Asia leverage – after the boom

Asian companies and governments are dealing with the consequences of over-borrowing, and China remains the biggest concern

In a year of lacklustre world growth, and despite the region’s great openness to trade, Asia’s GDP growth continues to outperform impressively.

The main factors behind this outperformance, which has been going on since the global financial crisis, have been strong intra-regional trade and domestic demand. Another crucial factor has been growth in borrowing – or leverage.

Some Asian economies have experienced excessive credit growth in certain sectors in recent years. Now that the region’s credit boom is over, companies and governments are dealing with the consequences of past excesses.

In 2016, Asia finds itself in a consolidation phase, as credit growth slows, but that doesn’t mean the problems are over.

China remains the biggest concern in Asia when it comes to leverage. While the rate of increase has peaked, China’s credit growth may continue to exceed GDP growth. This means that China’s ratio of total debt to GDP may keep rising, albeit at a slower pace.

China’s debt-to-GDP ratio has increased by 85 percentage points to 232 per cent since the end of 2008, in the wake of the government’s massive stimulus programme to counter the effects of the global financial crisis.

While China’s ratio of bad debt to GDP appears much lower now than in 1997, the issue is more complex this time. Bad debts are not concentrated with large state-owned companies and banks; they now extend to small and medium-sized enterprises (SMEs) and smaller-scale banks.

The contingent liabilities of local government financing vehicles are another potential risk. Off-balance-sheet transactions and so-called ‘shadow banking’ activities (consisting mostly of wealth management products) are seen as raising credit risks and destabilising financial markets.

China’s policy makers are well aware of rising credit risk in the financial system as a result of the economic slowdown. They have implemented several policies to mitigate such risks: the recent recapitalisation of policy banks to provide new loans to boost growth, the use of existing national asset management companies (and the creation of new local ones) to take on bad debts, the debt-to-bond swap, and capital-market development.

Other options being discussed include securitisation of bank assets and a debt-to-equity swap. We think a direct government bailout would be a last resort.


Asia’s leverage risk varies from high to low

We group Asian economies into three in terms of leverage-related risks (high, medium and low), and China – along with Japan, Hong Kong and Malaysia – are in our high risk category.

India and Singapore remain in our medium-risk category, joined by South Korea (previously in the high-risk category) and Indonesia (previously low-risk). While India’s overall debt remains fairly low, at only 138 per cent of GDP, the risk profile of existing debt has deteriorated, particularly in the past two years.

We flagged India’s corporate debt as a concern back in 2013 due to its rapid accumulation. Weak profitability, combined with debt concentration in the commodity sector, has further increased risks in the corporate sector.


Corporate debt has deteriorated after commodity price drop

Indonesia’s move from the low-risk to the medium-risk category reflects a deterioration in corporate debt – particularly in the commodity space after the slide in commodity prices over the past two years – as well as an increase in external debt, a large portion of which is foreign-currency-denominated.

Taiwan, Thailand and the Philippines remain in the low-risk category. All three have plenty of room to expand leverage, particularly in the private sector. While the Philippines’ household credit growth has far exceeded income growth in recent years, credit growth is coming from a very low base – the country’s total household debt is by far the lowest in Asia. A continued, but contained, increase in household leverage would help to sustain the recent strength in consumer demand, a significant contributor to GDP growth.

Thailand’s government and corporate debt remain very low, with scope for further leverage to boost growth. Household leverage remains a concern, however, given the high debt-to-income ratio and the relatively high household debt-service ratio. Bank credit to households needs to be monitored closely, particularly in case of a weak economic recovery.

Generally, Asia is divided in terms of household leverage risk. While households in Malaysia, South Korea, Australia and Singapore are highly leveraged, those in other parts of the region – particularly China, India and Indonesia – have significant room for more borrowing.

A bright spot in Asia’s leverage landscape is that the household sectors in China, India and Indonesia – Asia’s largest emerging economies – all have room to increase leverage, helping them to cope better with shocks and boosting their consumption power. This should help Asia’s external sector become even less dependent on the West than it is today.

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