By Alexander Scherpf for Global Risk Insights
Levels of debt have skyrocketed in a number of Asian economies, raising fresh concerns. In the 2015 report on debt and deleveraging, McKinsey Global Institute (MGI) analysts highlight that Asian governments, corporations, and households have accumulated debt worth 205% of total annual economic output.
By comparison, the debt-to-GDP ratio in Asia was 144% before the global financial crisis in 2007, and 136% in 1996, just before the Asian financial crisis hit.
The borrowing has played out differently across the region. In China, corporate debt was the largest driver. At 125 percent of GDP, up 52 percentage points since 2007, China now has one of the highest levels of corporate debt in the world.
In Malaysia and Thailand, by contrast, household debt is reaching new peaks as consumers borrow to fund the trappings of a middle-class lifestyle. The household debt-to-income ratios in the two countries have grown significantly, and are now on par with the US level.
Considering a number of metrics, including level/growth of debt-to-income ratios, debt service ratios, and house price changes, the high household debt in Malaysia and Thailand is unsustainable and signals increased vulnerabilities. To avoid a crisis, effective tools are needed for issuing, monitoring, and managing household debt.
Debt as a drag on growth
Rising debt is obviously not confined to Asia. Since 2007, global debt has grown by a staggering $57 trillion, amounting to a rise in the ratio of debt to GDP of 17 percentage points.
Beyond a doubt, debt remains an essential tool for the global economy to finance growth and can reflect a healthy financial deepening in emerging economies.
However, academic research reveals that high levels of debt, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises.
First-quarter growth rates at 7 percent year-on-year marked a further deceleration of economic growth in China. The Chinese economy expanded at its lowest rate since 2009 putting economic planners in a delicate position. Fiscal and monetary stimuli threaten to further boost debt in the People’s Republic.
China’s burgeoning debt problem is exacerbated by low inflation rates. Since most debt is fixed in nominal terms, higher inflation erodes its real value and can facilitate debt escape.
Although policy makers cut interest rates for the second time in just three months, the consumer price index increased by a meager 1.4 percent year-on-year in March, well below Beijing’s target of around 3 percent.
The open trading members of ASEAN are well advised to eye the economic performance of their largest single trading partner, as spillover effects could be considerable.
Singapore, Malaysia and Vietnam stand out in terms of their direct trade exposure to China, but Indonesia and Thailand also depend on Chinese demand as large resource providers.
Caution, yes. Panic, no.
The question now for investors is whether rising debt across Asian economies will spark a crisis. It is always impossible to say, but the debt burden needs to be seen in context, and a number of factors suggest that such fears are exaggerated.
Most countries have not borrowed excessively in foreign currencies. Currency depreciation, as happened prior to the 1997 Asian crisis, will hence be no trigger.
A notable exception here is Malaysia. Foreign currency debt, at 65 percent of GDP, is among the world’s highest and gives reason for concern as falling commodity prices have caused a depreciation of the Ringgit by 15 percent since August 2014. Fitch Ratings’ announcement of a possible rating cut in Malaysia has added further pressure on the local currency.
Debt-to-GDP ratios remain low in Vietnam, the Philippines and Indonesia at 146, 116 and 88 percent, respectively. In Indonesia, foreigners hold nearly 40 percent of Rupiah-denominated bonds, making it somewhat vulnerable to external events, such as a Fed tapering expected for later this year.
Singapore’s real economic debt has increased by a staggering 162 percentage points, amounting to a debt-to-GDP ratio of 382 percent—almost as high as Japan’s 400 percent, topping the list. However, Singapore’s unusually high debt-to-GDP ratio does not signal imminent danger.
The Southeast Asian city state is a major business hub, and the high debt being raised by (foreign) corporations is used to fund operations across the region. Earnings in other countries support such debt.
While the debt surge across Asia does heighten risk for investors and needs to be observed carefully, in particularly in relation to deficits and rapid demographic changes, there is no reason for panic.