Financial Stability’s Treading Traction Trace
The IMF’s April Global Financial Stability Report flagged higher emerging market risks on is periodic “heat map,” and urged deeper “policy traction” against corporate balance sheet and commodity price deterioration outweighing lower inflation and more competitive currency benefits. China’s disinflation was singled out as more structural due to overcapacity in real estate and industrial sectors and its potential for “abrupt and disorderly” deleveraging with bank property loan exposure at 20 percent of GDP. The Asia high-yield bond market with $125 billion in mainland issuance since 2010 has felt the impact with developer Kaisa’s missed payments, which raised basic collateral and seniority questions amid fraud and mismanagement allegations. Chemical and mining companies have also borrowed heavily offshore, and state banks may be vulnerable through previous shadow channels used to evade prudential rules, the Fund believes. With retrenchment capital spending plans have been curtailed and may erode the economy’s underlying investment potential although returns have steadily diminished post-crisis with the massive central and local government stimulus push.
Oil and gas shocks have been “systemic” in Nigeria, Russia and Venezuela and since 2007 energy firms have issued one-third of external corporate debt including syndicated loans. Their financial ratios in terms of profitability and servicing capacity had begun to slip before this year’s price crash, and state-owned borrowers in Argentina, Brazil and South Africa are also in trouble. The dollar’s 15 percent nominal appreciation since late 2014 has revealed fault lines in household loads as well in Asia. The private sector has binged in Chile, Poland and Turkey, and non-resident ownership of local government bonds is a vulnerability at 30 percent plus ranges in Indonesia and Mexico as “original sin 2.0” according to the report. The Swiss franc’s sudden move has likewise battered Central Europe markets with the mortgage denomination and Latin American equities have been in uniform decline with the currency volatility spike.
Corporate weakness will also affect domestic banks in Nigeria, Peru, Turkey and Ukraine with half of loan books there. While Tier I Basel standard equity is above 10 percent in most systems loss-absorbing buffers may be low in Chile, Hungary, India and Russia. Russian liquidity and solvency risks are currently contained, but NPLs as of December were 7 percent and the loan-deposit relationship at 150 percent assumes continued wholesale funding which has evaporated from overseas sources post-sanctions. Banks owe around $30 billion in external debt through the rest of this year but have been able to refinance through a central bank facility as the ruble has retraced half its 2104 spill against the dollar. Portfolio outflows have also eased with stock funds among the few country gainers in Q1 according to tracker EPFR.
China should allow public bond defaults and central banks generally should sharpen macro-prudential tools to restrain foreign currency dealings. Tax incentives favoring debt could be removed and information collection must focus on murky areas like derivatives where claimed hedges may not truly be in place. Countries should have liquidity backstops to remedy market seizures and bilateral and multilateral currency swaps can salve cross-border misery in similar fashion, the publication concludes.
