt levels become twice as big as sovereign debt.
And much of the debt has been in US dollars, which has grown ten-fold over the past six years. As the Bank of International Settlements recently pointed out, most of the dollars created by the US Federal Reserve as part of its quantitative easing programs have either been lent to the US government, or to non-US corporates – particularly in emerging markets.
According to Guy Stear, head of emerging markets at Societe Generale, the explosion in corporate indebtedness has become the Achilles heel of the emerging markets.
The chart below reveals the rapid growth in dollar-denominated corporate debt in emerging markets since 2009. It will give you pause for thought.
Brazil, Russia and China feature heavily – those nations that have created the greatest amount of angst among investors this year given their importance to the global growth outlook. They were meant to be the beacons of light for the global economy, three of the four “BRIC” nations that were going to power economic growth in the decades ahead.
While they enjoyed a strong growth levels in the immediate aftermath of the global financial crisis, largely due to stimulus-on-steroids rescue package unleashed by the Chinese government between 2008 to 2011, it is clear that much of the growth was fuelled by taking on greater levels of debt.
Now, with the US on the cusp of raising interest rates either late this year or next, markets are understandably nervous. Already heavily indebted, Russia and Brazil are in the midst of severe economic contractions while China, at least based on traditional growth metrics, is also slowing fast.
All this before the US raises interest rates, which is unlikely to inspire investor confidence.
Alhough emerging market corporate debt has held up relatively well despite recent volatility, it’s clear that many investors are watching developments in this space.
Emerging market currencies have been hammered over the past year, especially in recent months. This, to some, points to the increase likelihood that corporate debt may be next.
“Defaults are positively correlated with the growth in debt, so it would make sense to assume a high level of defaults in the very weak economic growth scenarios we are discussing,” says Stear.
Given the rapid run up in corporate indebtedness in emerging markets, lacklustre global growth outlook and the potential for higher interest rates in the US, it’s clear that risks, at least on the surface, are building.
“The worst may well be yet to come,” muses Stear. “The market’s woes could be just beginning”.