Recent headlines warning of excessive debt in emerging markets are alarmist and investors would do well to differentiate between countries, says Anton Kerkenezov.

 

If you delve into the numbers you will see overall debt to GDP ratios do not look excessive, especially relative to the situation in developed nations. Furthermore, little of the debt outstanding is denominated in ‘hard’ currencies – the source of many emerging countries’ problems in the past. While there are some obvious areas of concern such as the sharp rise in Chinese corporate debt, many countries such as Hungary appear to be in a comfortable position.

Central banks in emerging countries, like their peers in the West, have kept interest rates low in recent years. Consequently, leverage across government, corporate and household sectors has increased. But with one or two exceptions, it does not look especially high. The biggest increase has taken place in the corporate sector, as highlighted in the chart below.

A challenging start to the year

Although the outlook for emerging economies has deteriorated largely due to the recent rise in US interest rates, low commodity prices and a softer global backdrop, prospects remain reasonably bright overall. While credit conditions within emerging countries have tightened, credit growth in the mid-to-high single digits, which is in line with the long-run average, should not act as a major drag on growth. This view is shared by the International Monetary Fund (IMF), which expects emerging economies to expand by 4.3 per cent this year and by 4.7 per cent in 20171. Moreover, this acceleration will occur despite a well-publicised slowdown in China.

Critically, the bulk of the growth in debt has been financed in local currencies, which now accounts for around 90 per cent of the outstanding total. This marks an important difference to previous debt cycles, such as that which preceded the Asian Financial Crisis of 1997. That episode saw Asian governments and companies borrowing heavily in foreign currencies, particularly US dollars. When their currencies subsequently collapsed, countries such as Thailand and Indonesia had to be bailed out by the IMF.

1 IMF World Economic Outlook, January 2016

In stark contrast to previous periods, emerging nations’ banking sectors are generally healthy.


Additionally, and in stark contrast to previous periods, emerging nations’ banking sectors are generally healthy. So governments, households and corporations, can refinance their local currency debt, even if it is more expensive to do so.


The countries where we have most concern are China, Brazil and Turkey. China has seen the largest increase in debt, which now stands at 196 per cent of GDP. In Brazil, debt stands at 136 per cent of GDP and the country is currently in a recession. And in Turkey, where debt represents 101 per cent of GDP, the political environment is volatile and foreign exchange reserves are low. This is particularly worrying given high levels of hard-currency debt and the country’s current account deficit. Other countries where debt is worryingly high include: Malaysia (217 per cent of GDP), S. Korea (203 per cent of GDP) and Hong Kong (329 per cent of GDP).

Government debt levels relatively low

Looking at a breakdown of the composition of total debt, government debt does not look excessive. On average it remains below 50 per cent of GDP, while foreign exchange reserves have increased over the past 15 years. Certainly, the level of government debt compares favourably with the situation in the developed world where it stands at 92 per cent of GDP in the EU, 106 per cent in the UK and 126 per cent in the US.

There are plenty of examples of countries whose fiscal position looks favourable. Take the case of Hungary. With a budget deficit of less than three per cent of GDP, sovereign debt now stands at 76 per cent of GDP, having fallen since 2011. Furthermore, to reduce its vulnerability to a shortage of external funding, the country has increased the share of debt that is denominated in local currencies.

Healthy household finances

Neither do countries’ household sectors look over-indebted. Debt levels have grown by around six percentage points since 2008 but at 33 per cent of GDP appear manageable. Having said that, this number masks wide differences between regions. Asia boasts the highest household debt. But this is in the more advanced economies, such as Malaysia (85 per cent of GDP), South Korea (84 per cent of GDP), and Hong Kong (66 per cent of GDP). In mainland China it stands at 24 per cent. This figure is likely to continue growing, offsetting the deleveraging we expect to see by households in the aforementioned three nations. In Latin America and emerging European countries, household debt ranges between just five and 40 per cent of GDP.

Corporate debt lower than in developed economies

Emerging market corporate debt has risen sharply in recent years and stands at 104 per cent of GDP in 2015, up 25 percentage points since 2008. This has prompted some commentators to suggest corporate debt is unsustainably high and there will be a need for corporate deleveraging, which could weigh on economic growth. However, while that is not to say these figures present no concern, we believe this is an overly pessimistic scenario. For a start, much of the corporate debt has been issued by companies based in China and Hong Kong – which is a proxy for lending to China. Stripping out this effect, debt is a much more manageable 80 per cent of GDP. The fact is corporate debt is much higher in developed nations, where it has reached 125 per cent of GDP. Besides, hard currency corporate debt stands at only 8.5 per cent of GDP.

India is an example of a country that has managed to continue posting strong economic growth despite concerns around the health of the banking sector, which could dampen the outlook for future economic growth.


To sum up, we do not believe the rise in emerging market debt seen in recent years is indicative of an impending crisis. Even the three countries where we have most concern – Brazil, China, and Turkey – are supported by strong banking sectors, and in China’s case offer the potential of strong government support. Investors would be advised to differentiate between the relatively small number of countries where debt has risen to levels that could prove destabilising and those where it remains low and manageable and is unlikely to impede economic growth.

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