Global Deleveraging – Using dulcet tones, a Morgan Stanley report on global debt and deleveraging notes progress but warns against a rapid expansion of the interest rate tightening cycle. As a result, don’t expect much more than a “tepid recovery in private demand.” What to watch is the debt deleveraging relative to economic growth as well as debt to GDP ratios that could “pose financial stability risks.”
US households are pulling out of their balance sheet recession, but corporate debt grows
With debt to GDP ratios continuing to climb – the US ratio is near 104%, up from 64.8% in 2007 – the Morgan Stanley report looks at different measures to determine the success of deleveraging.
Given this as the metric, the September 21 report from Morgan Stanley Economists Chetan Ahya, Elga Bartsch and Jonathan Ashworth points to a developed market making progress.
“Households in the US appear to be the first troubled entity to be showing signs that they are moving out of the balance sheet recession phase,” the report noted. “However, there are still signs that the deleveraging cycle has not run its full course.”
While the private balance sheets have shed excess leverage, corporates, in a low interest rate world, are levering up, the report noted:
The US, which was the epicentre of the global financial crisis,has made significant progress and is close to getting out of the balance sheet recession. Indeed, private sector debt/GDP had bottomed in 2013, driven by an increase in the corporate sector’s leverage. More importantly, in 2Q16,household debt growth outpaced nominal GDP growth for the first time since the global financial crisis. While these developments are encouraging, the recent slippage in corporate debt growth and the rise in its saving have meant that the transition is not fully complete.
After growing dramatically following the 2008 financial crisis, the more common government debt to GDP ratio has been rising recently at between one to two percent per year, putting it on a more traditional arch.
Global Deleveraging – Developed markets are culling back leverage, but emerging markets are spending gratuitously
In emerging markets debt to GDP are growing at a more frenetic pace.
The high and rising leverage in China, Korea and Thailand in particular are on Morgan Stanley’s radar, with the report pointing to an increasingly common word among bond analysts, “shock.”
Shock might be used to describe debt to GDP levels in China, standing at 273%, Korea, 287%, and Thailand at 229%.
“The build-up of debt in these economies has been unproductive, though the current macro set-up and policy preferences should mean that policy-makers can still control liquidity conditions and prevent an immediate financial shock,” the report said. Chinese debt in particular has risen to unsustainable levels, as previously noted in ValueWalk, as analysts have discussed state-owned enterprises (SOEs) with a particular note of concern.
Specifically, the report states regarding China:
Indeed, China’s leverage pick-up in recent years has been stark, when judged by its own historical trend and also on a comparative basis globally. Policymakers continued to opt for a gradual adjustment process in addressing the leverage issue as they have not allowed for aggressive defaults in the financial system, thereby implicitly allowing the low returns on investment to go on for longer. In the meantime, excess capacity has resulted in deteriorating returns, inhibiting private sector risk attitudes and investment. To offset the weakness in growth, policy-makers have embarked on fiscal stimulus and lifted public fixed asset investment higher, which, in an environment of excess capacity, has led to a continued deterioration in productivity of incremental credit, taking debt/GDP ratios higher.
What is the answer in a world gone awry in debt? Keep interest rates low so those debt servicing payments don’t eat up too much of a government budget.
To keep the economy moving right along, “policy-makers will still need to maintain accommodative policies to prevent a relapse,” the report said. “It is not yet time to lower the guard against balance sheet recession dynamics. The point is to avoid a “relapse back into a more adverse balance sheet recession environment.”