High debt levels have left some of Asia’s biggest economies exposed to a surge in interest rates. With the U.S. Federal Reserve pressing ahead with rate hikes, is Asia’s growth outlook threatened?
On June 14, the U.S. Federal Reserve raised its key interest rate for the third time in six months, citing a strengthening domestic labor market and higher economic activity. The increase in the target range for the federal funds rate to 1 to 1.25 percent came despite inflation staying below the Fed’s 2 percent target, with the central bank projecting only “gradual increases” in the rate, including another 0.25 percentage point rise in 2017.
Asian financial markets have shown a relatively calm response to the Fed’s long-expected tightening, with funding costs in Asia staying relatively low. However, the risks are rising with every increase, including in some of the region’s major economies, according to HSBC analysts Frederic Neumann and Abanti Bhaumik.
The United States and China, the world’s two biggest economies, have swapped positions concerning private non-financial sector debt since 2007, with U.S. debt declining and China’s escalating. China’s total private non-financial debt has now swollen to 19 percent of gross domestic product (GDP) compared to the U.S. level at around 13 percent, while debt servicing costs (the sum of principal and interest repayments) have risen to around 20 percent in China but are below 15 percent in the United States.
Both economies have benefited from interest rates remaining low; however, any sudden increase would have a major impact on their debt servicing costs.
For the Asia-Pacific region, the analysts found that when comparing the percentage of total income required to service each nation’s debt, some of the largest economies are at risk of a blowout.
Hong Kong topped the field with a debt servicing ratio of nearly 26 percent, followed by Australia at 21 percent, and China and South Korea at around 20 percent. Japan’s was at 14 percent, while Myanmar’s stood at around 13 percent, Thailand at 10 percent, and India at 7 percent.
By comparison, the peak debt servicing ratio for Spain in the lead-up to the global financial crisis (GFC) was around 24 percent, with Britain and the United States below 20 percent.
The analysts said Hong Kong’s high level was “partly because it is a regional financial center and therefore not necessarily comparable.”
However, Australia’s debt is currently at a historically high level, with gross government debt recently reaching A$500 billion (US$378 billion), rising to an estimated A$600 billion by 2021.
Credit-rating agency Moody’s recently downgraded its ratings for Australia’s “big four” and other banks, citing “elevated risks within the household sector [which] heighten the sensitivity of Australian banks’ credit profiles to an adverse shock.” It pointed to rising household indebtedness, particularly in the nation’s two biggest cities of Sydney and Melbourne, which have seen “significant” house price appreciation and resulting higher borrowings.
China’s total debt level has been estimated at exceeding 260 percent of GDP, up from 163 percent in 2008 and outpacing the surge in U.S. and British debt before the GFC. Moody’s downgraded China’s sovereign credit rating recently, citing concerns over its growing indebtedness, much of it held by state-owned enterprises.
Explaining its decision, Moody’s said: “While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government.”
South Korea has also seen a surge in household debt, currently more than 90 percent of GDP, on the back of a housing boom that has increased the number of households at risk of default. According to the Bank of Korea, debt-to-disposable income at South Korean households was at 153 percent in the first quarter 2017, with 60,000 households seen vulnerable to default should rates rise by just 1.5 percentage point.
Yet despite the Fed’s tightening, Asian financial markets have remained relatively calm, with strong portfolio investment inflows continuing in recent months, according to ANZ Research.
“Asian central banks are unlikely to follow the Fed in hiking rates. Core inflation has remained benign across the region, and we see the possibility of headline inflation numbers grinding lower on the back of retreating commodity prices. In addition, the strong export rebound this year looks to have peaked and a moderation may take place over [second half] 2017,” the Australian bank’s economists said in a June 16 report.
ANZ said China’s central bank might even need to inject net liquidity of 1.1 trillion yuan ($160 billion) to “stabilize corporate funding costs” as the Chinese economy slows.
The Asian Development Bank (ADB) has also noted a continued downward trend in bond yields in emerging East Asia between March and May. Indonesia experienced the largest fall in yields as it benefited from positive investor sentiment and a credit rating upgrade, although bond market issuance slowed in China “amid debt concerns and the Chinese government’s associated deleveraging efforts.”
However, the ADB noted upcoming risks for East Asian bond markets despite favorable macroeconomic conditions, including “tightening global liquidity conditions and the vulnerability of financial markets to cyberattacks.”
Nevertheless, in April, the Philippines-based bank pointed to rising economic growth in two-thirds of developing Asia, supported by stronger external demand, rebounding commodity prices, and domestic reforms, making the region the largest single contributor to global growth at 60 percent. The ADB sees GDP growth in Asia and the Pacific reaching 5.7 percent in 2017 and 2018, only a slight drop from the 5.8 percent recorded last year.
“Developing Asia continues to drive the global economy even as the region adjusts to a more consumption-driven economy in [China] and looming global risks,” said Yasuyuki Sawada, ADB’s chief economist. “While uncertain policy changes in advanced economies do pose a risk to the outlook, we feel that most economies are well positioned to weather potential short-term shocks.”
Yet should Asia eventually join the United States in “normalizing” monetary policy, the relative calmness could quickly evaporate.
Former World Bank head Robert Zoellick has cited two major risks that could trigger the next financial crisis: “an exit from extraordinary monetary policy and cybersecurity,” according to the Nikkei Asian Review.
With the Fed, the European Central Bank, and the Bank of Japan all attempting to gradually exit “ultra-easy” policy, any miscalculation could have a damaging impact. Meanwhile, “cybersecurity can also easily cause a crisis in today’s financial markets, given the vast amounts of data being transferred every second,” the Japanese financial daily said.
For Asia’s biggest debtors, reducing vulnerabilities to any such crisis should be a priority, some 20 years after the Asian financial crisis and just 10 years since the GFC inflicted widespread losses.