The IIF’s Staggered Structural Reform Strictures

The IIF’s September Capital Markets Monitor stifled the noise from the Fed’s “taper tantrum” to reiterate a call for structural and growth model changes previously “masked by abundant global liquidity.” In the near term major emerging markets’ 10-20 currency depreciation should aid exports with industrial economies stabilizing as reflected in PMIs, and equities at a P/E ratio below 10 are cheap historically as EMBI spreads have also widened 100 basis points recently to reset relative bond risk and reward. Combined asset class fund outflows through August at $50 billion were around one-quarter of the past year’s influx. The worst-hit countries depend on external current account and public and private debt finance at the equivalent of 10-25 percent of GDP, including Indonesia, South Africa and Turkey. Exchange rate falls in India and Brazil have increased inflation and central banks have intervened and raised interest benchmarks in response, but a full-scale Asia-type crisis as in the late 1990s is unlikely with greater regime flexibility and reserve positions, the group believes. However commodity-reliant states like Russia and Saudi Arabia must rebalance internally, while China’s approach shifts from net exports and fixed investment as pledged by the new leadership. This agenda has been diverted and distorted by years of double-digit credit growth which now must be unwound with debt/GDP levels above 100 percent in several cases not due to central government but to bank and company borrowing. Non-performing company and household loans are up and future servicing ability is due to worsen, according to the last quarterly survey. In China total social financing including the shadow system rose 30 percent in the first half, and big city housing prices climbed at half that pace, as cooling efforts were offset by the need to preserve 7 percent minimum output expansion. India’s mostly unhedged dollar-denominated corporate debt burden stands over $200 billion with 4 percent economic growth the lowest since the 2009 crash. Brazilian private credit has advanced 20 percent annually over the past decade, and households face a steep servicing/income ratio, 5 percent above US families at the post-Lehman crisis peak, with 50 percent rates on short-maturity loans.

Euro area calm over the summer has sparked global securities appetite for both core and periphery offerings on the assumption that imminent German elections will result in policy continuity regardless of coalition composition, and that the European Parliament will pass single-supervisor legislation for the ECB as it conducts regional stress testing. For banks lacking sufficient capital, the EUR 60 billion set aside in the ESM could be tapped, but regulators seek a larger facility to avoid repeats of the Ireland and Cyprus rescues in particular. The former after nationalizing the largest institutions has yet to allow family mortgage foreclosures to boost asset recovery, and in the latter deposits were off 30 percent in August with capital controls extended indefinitely in the stricken structure.