Asia has a debt problem, and it’s getting worse.
Analysts at UBS led by Duncan Woolbridge and Niall MacLeod have pinpointed exactly why.
While interest rates are low and falling in Asia, the debt service ratio has risen.
This ratio shows that the amount of cash companies in China and Hong Kong have to pay to service their existing debts — in interest and coupon payments — is rising faster than their income is growing.
Here’s what the analysts said:
Rates across Asia have fallen since 2008, but the dirty secret is that Asia’s private sector debt service ratio continues to rise.
What’s happened in Asia is that the debt to income ratio has risen faster than central banks’ willingness to reduce rates. Asian central banks are naturally torn between supporting economic growth in the near term, which calls for bringing rates down faster, versus worrying about the eventual fallout from large credit expansions in the long term, which argues for tightening policy.
Here’s the key chart which shows how debt growth (in green) is outpacing GDP growth:
And this is the chart that shows the debt service ratio increasing:
Asia’s slowing economies and high levels of debt have the potential to stunt global growth, the commodities industry and trade flows.
This has been referred to as the “third wave” of the 2008 global financial crisis because it has its roots in investor behaviour after the banking collapse.
Central banks lowered interest rates to near zero in response to the crash in 2009, forcing investors to find decent returns elsewhere.
Companies in emerging markets like China were booming and their debt yielded high returns, so the money flowed in.
But now there are concerns that the economies are slowing and central bank rates are about to rise, reversing capital flows out of emerging markets.
This may not end well.
Here’s UBS again (emphasis ours):
Unfortunately for Singapore and Hong Kong, interest rates and debt service ratios will likely rise because of strong links to US interest rates. And you probably know how that turns out.