Export Powerhouses’ Dented Debt Delivery
The IMF’s September Global Financial Stability Review in a somber tone specifically cited the onset of increased emerging market risk since 2008 as an overlooked contributor, with the “export” of credit risk to global investors with Chinese property companies an important element. It noted that as portfolio and bank-related versions again dominate capital inflows in most regions, volatility and outright flight could again ensue and that corporate external debt in the “search for yield” could be ripe for mispricing and deficient due diligence. Issuance in the asset class at over $150 billion already will hit another record this year, with cross-over demand from US high-yield a major impetus, particularly for neighboring Latin American allocation. Speculative participation is near one-third the total, and accounting and fraud scandals as in Sino Forest’s default could be looming. In China’s case companies have also gone offshore not only to tap cheaper funding with the assumption of yuan appreciation but to escape tighter domestic prudential regulation through administrative and monetary policies. Rapid loan growth there and elsewhere like Brazil and Turkey, especially to households, may invite danger based on recent historical experience, and stress test models point to rising NPLs. Asia could see the greatest spike followed by EMEA, which has so far borne the brunt of the Eurozone crisis, but Latin America will not be spared although its comparatively harsher blow could come from falling commodity prices in a terms-of-trade shock. Bank capital adequacy may be insufficient to absorb these swings, and economic conditions may be less favorable to immediate redress than during the post-Lehman period. The accompanying World Economic Outlook publication has cut developing countries’ GDP growth outlook, and structural fiscal deficits remain large amid climbing inflation and leverage and often “stretched” securities market valuations. Capital controls that have proliferated as an anti-overheating and exchange rate management tool may be “of limited use” in the current risk-averse and pressing financial institution oversight environment, the authors recommend, with “time running out” to properly mobilize political will and policy priorities.
A separate chapter in the document probes hundreds of long-term institutional investors about their post-crisis lessons and preferences, and underscores an emphasis on sovereign credit quality and instrument liquidity and “back to basics” derivatives approach for straightforward hedging. An “ongoing” trend toward emerging market diversification has resumed with equity ahead of debt, but with discrimination rather than a homogeneous segment view. A complementary focus in the alternatives category is commodities and infrastructure, although the ability to exit in all these areas is a lingering impediment that could be further spotlighted with the launch of the latest round of stricter insurance and pension fund guidelines for Europe’s single market as monetary integration otherwise may slacken.
