Global Financial Stability’s Local Debt Ladle

The IMF’s October Global Financial Stability Report cited higher emerging market risks in its global “heat map,” alongside lingering dollar-access and European banking constraints on credit and the real economy as it calculated domestic bond resilience to foreign investor outflow. The compilation cited systemic blockage in cross-border project, syndicated and trade lines, with the exception of Asia where Chinese and Japanese lenders have stepped in, and underscored the core-periphery split in the Eurozone with wider borrowing spreads and household and corporate deposit flight in Mediterranean members. The estimate for near-term regional bank deleveraging was raised despite the declaration of ECB bond-buying help as asset quality continues to deteriorate with regulation now to be reinforced by fuller union. National and cross-border exposure has shrunk for both advanced and developing countries as non-strategic businesses and subsidiaries were sold in preparation for greater separation between the loan and securities sides in the traditional universal model. Non-residents held one-third of outstanding government bonds for a half-dozen EU issuers, although rollover risk was mitigated with 6-year plus average maturity. In the US the overseas share is 40 percent, and primary dealers have come under pressure from stricter inventory rules under the Dodd-Frank law which has already limited corporate trading. Central and Eastern Europe remains the “most vulnerable” to the continent’s crisis with their foreign currency portfolio concentrations and the NPL ratio above 10 percent in Bulgaria, Romania and Ukraine. Local bond volatility which again spiked last year has settled, but institutional investor bases are lacking in places like Hungary and Indonesia to cope with sudden international retreat. According to the Fund’s shock simulations, exit could range from 7 percent in Korea to 23 percent in Mexico. Pension funds and banks would be forced to absorb the slack and Malaysia and Poland may have room but other recipients are not as well-positioned.

Asia and Latin America have in turn experienced 15-percent annual credit growth the past five years in Brazil, China, Vietnam and elsewhere. Real estate prices have boomed and bank equities have staggered under late-cycle stress. Corporate leverage is over 100 percent in India and Korea, and central banks have introduced prudential cooling measures. The Chinese “shadow” system put at 5-10 percent of GDP complicates the task. It is centered in several provinces and is officially authorized in Wenzou where 20 percent loan rates are common. The trust company sector is more transparent with assets under management of yuan 5.3 trillion as of June, and may soon outstrip the insurance industry. Wealthier customers invest in these high-risk products which may be mixed in a broader category of off-balance sheet transactions, including corporate bonds where disclosure is sketchy and recent deposit liberalization may hurt profitability. Funds have reportedly been rescued quietly after losses as the post-leadership transition din for political and economic clarity reaches fever pitch.