The BIS’ Boom Cycle Backpedaling

The Bank for International Settlements’ annual report dedicated a chapter to  post-crisis disconnect in business and financial cycles, with emerging markets in a decade-long asset and credit upsurge only “briefly interrupted”  in 2008-09 on private sector borrowing up 10 percent annually. Both banks and non-banks have contributed, with signs of a “stalling boom” in Brazil, China and elsewhere. Global liquidity-driven inflows have magnified domestic growth with developing economies raising over $2 trillion abroad the past five years. These figures are based on residency and may understate the total by one-third with offshore affiliates often used by the same company for bond issues in particular as they have displaced traditional syndicated and project lending. Average nominal long-term yields have fallen from 8 percent in 2005 to 5 percent last year or just 1 percent in inflation adjusted terms. Credit/output ratios have deviated over 10 percent from the historic trend in many countries indicating imminent strains, according to the organization. Corporate debt service remains manageable but an interest rate reversion such as 2004’s 250 basis point hike would touch “critical thresholds.” The other side of the equation is slower economic growth which has taken hold, with global commodity exporters especially linked to China’s rebalancing. The nature of risk is now different with bond markets, and although immediate rollover needs at an annual $100 billion or one-tenth the total can be met capital outflows could suddenly accelerate due to internal or external factors. Brazil, China, India and Turkey are in the boom category, while Central and Eastern Europe, Korea, Mexico and South Africa show “mixed signals.” The BIS notes the increasingly short-term horizon of ETF investors who account for one-fifth of bond and equity fund allocation since their launch over a decade ago. They can be sold off easily, despite redemption problems at the height of the post-2008 period and Fed tapering fright, and exiting retail buyers may never return. Corporate debt contagion from overseas to local channels may also occur as deposits are pulled to cover lost access in mid-size places like Chile, Indonesia, Malaysia and Peru where they represent 20 percent of bank footings.

Relatively minor redeployment of global money managers’ $70 trillion in assets could have “systemic implications,” as a 5 percent move would be equivalent to 15 percent of emerging market securities outstanding, and correlated positions would exacerbate swings. Currency exposure has essentially been ignored with 90 percent of international bonds in G3 units, and property and utility firms heavy borrowers without matching payment streams. To the extent hedges exist they are incomplete and typically unavailable with large fluctuations. To restore sustainability regulatory changes are overdue in many countries to allow business and household restructuring, as scenarios such as in Brazil and Korea suggest a debt trap based on longstanding monetary and real estate model explosions.