A version of this material originally appeared in the Financial Times on 26 February 2020.
The debt burdens carried by emerging markets have become a regular feature of reports on threats to financial stability. The total debt for 30 large EM countries reached $72.5tn in 2019, a 168 per cent rise over the past 10 years, according to BIS data. This figure certainly merits watching. But a deeper analysis of the numbers suggests a more nuanced and less worrisome picture.
The $73tn figure includes Hong Kong and Singapore, which are small, wealthy economies that should probably not be grouped among emerging markets. The data also includes financial sector debt that typically double-counts borrowing by other sectors of the economy.
The data includes China too, which is a special case, both for its overwhelming size and its speed of economic and debt growth. The country now accounts for nearly 60 per cent of total EM debt and about 80 per cent of the growth in EM debt over the past five years.
If we exclude these three areas, total EM debt has risen by $9tn over the past decade to $22tn. Taking into account GDP growth of $7tn, EM debt as a share of output is up only marginally, to 125 per cent from 119 per cent since 2009. Repayment capacity relative to income has largely remained intact.
In assessing debt levels, it is important to distinguish between genuine threats to debt sustainability on the one hand, and on the other, the successes of past structural reforms and financial integration, such as the increasing tendency for EM sovereigns to borrow in their own currencies.
First, the positive: the majority of investable EM economies can fall back on currency depreciation as the primary adjustment mechanism for external shocks. As they have moved away from fixed exchange rates and foreign-currency borrowing, they now have greater recourse to policies that can bridge good times and bad.
It is true that debt denominated in foreign currencies — traditionally at the centre of EM crises — is up a sharp $2.3tn since 2009. Yet once changes in asset positions are taken into account, the numbers are less alarming. Again, excluding China, Hong Kong and Singapore, the net EM foreign currency position is largely flat over the last 10 years.
This is not to say that the $9tn in new debt created since 2009 is of no concern. Rather, it should be considered alongside the growth in nominal GDP and a shift from an undervalued to an overvalued dollar.
Bear in mind, too, that EMs have been forced to adjust after a period of excess associated with China’s massive stimulus in 2009-12. EMs suffered repeated shocks to real export demand and to financing conditions through the US “taper tantrum” in May 2013. Now, many are steering clear of running big current account deficits and have reined in domestic credit growth.
Meanwhile, there have been repeated tests of DM investors’ commitment to EM fixed income, suggesting that increased EM holdings is not just a consequence of an extended global financial cycle. While foreign investors often hedge currency exposures in times of trouble, foreign holdings of EM debt have generally remained stable through thick and thin.
Finally, some 56 per cent of total EM debt denominated in foreign currencies is issued by creditors whose sovereign governments have credit ratings of A- or above, up from 46 per cent a decade ago. More than 80 per cent of total borrowings relate to investment-grade countries, rated at least BBB-. EM borrowing looks like a high class problem.
The concern instead must be about China, where total debt has risen to $43tn from $10tn a decade ago. Even excluding financial sector debt, the debt ratio has risen by more than 50 per cent to some 266 per cent of GDP over the same period.
However, the unique aspect of China’s high and rising debt is that it is mostly quasi-fiscal in nature, either associated with local government borrowing or concentrated in the shadows of a still reasonably profitable banking system, which has a strong capital backstop from the sovereign. Moreover, controls on capital flows abroad remain binding, thus trapping a large (but declining) pool of domestic savings. Accordingly, the risk that debts cannot be rolled over seems low.
This does not mean that we are complacent about the rise in EM debt. China’s ability to grow its way out of its current debt overhang is open to question. We also worry about weakening EM productivity growth and a protracted global conflict over trade.
Nonetheless, it is hard to get too concerned about systemic consequences of EM balance sheet risks. There is a lack of large current account deficits; most EM currencies are undervalued; and the debt stock is of a mostly high quality. Finally, there is clear evidence that increased allocations to EM fixed-income markets among DM investors are structural and sticky in nature.