LONDON (Reuters) - The global economy is being hit by a slowdown in growth, large swings in exchange rates and tumbling commodity prices.
These three factors are often portrayed as separate “shocks” but should really be seen as manifestations of the same maturing financial and economic cycle.
The case for a single interconnected adjustment was made by Jaime Caruana, general manager of the Bank for International Settlements (BIS) on Friday (“Credit, commodities and currencies” BIS, Feb 5).
The BIS, nicknamed the central bankers’ central bank, has long worried about growing indebtedness in the global economy and the links between credit conditions, borrowing and growth.
But Caruana highlighted the rapid increase in indebtedness by private sector, non-financial borrowers in emerging markets.
Private non-financial sector debt in emerging market economies has increased from 75 percent to 125 percent of GDP since 2009.
Borrowing by non-financial companies in emerging markets now represents a higher proportion of GDP than in advanced economies.
Corporations in emerging markets have been raising their leverage even as their profitability has been falling in recent years.
Much of the borrowing has been conducted in U.S. dollars and was made possible by low interest rates in the United States and the relative weakness of the U.S. currency.
The BIS found a “strong association between the strength of the dollar and the dollar-denominated borrowing by emerging market economy borrowers.”
“A 1 percent depreciation of the U.S. dollar is associated with a 0.6 percentage point increase in the quarterly growth rate of U.S. dollar-denominated cross border lending outside the United States.”
Until 2011, the steady depreciation of the U.S. dollar supported emerging market corporate borrowing. The U.S. currency has been appreciating gently since then, but remained relatively weak.
But since the end of September 2014, the U.S. currency has surged higher, and cross-border dollar lending has stalled.
The stock of dollar-denominated debt of non-bank borrowers outside the United States stopped growing in the third quarter of 2015 for the first time since the global financial crisis.
“Global liquidity conditions may have peaked for the time being in emerging economies,” Caruana warned.
Some of the dollar borrowing has been used to fund the acquisition of local currency assets, which creates an additional source of currency mismatch risk.
The weakening dollar also flattered corporate balance sheets in emerging markets (and in many advanced economies too) but that former source of strength has now gone into reverse.
Stronger balance sheets in turn made it possible for emerging market corporations to contract more loans since it apparently gave them spare capacity to borrow more, but again the process is now going into reverse.
OIL AND GAS LENDING
Oil and gas companies were among the biggest borrowers during the boom years, according to an analysis by the BIS.
The outstanding stock of oil and gas companies’ bonds increased from $455 billion in 2006 to $1.4 trillion in 2014, a compound annual increase of 15 percent.
Syndicated loans to oil and gas companies increased from $600 billion to $1.6 trillion over the same period, an annual increase of 13 percent.
Not all the money went to oil and gas companies in emerging markets, but a “substantial portion” was lent to state-owned enterprises in developing countries, according to the BIS (tmsnrt.rs/1TNRctx).
Borrowing by oil and gas companies rose at an annual rate of 25 percent in Brazil, 31 percent in China and 17 percent in other emerging markets.
Emerging market oil companies “were particularly active in issuing bonds through offshore subsidiaries,” according to the BIS.
“In many instances, the dollar borrowing by emerging market economy oil firms coincided with large dividend payments to their sovereign owners, directly contributing to the budget”.
Now emerging market borrowers are caught in a feedback loop created by increased debt, a rising U.S. dollar, tightening credit conditions and falling commodity revenues.
The huge shock to emerging markets is being transmitted from one to another, because emerging markets are often each other’s largest trading partners, as well as back into the advanced economies via trade and financial channels.
As the BIS concludes: “Rather than being regarded as separate exogenous shocks, the combination of disappointing growth, large adjustments in exchange rates and falls in commodity prices is better seen as a set of outward manifestations of the combination of maturing financial cycles, this time in a number of emerging economies, and shifts in global financial conditions.”
(John Kemp is a Reuters market analyst. The views expressed are his own)
Editing by Alexander Smith
Our Standards: The Thomson Reuters Trust Principles.