Ten years after the 2008 financial crash, soaring foreign currency debt is endangering financial markets. It has already caused problems in emerging markets this year, states the Bank For International Settlements (BIS) latest quarterly report.
Companies and governments around the world have raised their dollar foreign debt from $6 trillion in 2008 to $11.4 trillion in 2018, estimates the BIS. Euro and yen debt have also surged. The currencies converted into US dollars add a further US$3.1 trillion. Total global foreign currency borrowings–mainly bonds and loans–thus amounts to $14.7 trillion. Balance sheet debt, however, isn’t the entire story. Foreign exchange and credit swaps off balance sheets, boost the total to $27.4 trillion (see calculation below).
Turbulence and financial crash dangers
The BIS says that the US is diverging from Europe and Asia as its equity market has been booming. The question is how long will the performance gap last?
“Further turbulence is likely at some point given that markets in advanced economies are overstretched, financial conditions are too easy and global debt is too high,” said Claudio Borio, Head of the BIS’ Monetary and Economic Department. “Interest rates are unusually low and central banks’ balance sheets are still bloated as never before. So there is little left in the medicine chest to nurse the patient back to health or care for him, in case of a relapse.”
The strength of the US dollar has aggravated problems for borrowers. In particular, it has hurt emerging market companies and governments. They have to find more devalued local currency to pay interest and repay loans in the US currency.
Emerging markets under stress
“Since late March, the cumulative valuation losses on many emerging nation asset classes and currency exposures have been substantial. In some respects, they have exceeded losses during the taper tantrum in 2013. They have also come close to the downturn following the renminbi depreciation in August 2015,” Mr Borio said. “US dollar lending to non-bank emerging market economy residents has more than doubled since the Great Financial Crisis (GFC), to some US$3.7 trillion.” Including yen and euro debt, the total is equivalent to $4.6 trillion.
The impact of swaps on global corporate liabilities
Even though those numbers are huge, they are only part of the exposure. Foreign debt liabilities are an underestimate, the BIS says in a separate paper FX swaps and forwards: missing global debt?
“Every day, trillions of dollars are borrowed and lent in various currencies,” the BIS study states. “Many deals take place in the cash market, through loans and securities. But foreign exchange derivatives, mainly FX swaps, currency swaps and the closely related forwards, also create debt-like obligations.”
“A key finding is that non-banks outside the United States owe large sums of dollars off-balance sheet through these instruments. The total is of a size similar to, and probably exceeding, the $11.4 trillion on-balance sheet dollar debt. Even when this debt is used to hedge FX risk, it can still involve significant maturity mismatches.” Some 90 per cent of the swaps market is in dollars, the BIS finds. The remaining 10 per cent swaps in euro, yen and other currencies can be estimated at $1.3 trillion.
Total global foreign exchange debt can thus be calculated as $14.7 trillion on balance sheets plus $11.4 trillion dollar swaps and $1.3 trillion euro and yen swaps off balance sheets. The total state and corporate foreign exchange debt exposure can thus be assessed as$27.4 trillion.
“This surge has been part of a broader expansion of international credit to non-banks,” Mr Borio said. “It is a key indicator of global liquidity, which rose from 33 per cent to 38 per cent of global GDP between the first quarters of 2015 and 2018. Moreover, bank loans lost ground to securities.”
Negative Implications of Zombie Companies
The BIS also has a paper on The rise of zombie firms: causes and consequences. Economists Ryan Banerjee and Boris Hofmann examine the prevalence, causes and consequences of unprofitable firms that still manage to survive. The term “zombie” has become fashionable to denote such firms. The authors, however, refine the definition to focus the question more sharply. They examine firms with interest payments that exceed their profits. Another zombie indicator is a share price that consistently lags its sector’s median.
The authors sampled 32,000 firms from 14 advanced economies. They found that about 6 per cent or around 2,000 of the companies fell into the zombie category. The authors found that the “prevalence of zombie firms has ratcheted up since the late 1980s, tending to rise in recessions but not fully falling back to previous levels during recoveries”.
A key reason for zombie company resilience is that low-interest rates have reduced financial pressures. The greater number of zombie firms, however, caused overall corporate productivity to decline. This, in turn, dampened economic growth.
© Copyright Neil Behrmann
Neil Behrmann is London correspondent of The Business Times. Jack of Diamonds his thriller on global diamond mining and smuggling, has recently been published. It is the sequel to the thriller, Trader Jack, The Story of Jack Miner.
See reviews of both books on: https://www.amazon.co.uk/Neil-Behrmann/e/B005HA9E3M