The global economy is struggling under a mountain of debt and heading for a fresh financial crisis, the International Monetary Fund (IMF) has said.
Emerging market debt is chief among the “triad” of risks facing the globe, as these economies have over-borrowed by $3.3 trillion (£2.15 trillion) in the last decade, the IMF said in its twice-yearly Global Financial Stability Report.
Although the global crash was caused by debt, far from deleveraging, companies in emerging markets have taken the last six years of ultra-low interest rates in developed markets as an opportunity to borrow money cheaply. This “exceptionally accommodative” environment means private sector firms have jumped at the chance to leverage up, and their debt is now quadruple the level it was in 2004.
Non-financial firms have borrowed $18 trillion as of last year, compared with $4 trillion ten years ago.
Although some of this will be used by emerging markets for investment and thus economic growth, “the upward trend naturally raises concerns”, because financial crises tend to be precipitated by the rapid build up of debt.
The importance of emerging markets to the global economy should not be underestimated.
This was starkly illustrated this summer when China’s slowdown sparked a rapid unwinding in its stock market, followed by trillions being wiped off equities around the world. China’s unravelling then hit its neighbours’ currencies, with Malaysia, Thailand, Indonesia and even Kazakhstan suffering rapid falls.
“Vulnerabilities in emerging markets are important, given their significance to the global economy,” says Jose Vinals, director of the monetary and capital markets department at the IMF. “The recent financial market turmoil is a demonstration of this materialisation of risks.”
Now the key risk facing emerging markets is a reversal of this accommodative monetary policy in the west.
The organisation predicts rate rises could trigger a wave of defaults and tip the world into recession, wiping three per cent off global GDP. “Emerging markets must prepare for the implications of global financial tightening... and should prepare for an increase in corporate failures,” it said.
The IMF called on the US Federal Reserve to delay rate hikes and remain with loose policy to stave off the threat. Other key advanced economies, including the UK, Eurozone and Japan, should also stay with easy policy.
“Policy mis-steps and adverse shocks could result in prolonged global market turmoil that would ultimately stall the economic recovery,” says Vinals.
Alongside debt levels, the IMF also singled out lower market liquidity – because banks have pulled back from much of their pre-crisis trading – and non-performing loans in the Eurozone as other issues which need to be tackled.
The IMF is not alone in its economic warnings.
Total global debt issued by corporations and governments has grown by $57 trillion, according to data released by McKinsey earlier this year.
Its report, entitled Debt and Not Much Deleveraging, says the escalation in borrowing “poses new risks to financial stability and may undermine global economic growth”.
This escalation in debt was also the subject of the 16th Geneva Report, called Deleveraging? What Deleveraging? written by esteemed academics, including Morgan Stanley’s chief UK economist, Vincent Reinhart, and Brevan Howard’s head of global strategy, Luigi Buttiglione.
The McKinsey report details how corporate and government debt has increased consistently every year since 2010. This was following a brief pause while the world’s economies were in the throes of crisis.