This Time is Different: A Look at the State of Emerging Market Debt


Charles Wilson, PhD

Lessons learned during the Asian financial crisis helped emerging economies properly prepare for today's currency volatility and drive future growth.

Headlines over the last few weeks have been filled with rising concerns about economic growth, which has translated into sharp declines in global equity and fixed income prices. High-yield debt and particularly energy-related credits continue to underperform in the face of potential bankruptcies from the oil patch. Many investors are trying to anticipate where the next shoe will drop and some are pointing to emerging market debt, the stock of which has grown substantially over the last five years. Yet the presumption that emerging markets and their debt loads represent a monolithic asset class is misguided.

Two questions should really drive the concerns:

  • Can emerging markets continue to service their existing debt in the event of an external shock?
  • Do they have the ability to stimulate growth through additional leverage at the government or household levels?

The short answer is yes to both. According to the Bank for International Settlements, debt-to-gross domestic product (GDP) in the major emerging markets has increased since 2010 an average of 22%. Despite the increase in total debt, external-debt-to-GDP in emerging economies has remained in the 25% range, as Figure 1 shows. That is well below the peak of nearly 40% seen in the late 1990's during the Asian financial crisis. As we learned from the Asian crisis, there are several reasons low levels of external debt are important for withstanding an external shock. First, compared to external debt, internal debt provides much greater flexibility to “pretend, amend, and extend” if necessary. Governments can get creative about terms and funding vehicles when trying to work out domestic bonds. Those options are often not available when dealing with international creditors. Second, with internal debt there is no currency mismatch, which can lead to debt servicing difficulties in the event of a rapid currency depreciation. This is exactly what happened to Thailand during the Asian crisis.

Emerging Market External Deb-to-GDP

Great—emerging markets are less likely to blow up. But can they use more leverage to stimulate growth in this low-growth world? Some countries can. In Figure 2, we show the components of total debt-to-GDP for a variety of developed and emerging markets. The numbers for total debt range widely, from 387% in Japan to 66% in Indonesia. It's worth noting the emerging markets have lower total debt-to-GDP than the three developed markets included in the table. It's also worth highlighting that several countries have very low total debt-to-GDP levels, particularly India, South Africa, Turkey, Russia, Mexico, and Indonesia. While the total debt number is an important indicator, the mix of debt likely has more impact on the flexibility of a country's growth model. Except for Hungary, all the emerging economies listed have government debt levels that are near or below the 60% level believed to limit growth based on several recent academic studies. All three developed markets top the list for highest-debt levels and exceed the recommended developed-market government debt-to-GDP threshold of 90%. Several names that stand out in terms of low government debt-to-GDP include Russia, Indonesia, Thailand, and Mexico. In terms of household debt, the differentiation between developed and emerging countries isn't quite as black and white. Korea, Malaysia, the United States, and Thailand top the list for highest debt levels, while Turkey, India, Mexico, Indonesia, and Russia again show some of the lowest debt levels.

Emerging Market External Deb-to-GDP

To be clear, low total-, government-, or consumer-debt levels are not a silver bullet for economic growth or equity performance. But they lend flexibility in times like this, when global growth is lagging. Countries with low overall debt can choose to stimulate through a wider range of mechanisms (fiscal or monetary). A country with a high consumer debt load may see less of a growth impulse from additional monetary stimulus if the consumer is unable to take on additional leverage. High levels of government debt can restrict the capacity to extend fiscal support if it restricts the government's ability to service its debt or increases the deficit further. Recognizing potential areas for future growth can be important in identifying well-positioned companies. For example, the Chinese government has been very vocal about transitioning its growth model from investment-led to consumer-driven. While China has a high overall debt burden, it has low leverage at the consumer level. Looking to the consumer makes sense for the Chinese growth strategy going forward, and makes it a great place to look for potential investment ideas. I recognize that I did not address the elephant in the room, China's total debt burden. Stay tuned for more on that next week. Happy Lunar New Year.

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