The post-financial crisis push in Western countries towards low interest rates, QE and encouraging corporates to utilise the capital markets has had an impact beyond the borders of the developed world, leading to some unintended consequences.

Be careful what you wish for. Policy-makers wanted corporates to borrow less from banks and more from the capital markets and they have – at least they have in Europe. 

Policy-makers also wanted to promote corporate borrowing (and hence investment and growth) and so they indulged in quantitative easing (QE) and low interest rates. This has also been effective but it seems that while the QE was going ahead in the Western economies much of the borrowing has been taking place in emerging markets. 

Emerging market corporates have borrowed heavily, not only in the capital markets but equally from banks. They have also borrowed heavily in foreign currencies leading to fears about repayment now that leading emerging market currencies have taken a hit. 

These are the findings of a recent report from the Financial Stability Board (FSB) on corporate funding structures and incentives aimed at discovering the scale of the risk now that corporate debt issuance is outpacing that of sovereigns and banks. For example, in 2014 emerging markets issued $300bn of corporate debt and $99bn of sovereign debt compared to $14bn corporate and $50bn sovereign in 2000. Bank for International Settlements research shows US dollar credit to non-bank borrowers outside the US has increased from $6000bn to $9000bn since the crisis. 

The report says: “Corporate debt has grown faster than earnings in most EMDE [emerging market and developing economies] countries over the past several years, evidenced by the increase in the ratio of net debt to earnings before interest and taxes which suggests that the leverage of EMDE corporates is increasing, negatively affecting their creditworthiness.”

So which countries are the most vulnerable? The China case is well known with a 53% rise in corporate debt since 2007 resulting in a 154% corporate debt-to-gross domestic product (GDP) ratio last year. Other significant increases over the same period have come in Brazil (up 19%) and Turkey (up 27%). The good news is that the resulting corporate debt-to-GDP levels are still low for most emerging markets – 51% in India and Turkey, 50% in Russia and Thailand, 47% in Brazil – compared with levels in advanced economies. For example, Sweden has seen a 36% rise to 166% corporate debt to GDP, the Netherlands has a 124% ratio, France 122% and Spain 114%. 

In Europe the long-argued shift to the capital markets by corporates is well under way, with them now accounting for 40% of total issuance in 2013 compared with 17% before the crisis. Non-investment grade bonds that were scarce before the crisis now account for 12% of issuance.

The FSB concerns are that rising bond prices could lead to “a bond bubble” that will at some stage burst and that “high private sector debt levels can… negatively impact economic growth”.

The lesson is that policy measures such as QE and low interest rates, together with the increasing bank capital requirements that have pushed many corporates into the bond markets, tend to both overshoot in their impact as well as lead to unintended consequences. 

But what can be done now and could those much trumpeted 'macro prudential measures' be effective as a remedy? In the FSB report, this seems to boil down to requiring the banks to hold even more capital against corporate exposures, although this runs the risk of pushing yet more of them into the capital markets and furthering the build up of a bond bubble. It would also choke off the recovery and is likely to be resisted by governments.   

The report also mentions “targeted capital flow management measures” or capital controls in plain speak, but shies away from going deeper into such a contentious policy area. 

The real solution, of course, is to go back to the cause – continuing low interest rates in the US and the UK long after their usefulness has been outlived, as discussed in this opinion piece in The Banker

Corporates respond to policy signals and the ones they have been getting for the past few years effectively say ‘we want you to borrow more and cheaply’. In the emerging markets, where growth prospects have up until recently been good, this has been an attractive proposition. Economy policy-makers in the major economies need to realise that in a globalised economy they are sending signals throughout the world and not just to their domestic economic players.

Brian Caplen is the editor of The Banker.

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