We have seen the emerging markets (EM) get hammered as of late, along with their currencies as government balance sheets have worried investors. Then there are the corporate balance sheets, the one that should really worry investors.
Over the last few weeks, currencies in Argentina, Turkey and South Africa have fallen off sharply. This has caused wide spread selling across the emerging markets. The markets of India, Indonesia, Turkey and Brazil, also known as the Fragile Five have been hit the hardest.
Is There a Traditional EM Crisis in Play?
The fear of a tradition EM crisis might be misplaced to say the least. All these countries have related problems. Huge current account deficits, foreign exchange reserves, exchange rate valuations, and sovereign debt to GDP ratio however, we can add one more factor that can make things worse. The repayment schedules of corporate borrowers. This could be what matters the most.
We have seen more and more corporate debt being issued in EM than ever before. It is now estimated that nearly 1.2 percent of EM GDP’s are corporate debt. In 2010 this valuation stood at 0.69 percent. The Bank of International Settlements (BIS) has also shown EM issuance of corporate bonds to have skyrocketed. In 2013 we saw $335.65 billion of corporate debt issued. In 2010 this figure stood at $151.6 billion. The average credit quality in the emerging markets is deteriorating.
There have been some positives as EM governments have avoided mistakes that jumpstarted the previous crisis. They have not issued huge amount of debt of their own currencies. Corporations in the EM have also been issuing debt in international markets as well as their own.
Corporate Debt Growth is Worrisome
It is this growth, sharp spike in debt that has many worried. By allowing this to happen companies are increasing their exposure to foreign exchange risks. As developed markets and economies begin to raise interest rates and ease the throttle on quantitative easing (QE) we will see downside pressures on EM currencies evolve and accelerate. This will increase the amount of local currency to pay off the servicing dollar debt.
This could cause corporations, thanks to maturing obligations, to borrow more and more local currency to pay down foreign debt which in turn will dampen, even further, EM currencies. This in turn will make monetary policy decisions even harder on their central banks.
We have seen EM equities stabilize over the last week or so, after their sharp selloff, but the risk for even further damage remains. The problem of EM offshore borrowing will have continued impact exchange rates which will impact policy rate decisions. This could lead to equities being influenced and not in a positive way. The bottom line, it is all about refinancing risks and borrower solvency.