Global economics: $3 trillion corporate credit crunch looms as debtors face day of reckoning, says IMF
A poisonous “triad” of global risks is pushing the world to the brink of a new financial crisis, says stark IMF report
Governments and central banks risk tipping the world into a fresh financial crisis, the International Monetary Fund has warned, as it called time on a corporate debt binge in the developing world.
Emerging market companies have “over-borrowed” by $3 trillion in the last decade, reflecting a quadrupling of private sector debt between 2004 and 2014, found the IMF’s Global Financial Stability Report.
This dangerous over-leveraging now threatens to unleash a wave of defaults that will imperil an already weak global economy, said stark findings from the IMF’s twice yearly report.
The Fund warned there was no margin for error for policymakers navigating these hazardous risks.
The slightest miscalculation, they said, could collapse into a “failed normalisation” of interest rates and market conditions, wiping 3pc from the world’s economic output over the next two years.
But stretched corporate balance sheets were just one element of unprecedented “triad” of challenges facing the financial system, said the twice yearly report.
Seven years after the financial crisis, a combination of lingering debt burdens in advanced economies, and vanishing market liquidity could result in a new credit crunch when conditions tighten.
“Policy missteps and adverse shocks could result in prolonged global market turmoil that would ultimately stall the economic recovery,” said Jose Viñals, financial counsellor at the IMF.
The world’s major central banks should ensure policy remains “accommodative” for fear of setting off a new wave of instability that would see bond prices rise and asset prices collapse, said the IMF.
“Risk premia could decompress in a disorderly way causing a vicious cycle of firesales, redemptions, and more volatility,” said Mr Viñals.
The report called on the Federal Reserve to hold off on its first interest rate hike in nine years and for the authorities in the eurozone and Japan to continue with unprecedented stimulus measures.
“Managing any outbreaks in financial contagion will require nimble and judicious use of available policy buffers,” added the report.
The IMF painted a picture of a brittle financial system that was coming to the end of a period of cheap liquidity propped up by low rates.
These benign conditions are set to evaporate as the credit cycle tightens in emerging markets.
The summer’s stock market volatility and unprecedented outflows from emerging markets hint at the disruption that awaits markets, said the report.
“Some markets show clear signs that liquidity conditions have worsened and that accommodative monetary policy is masking underlying risks,” the report said.
“The challenge will be for abnormal market conditions to adjust smoothly to the new environment.”
China’s authorities will also have to put up with mass corporate bankruptcies and debt write-offs, said the IMF.
In the wake of its stock market collapse earlier this year, the report called on Beijing to embark on an “orderly deleveraging” by removing stabilisers artificially propping up its indebted companies.
“Moving decisively will ultimately prove less costly than trying to grow out of the problem.”
Although governments in the developing world had taken the right policy actions to strengthen their public finances and reduce external debt, leveraged banks and corporates could now drive them into the ground, said the report.
Sovereigns could then lose their investment grade status from ratings agencies, heaping more pressure on spiralling borrowing costs.
Last month, Latin America’s biggest economy, Brazil, was “junked” by Standard & Poor’s rating’s agency.
This cocktail of financial risks is compounded by an environment of anaemic growth. The IMF forecasts global output will fall to its lowest level in five years at just 3.1pc this year.
“Low nominal growth would put pressure on debt-laden sovereign and private balance sheets, raising credit risks,” said the report.
“Corporate default rates would rise, particularly in China, raising financial system strains, with implications for growth.
“Some markets show clear signs that liquidity conditions have worsened and that accommodative monetary policy is masking underlying risks.”
In a bid to manage the transition, the IMF urged authorities to play closer attention to the asset management industry and beef up capital requirements for emerging market banks.
In Europe, EMU authorities should press ahead with their plans for a banking union to plug the architectural gaps that have undermined the future of the single currency.
“What we want to achieve is a successful normalization of financial conditions and monetary policies together with a sustained economic recovery”, said Mr Viñals.
“Three percent of global output is at stake”.