Rajesh Kumar
"The idea that deficits don't matter for countries that can borrow in their own currency I think is just wrong. I think that US debt is fairly high…and, much more importantly than that, it's growing faster than GDP (gross domestic product)," said Jerome Powell, Chairman of Federal Reserve in a testimony to the US Congress earlier this week. At a time when there are concerns about higher government deficit and rising level of debt in a country like the US, should financial markets not be worried about the increasing level of corporate debt? The answer is yes as it can pose risks to financial stability and global growth.
While the issue has been flagged by the International Monetary Fund among others in the past, a new paper by the Organisation for Economic Co-operation and Development (OECD) has again put the spotlight on global corporate debt. There are a number of findings that deserves policy and market attention.
First, the issuance of bonds by the non-financial corporate sector increased significantly in the aftermath of the global financial crisis. Compared to the annual average of about $ 864 billion in the years preceding the crisis, issuances went up to $1.7 trillion during 2008-2018. The biggest reason for this was the easy availability of money, owing to near zero interest rates and quantitative easing in advanced economies. Now that interest rates have been increased in the US and quantitative easing has ended in Europe, higher bond yields could put pressure on corporations, spread across the world, and affect global growth.
Second, bond issuances increased significantly in emerging market economies led by China. As the paper shows, Chinese issuances reached a high of about $ 600 billion in 2016 from a negligible level before the financial crisis. China used the debt-fuelled investment path to push growth. However, as the growth is slowing, concerns about the Chinese debt pile are rising. A sharp slowdown and the inability of companies to repay debt would affect the global economy in more ways than one. Aside from affecting global growth, capital flight from China could lead to higher volatility in global markets.
Third, it's not that only the stock of bonds has gone up significantly, the quality of issuances have also declined. The study has mapped even the composition of issuances. For instance, within the investment grade, the issuances of BBB rated bonds—one level above the non-investment grade—have increased. Downgrades could have a significant impact on liquidity and yields in a large part of the market. For instance, the paper notes: "Considering that the current stock of BBB rated bonds amounts to $3.6 trillion, this would be the equivalent of $274 billion worth of non-financial corporate bonds migrating to the non-investment grade market within a year. If financial companies are included, the number would rise to nearly $500 billion." Since a large number of institutional investors only hold investment grade bonds, yields could spike and make refinancing more difficult for a number of companies. This could affect economic activity and worsen a possible economic downturn.
Fourth, firms in both advanced and emerging economies will face significant redemption pressure in the near to medium term. In emerging markets, the study shows, the due amount will reach 47 percent of the total outstanding. In total, companies will need to pay back or refinance corporate bonds worth about $4 trillion in the next three years. Now that the search for yield has moderated with the US Fed raising rates and the ECB ending its bond-buying programme, refinancing can become difficult. Lower activity in lower-rated bonds in 2018 also suggests that the risk appetite among investors is ebbing.
Therefore, the build-up in the global corporate debt market is a risk for both the global financial system and the economy. A growth slowdown or higher yields could have a disproportionate impact on the bond market and worsen the outlook for the global economy. Also, global growth in the aftermath of the crisis was aided by debt, and deleveraging in various parts of the world could itself lead to a slowdown. So, the challenge for policymakers will be to make sure that the deleveraging happens in an orderly fashion.
So, where does India stand? India is also suffering from overleveraging in the corporate sector, which has significantly affected bank balance sheets and impeded growth in recent years. In terms of corporate bonds, the study shows that India’s share went up from 4 percent to 10.2 percent among emerging markets.
However, the bigger risk would be the spillover impact from global markets in case of a mishap. As the 2008 financial crisis showed, the global financial system is too interlinked and interdependent for a country like India to remain isolated.
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