Low economic growth and high debt levels are a brutal combination that the rich world has been all too familiar with in the years since the financial crisis.
It’s referred to as a “toxic mix” by the authors of a new HSBC note. A team led by Murat Ulgen, HSBC’s global head of emerging market research, says that the developing world is now exhibiting the same worrying blend.
The easy growth in the emerging world is now behind us, according to the note:
It is clear that the low-hanging fruits of cheap credit, surging commodity prices and unproductive domestic investments are largely exhausted. As such, EM needs to re-energise via hard work, namely sweeping fundamental reforms to restore competitiveness and to address supply-side bottlenecks. The alternative is EM stagnation with a fairly heavy debt load.
There’s no doubt that there was a lot of catch-up growth — even in the 2000s, a lot of growth in emerging markets was effectively a fast-forwarded version of the industrial revolution, with countries like China achieving progress in a decade that took a century for Europe.
But things have changed.
Charts tracking the debt load of emerging markets are eye-watering right now. Though it’s still some way below the developed world, there’s been an unmissable ramp since the 2008 financial crisis:
The dynamics of the debt are different to those of the developed economies. For starters, a huge amount of the increase has been in non-financial corporate debt, not government debt. On that front, China has led the way, with ballooning corporate credit since the financial crisis.
Goldman Sachs has gone as far as to call the emerging market debt load the “third wave” of debt problems since the financial crisis — on a par with the US sub-prime housing crisis and the eurozone debt crisis.
There’s a common thread between the three. The US housing crisis, financial crisis and recession led to rock-bottom interest rates around the advanced world. Policies like quantitative easing have spilled over into emerging markets too.
Here’s the way the HSBC report explains it:
In the post-crisis world, EM demand has been buffered by extremely cheap and abundant external liquidity seeping through to domestic credit markets. Since the 2013 ‘taper tantrum’, global credit conditions have deteriorated steadily and over the last few quarters, they have actually worsened, exerting upward pressures on external and local funding costs, reducing capital flows and raising market volatility.
Riding the waves of US interest rates is a perennial challenge for emerging markets — when rates are lower developing countries often see surges of investment, only to have their wings clipped when rates start to climb again. With the US Federal Reserve looking to hike rates soon, emerging markets will be put in a difficult position.
What’s more, there’s no cavalry on the horizon for emerging markets, or the global economy in general. The note from HSBC explains that there’s no “global consumer” or “investor of last resort” anymore — the two positions filled up by advanced economies before 2008 and China since 2008.
That cheap liquidity was a sign of the dreadful situation many advanced economies found themselves in during the post-crash period, and any tightening in the next couple of years will actually be a positive signal about how far those economies have recovered. For emerging economies, these years will will be far more demanding.