Surging Private Debt Threatens Asia's Public Debt Sustainability
From past experience we know how quickly the bursting of a privately leveraged boom cycle ends up weighing on national budgets and public debt.
Relatively low public debt ratios across most countries in developing Asia reflect robust economic growth and sound fiscal management. An ongoing ADB technical assistance project assessing public debt sustainability in the region suggests that public debt is on a sustainable track.
But behind this public rectitude there is a lurking danger.
Across a host of Asian countries, private debt has been rising at a fast clip. And past experience has shown, again and again, just how quickly the bursting of a privately leveraged boom cycle ends up weighing on national budgets and public debt.
Between 2008 and 2015, the average household debt-to-GDP ratio in Asia increased by 15 percentage points.
Household debt (% of GDP). Source: Institute of International Finance. EM Debt Monitor March 2016. Washington.
Meanwhile, non-financial corporate debt-to-GDP ratio rose by nearly 25 (Figure 2). By contrast, government debt increased by 7.4 percentage points and financial sector debt declined by 3.2 percentage points.
Non-financial corporate debt (% of GDP). Source: Institute of International Finance. EM Debt Monitor March 2016. Washington.
Sustained economic growth and high rates of savings provide Asian firms with an ample pool of domestic financing. However, firms have also ramped up overseas borrowing through bank loans and offshore bond issuances by their foreign subsidiaries. Emerging markets have absorbed massive outflows from advanced economies, driven by investors’ search for yield. Non-financial corporate debt scaled by GDP is highest for economies with internationally integrated capital markets, such as Hong Kong, China; Singapore; and the Republic of Korea.
A sharp reversal of capital flows constitutes a risk for emerging markets whose corporate sectors are leveraged internationally and may end up facing an unfavorable combination of interest rate, rollover, and currency risks. Non-financial corporate distress easily transmits to the financial sector through its holdings of a significant share of corporate bonds, and also indirectly via asset devaluation and adverse feedback loops throughout the economies affected.
On the other hand, economies where corporate sectors are leveraged domestically are vulnerable to a marked economic slowdown that would take the steam from the highly leveraged sectors. The People’s Republic of China (PRC) is a case in point, with debt standing at 170% of GDP in 2015, driven largely by borrowings by the real estate sector and state-owned enterprises. Any severe disruption to economic growth and earnings would see the non-performing loan ratio surge, asset prices collapse, and the government assuming debt repayments of failing state-owned enterprises and unviable local investment platforms.
Highly leveraged households constitute a further source of risk in economies where debts have risen rapidly. Malaysia’s and Thailand’s household debt-to-GDP ratios exceeded 70% by the end of 2015, and the PRC’s has more than doubled since 2008 to nearly 40%. Household debt to personal disposable income in Malaysia, Thailand, Singapore, the Republic of Korea and Taipei,China by the end of 2014 is at least as high as it was in the US in 2007, according to Deloitte.
Elevated household debt is not likely to set off a crisis as long as interest rates and unemployment rates are low. Such is the case of the Republic of Korea, whose households have long been the most leveraged in the region. Moreover, the country’s banking sector is resilient, profitable and well capitalized, as are those of the other economies in the region where households are highly indebted.
But against a backdrop of softer export markets, these benign conditions may not last. And a severe shock could mean that some Asian economies would be unable to rely on the external sector to pick up the slack in domestic demand. This could trigger household deleveraging, choking off consumer spending. Mounting delinquencies could spill over to the financial sector, feeding a full-blown financial crisis that could also result in massive deleveraging and a wave of defaults in the corporate sector.
Past crises have amply demonstrated that boom-bust cycles are anticipated by a surge in private debt. Household and corporate repayment difficulties have a ripple effect in the financial sector, the bailout of which increases public debt eventually. This was true for the Great Depression of the 1930s, as well as for the developing countries’ debt crises in the 1970s and 1980s, the Asian financial crisis in the late 1990s, and the latest global recession that began in 2007 as a private debt crisis in the US.
Proactive macro-prudential policies and enhanced surveillance of lending activities and risks—in banks and non-bank institutions alike—are necessary to detect any financial fragility and instability. And taming cross-border capital flows also remains an urgent task the international community has not yet attended to. There is no room for complacency whatsoever.