Déjà vu – lower rates, higher debt

Déjà vu – lower rates, higher debt

Global debt rose by over $3 trillion in Q1 2019:

The 2018 slowdown in debt accumulation is looking more blip than a trend, helped by the substantial easing in financial conditions; borrowers took on debt in Q1 2019 at the fastest pace in over a year, according to the Institute of International Finance (IIF).

In Sub-Saharan Africa, an increase in government debt pushed South Africa to the largest change in emerging market debt-to-GDP year-over-year, the fifth-largest difference among the emerging market assessed.

Then, Kenya and Nigeria both saw slight reductions in household debt as a % of GDP in Q1 2019. South African household debt rose slightly, from 33.3% in Q1 2018 to 34.1% this quarter. Also, Mozambique, Sudan, and Eritrea face the highest government debt-to-GDP ratios on the African continent.

Meanwhile, Nigeria’s debt hit N24.9 trillion in the first quarter of 2019, projected to beat N30 trillion by 2023. However, at $246 trillion -nearly 320% of GDP-, global debt is now just $2 trillion away from the all-time high of $248 trillion reached in Q1 2018.

Looking ahead, broad-based central bank easing could well prompt more debt build-up across the board, undermining deleveraging efforts and reigniting concern about long-term headwinds to global growth.

“For some vulnerable low-income countries, debt sustainability is already at risk; in the corporate sector, rising debt levels are a growing burden for smaller or highly leveraged firms—particularly given the increasing clouds over the global earnings outlook”, IIF noted.

Mature markets—some signs of fiscal expansion:

Following a substantial decline of $3.8 trillion in the last three quarters of 2018, total debt in mature markets rose by $1.6 trillion in Q1 2019 and now stands near $177 trillion.

Although most of the Q1 increase was due to a build-up in government debt (+$1 trillion), other sectors also saw a rise in debt levels.

Finland, Canada and Japan have seen the biggest increase in debt-to-GDP ratios over the past year; however, some Euro Area economies -notably the Netherlands, Ireland and Portugal- have continued with deleveraging.

EM debt hit a record high of $69 trillion (216% of GDP):

The persistent economy-wide increase in EM borrowing continues to feed into higher contingent liabilities for many sovereigns.

With EM household and government debt reaching record highs, the rise in overall debt-to-GDP ratios since Q1 2018 has been most significant in Chile, Korea, Brazil, South Africa, Pakistan and China.

In contrast, Ukraine, Egypt, UAE, Hungary and Lebanon have all reduced total debt ratios over the past year.

U.S. federal government hits a new peak:

Total U.S. debt has risen by $2.9 trillion since Q1 2018, bringing the U.S. debt mountain to an all-time high of over $69 trillion in Q1 2019. Unsurprisingly, the rise in government debt—now over 101% of GDP—was a key driver.

IIF reiterates that lower rates might not help much; with annualized interest expense reaching a record high of $830 billion in Q1, the institute estimates that even a 100 basis point decline in borrowing costs would only reduce federal interest spending by $20-25 billion per year over the medium term.

Amber light for the U.S. corporate sector:

With U.S. corporate debt growing above trend, an increase in bank lending has helped push the debt of non-financial corporate firms to a new high of near 75% of GDP, adding to worries about vulnerabilities in the corporate sector.

While declining borrowing costs could provide some breathing room for U.S. firms with high refinancing needs, this may not do much to improve business sentiment (or investment spending) given trade tensions and concern about earnings growth.

More broadly, IIF stated that its U.S. Business Health Index remains weak, driven by growing reliance on short-term debt, deteriorating interest coverage and quick ratios (as a proxy for liquidity), and declining RoA.

China: corporate deleveraging, but other sectors borrow more:

With total debt nearing 310% of GDP, deleveraging challenges for China remain acute, IIF noted. While authorities’ efforts to curb shadow bank lending, particularly to SMEs, have prompted a cutback in non-financial corporate debt, net borrowing in other sectors has brought China’s total debt to over $40 trillion—some 15% of all global debt.

Of note, onshore bond issuance suggests a big pickup in borrowing by local governments and banks this year.

EM corporates are taking on more short-term debt— and thus more refinancing risk

Short-term liabilities of listed EM non-financial firms make up some 35% of their total debt, as against around 20% in mature markets, varying from 13% in Brazil to 75% in China.

Read Also: 50% of Emerging Market Bank Ratings on Negative Outlook

This greater reliance on short-term borrowing leaves some highly indebted firms more exposed to swings in global risk appetite. Fed rate cuts (with some help from the ECB, BoJ and PBoC) would therefore offer a renewed opportunity for firms to lengthen maturities and repair their balance sheets.

Emerging markets rely less on FX-denominated debt:

Following a rapid rise in 2017, FX debt of emerging markets has been stable near $8.5 trillion, and lower as a percentage of GDP. But in some cases, currency depreciation as against the USD has meant higher FX debt ratios, e.g. for Argentina, South Africa, Turkey and Chile.

EM rollover risk:

Close to $3 trillion of EM bonds and syndicated loans come due through the end-2020, with USD redemptions accounting for over 30% of the total.

Déjà vu – lower rates, higher debt