Non-financial corporate debt relative to GDP crept up by 6 percentage points in China, and 5% in Saudi-Arabia and Turkey in the first half of this year. The combination of a quick rise in financial leverage, the decelerating economic growth in the region and this week’s start of a rate hiking cycle by the Fed seem set to result in a perfect storm for emerging market debt.
Total leverage in emerging market economies has now surpassed the 200%-mark, reaching $58trn at the end of the second quarter. Non-financial corporate debt in emerging has now reached similar levels as in mature markets, having risen from 60% of GDP in 2010 to approximately 90% now. The mining, materials and construction sectors saw the largest relative increase in debt.
Fund buyers turn bearish
So how has the debt surge in emerging markets affected investor appetite for emerging market corporate debt? Demand for the asset class has indeed decreased markedly. A year ago, those planning to increase allocation to EM corporate bonds outnumbered those intending to decrease exposure by about two to one. Now, there are hardly any buyers left and, though sellers are also scarce, increasing numbers of fund selectors have abandoned the asset class. Denmark is the only country where there is still significant appetite for emerging market corporate bonds.
Though government debt to GDP ratios have stayed pretty stable across emerging markets, with the exception of commodity dependent economies such as Brazil and Malaysia, appetite for EM govvies is hardly higher. Non-usage is at the same level, suggesting many investors do not distinguish to much between corporate and government debt in EM. This view is reinforced by a four-month streak of net outflows from emerging market bond funds, though local currency government bond flows recovered recently.
Contrast with DM
While almost all emerging market economies saw their financial leverage increase, developed countries saw the opposite happen. With the exception of commodity-dependent Norway, Canada and Australia, all developed market economies saw their total debt-to-GDP ratio decrease. Deleveraging by the financial sector was the main contributor to that.