Private Debt’s Hangover Remedy Rumbling
As IMF officials at their annual meeting continued to sound the alarm on private debt buildup as a looming systemic risk, big investment houses have projected calm, with JP Morgan statistics pointing to a slight annual drop to 115 percent or close to 80 percent of GDP excluding China. Government debt in turn increased marginally since 2016 to 50 percent of output, half the level of the US and Europe, with Gulf and frontier countries running up the tab. Egypt, Mongolia, Jamaica and Lebanon have burdens in the 100 percent-plus range, but the external portion for the overall universe has been steady the past decade at around 25 percent. Deleveraging started almost two years ago, including in China where shadow banking-spurred credit growth is down to single digits. Corporate debt spurted 25 percent to almost 85 percent of GDP since the 2008 financial crisis, and the private remainder is household particularly mortgages and credit cards in East Asia and this region has the highest commercial load at 150 percent-plus in China, Taiwan, Korea, Malaysia and Thailand. Since 2014 Mexico and Egypt totals rose 5 percent, and fell comparable amounts in Croatia, Kazakhstan and Ukraine. Domestic borrowing is almost 95 percent of the sum, and 80 percent is through traditional bank lending rather than bonds. As of Q3 credit expansion outside China was 6.5 percent, versus almost triple that pace in 2011. African countries like Nigeria dropped 20 percent on an annual basis, but the cycle has improved in Brazil, Russia and Turkey so that the net effect is no longer negative, according to the JP Morgan research. The trend is reflected in the IIF’s latest survey of banking conditions released before the IMF gathering, with a 48 result approaching the neutral 50 mark. The better outcome is also attributed to developing economy growth pickup across the board highlighted in the Fund’s upgrade to 4.5-5 percent this year.
The corporate benchmark CEMBI was introduced in 2007 and since avoided major selloffs, and local and foreign pension fund investors have jumped in with mandates to follow the 50 country $400 billion gauge. However index allocation misses half the universe in this segment as well as external and domestic sovereigns, and portfolio managers now argue for a blended or unconstrained approach through individual accounts. US public pensions have less than 5 percent of assets in EM debt, and September paper by fund giant Eaton Vance, which recently bought socially responsible specialist Calvert, argues for top-down multi-class exposure. After assessing economic and political risk, bottom-up company and instrument research and market trading and infrastructure capacity should be guides, and institutional investors may lack these dimensions with in house expertise. According to sentiment readings taken during the IMF heavy inflows already near $100 billion and fixed-income overweights should last through 2018, although equities will outperform. Currency and bond enthusiasm will shrug off industrial world central bank planned liquidity tightening, world geopolitical tensions now concentrated on the Korean peninsula, and likely credit rating downgrades which may continue for China, South Africa and other prime destinations caught in their own subprime borrowing predicaments.