NIKKEI ASIAN REVIEW
Debt-laden groups in China, India and Indonesia vulnerable to financial pressure
Perhaps no region is happier than Asia to hear the U.S. Federal Reserve may end its tightening cycle.
China, India and Indonesia earned the dubious honor of prominent mention in a new Institute of International Finance report calling attention to “the great corporate debt binge.” It focuses on nonfinancial corporate debt, which globally hit a record high of $75 trillion in the second quarter.
Most striking is the borrowing surge since 2013, when emerging markets had a “taper tantrum” over the specter of Fed interest rate hikes, which eventually began in earnest in late 2015. Yet actual Fed tightening moves did not stop nonfinancial companies from gorging on a further $16 trillion of debt after the 2013 market chaos.
Nowhere faster in Asia than its biggest economy. “China’s corporate sector has some of the highest debt levels in the world,” say researchers Khadija Mahmood and Emre Tiftik at the Washingtron-based IIF, an international banks’ organization. And while many mainland companies have ample cash reserves, China ranks among the economies where a “significant proportion of firms” may “continue to find it challenging to cover interest expense on outstanding debt.”
To be clear, IIF is not predicting a wave of massive defaults in Asia. India and Indonesia look even worse than China, as measured by the number of companies IIF terms “stressed.”
One such metric: the number of borrowers with interest coverage ratios under two. Such ratios are calculated by dividing a company’s earnings by interest expenses. Less than two in a rising-rate environment, it follows, could be dangerous. IIF looked at 3,174 Indian companies and 484 Indonesian ones. In both economies, about 30% of borrowers have interest-coverage ratios below two.
All this reminds us Asia has a financial foundations problem, one that poses big risks for 2019. The region’s Achilles tendon is complacency, born of decades of sustained economic growth. When growth returned after the 1997 crisis, policymakers put off reforms for another day. When the chaos of 2008 and 2013 subsided, corporate executives gorged on ultralow rates and borrowed with abandon. And
now, as the Fed hints at a pause in rate hikes, the tendency may be to think Asia’s finances are manageable. That would be a mistake.
Such burdens look less troubling when the world’s major central banks are easing — or holding rates at historically low levels. That is why news the Fed may be throttling back on rate hikes is particularly welcome in Mumbai, Jakarta and Shanghai.
Memories are still fresh for the 2013 carnage in emerging markets. Back then, India and Indonesia suffered the indignity of being included in Morgan Stanley’s “Fragile Five” along with Brazil, South Africa and Turkey. China missed the cut thanks to current-account and trade surpluses.
But will China be Asia’s weakest link if Fed resumes rate hikes? It could indeed, given the generalized explosion of debt and credit since the 2008 “Lehman shock.” China’s corporate debt has surged to 166% of gross domestic product and total debt to 260%. Hardly crisis levels given China’s 6.5% economic growth. But looked at in the context of an escalating trade war and upward pressure on interest rates, debt is a fast-growing concern.
That is particularly true of dollar-denominated debt as the yuan slides. In a Nov. 7 report, Nomura estimated that outstanding dollar debt among Chinese companies more than doubled since 2015. Despite about 175 basis points of Fed rate hikes, China’s own great corporate debt binge saw the stock of IOUs rise to about $751 billion in the third quarter.
On average, $33.3 billion of Chinese corporate dollar bonds will mature each quarter from now until the end of 2020. That is markedly higher than the roughly $11 billion due in the third quarter of 2017. Nomura, the Japanese investment bank, warns that offshore debt is “under increasing pressure against the backdrop of weakening domestic demand, rising credit defaults, a depreciating [yuan] and Fed rate hikes.”
Quite a mouthful, in terms of risk. But that is indeed the environment into which China is heading, taking the global economy with it. Though the U.S. still dominates, China’s $14 trillion economy is entering a period that President Xi Jinping’s Communist Party has never seen before.
No one can say how far Donald Trump will take his tariff arms race in the months ahead. Nor does Xi’s government know today how it might retaliate against the U.S. president’s policies.
Uncertainty abounds as a moment when China’s stimulus options are running thin. In recent weeks, Xi’s government rolled out tax cuts, corporate lending facilities and fresh infrastructure spending.
Weak lending activity has analysts buzzing about a People’s Bank of China rate cut, the first in three years.
But even the largest stimulus efforts face a diminishing returns problem. Over time, the GDP payoff from giant road, dam and bridge projects abates. Efforts to boost investment confront overcapacity. Monetary fuel enjoys less of a multiplier effect.
And before policymakers realize it, steps to pump life into industry end up creating corporate zombies. In China’s case, this potential corporate undead problem is encouraging bad behavior akin to the late 1990s.
The last aggressive Fed tightening cycle was in the mid-1990s. That put upward pressure on Asia’s currency pegs to the dollar. Suddenly, the region’s corporate debt binge left economies top-heavy with liabilities as export competitiveness evaporated. Devaluations led to an explosion of defaults.
China finds itself at a similar crossroads. Trump’s assault on the all-important export engine is threatening growth, profits and executives’ ability to make debt payments. The yuan’s 6.7% decline versus the dollar this year only heightens risks.
India and Indonesia, too. Central banks in Mumbai and Jakarta have busily hiked rates this year to stabilize cratering currencies. The rupee is down more than 9% this year and the rupiah has lost nearly 6%. These vulnerabilities slammed the Indian and Indonesian economies in 2013, and they are causing trouble anew.
Now, add fresh concerns about corporate debt pressures to Asia’s list of challenges. The bill may finally be coming due as the global economy approaches a highly uncertain 2019.
William Pesek is an award-winning Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia, for his work for the Nikkei Asian Review.
