Corporate Leverage’s Hectic Hoist
The IMF’s October Global Financial Stability Report probed the massive run-up in EM corporate debt ahead of the annual meetings and flagged cyclical and structural dangers as global liquidity abundance fades. It more than quadrupled to $18 trillion in 2014 and rose on average 25 percent in relation to GDP. Bonds are now 17 percent of the total, and although maturities are longer than with bank loans the instruments are also more volatile. After reviewing data sets for both big and small and state and private firms, the publication cites rising leverage across regions and sectors. Construction companies in China and Latin America loaded up on debt along with mining and oil and gas ones globally, and they also added foreign exchange exposure. The interest coverage ratio is below 3 and worsened since the 2008 crisis, and borrowing proceeds have gone for less-profitable projects. One-third of emerging economies have increased bond issuance at the same time the number of participants has decreased and activity is masked though offshore subsidiary use. It entails weaker monitoring that may promote “excess risk taking” and mutual fund investment structures can reinforce swings. Countries like Colombia, Malaysia, and Russia have placed proportionately more in local currency but dollar and euro resort has risen to almost half the outstanding sum ex-China. In the past five years company liquidity and solvency have “broadly deteriorated” but issuance terms have improved, with tenors stretched a year at lower yields. Domestic factors have become less important in these trends, and regression analysis also shows a close correlation between CEMBI and US corporate spreads.
The research urges near-term preparation for reduced market access and higher debt-servicing costs, and bankruptcy regime reform to enable faster resolution. Banking and securities regulators should consider macro and micro prudential measures, including exposure limits and stricter capital standards, and they must regularly conduct and share public versions of stress tests. China is an outsize case where real estate and construction leverage has almost been matched in mining and utilities, and state-owned enterprises dominate borrowing with declining financial ratios. Just a 1 percent interest rate rise would represent a sufficient shock to force future write-offs, and the analysis was completed before the mainland stock market intervention choking equity alternatives. In the medium term tax treatment favoring debt could be changed and data gaps combining local and overseas transactions must be bridged to enable accurate surveillance. During the 2013 Fed-prompted outflow period more leveraged and smaller firms saw debt costs spike and a “more disruptive” scenario is now plausible which could force central banks to provide emergency lines, the Fund concludes.
In a companion chapter bond market liquidity in both advanced and developing economies is examined and while newly-imposed regulatory constraints may not be decisive it points out that business, technological and dealer shifts may heighten fragility. Bid-ask spreads for emerging market investment-grade bonds were 0.20 at the end of 2014 and had increased faster than in developed markets. The EU’s ban on “naked” CDS dried up normal hedges, and EM currencies have become more liquid at the same time bond dealing may be less resilient though it is not yet “alarming,” according to the rescue brigade’s industry advisors.
