Tweet
'Uneasy' market calm masks debt timebomb, BIS warns
Bank for International Settlements (BIS) warns of emerging market vulnerabilities as investors remain hooked on "every word and deed" of central banks
The lightning flashes over the statue of Christ the Redeemer at Corcovado hill in Rio de Janeiro, Brazil Photo: AFP
By Szu Ping Chan
11:00AM GMT 06 Dec 2015
Follow
Comment
The "uneasy calm" in financial markets could rapidly reverse as the US Federal Reserve's first tightening cycle in a decade exposes fragilities in the new world order, according to the Bank for International Settlements (BIS).
The central bank watchdog said emerging market households and businesses reliant on cheap debt faced a credit crunch that could trigger panic in a world of evaporating liquidity and fewer market makers.
The BIS noted that that potential for spillovers in emerging markets from tighter US monetary policy and higher US Treasury yields was higher now than in 2013 It warned that the "potential for spillovers" to emerging markets from higher US interest rates was larger now than it was during the so-called "taper tantrum" in 2013.
BIS data show the stock of dollar denominated debt rose to $9.8 trillion (£6.5 trillion) in the second quarter of 2015, with dollar credit to borrowers in emerging markets doubling since 2009 to more than $3 trillion.
Tighter US policy and a stronger dollar would highlight financial vulnerabilities among domestic and foreign currency borrowers, the BIS said. According to the watchdog, total non-financial corporate debt in emerging markets, including dollar borrowing, currently stands at $23.5 trillion.
"Weaker financial market conditions combined with an increased sensitivity to US rates may heighten the risk of negative spillovers to emerging market economies when US policy is normalised," the BIS warned in its quarterly report.
Fed policymakers are widely expected this month to raise interest rates in the world's largest economy for the first time since 2006.
"Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years."
BIS quarterly report
The BIS noted that markets had quickly recovered from this summer's stock market sell-off, while volatility had declined despite expectations of imminent tightening.
"On the face of it, the turbulence turned out to be more like a brief summer storm than autumn thunder heralding the arrival of a long winter," said Claudio Borio, head of the economic department at the BIS.
However, Mr Borio also highlighted the "perennial contrast" between "hectic" financial markets and the slow burn of "deeper economic forces that really matter".
The BIS said debt and debt servicing ratios in the so-called BRICS of Brazil, Russia, India, China and South Africa had climbed to levels that traditionally signalled financial crises, despite the low interest rate environment.
Debt service ratios have soared in the BRICS
"Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years," the BIS said.
Financial vulnerabilities had far from "gone away", said Mr Borio, who said investor reaction to the European Central Bank's (ECB's) latest stimulus plan showed markets remained hooked on "every word and deed" of central banks.
Expectations of further ECB easing had led traders to place that bets on the euro that caused huge market swings when the central bank was perceived as failing to deliver.
"Against this backdrop, it is hard to imagine how the calm could be anything but uneasy. There is a clear tension between the markets’ behaviour and underlying economic conditions.
"At some point, it will have to be resolved. Markets can remain calm for much longer than we think. Until they no longer can," said Mr Borio.
Analysis published by the BIS suggested total non-bank dollar denominated debt in emerging markets could be around $600bn higher than its official estimate of $3.8 trillion because BIS data do not take into account forward sales of dollars.
The authors also highlighted key differences in dollar borrowing in emerging markets, suggesting some countries were more exposed to a rising dollar than others.
For example, policymakers in Korea enacted laws in 2010 that encouraged dollar bonds over dollar bank loans, which have a longer maturity than interbank deposits. This reduced the risk of "sudden massive outflows" seen in previous years.
The International Monetary Fund (IMF) warned in October of a looming corporate credit crunch in emerging markets.
A quadrupling in total corporate debt to $18 trillion in the decade to 2014 had been accompanied by weaker balance sheets, making companies more vulnerable to US rate rises.
Bank for International Settlements (BIS) warns of emerging market vulnerabilities as investors remain hooked on "every word and deed" of central banks
The lightning flashes over the statue of Christ the Redeemer at Corcovado hill in Rio de Janeiro, Brazil Photo: AFP By Szu Ping Chan
11:00AM GMT 06 Dec 2015
Follow
Comment The "uneasy calm" in financial markets could rapidly reverse as the US Federal Reserve's first tightening cycle in a decade exposes fragilities in the new world order, according to the Bank for International Settlements (BIS).
The central bank watchdog said emerging market households and businesses reliant on cheap debt faced a credit crunch that could trigger panic in a world of evaporating liquidity and fewer market makers.
The BIS noted that that potential for spillovers in emerging markets from tighter US monetary policy and higher US Treasury yields was higher now than in 2013 It warned that the "potential for spillovers" to emerging markets from higher US interest rates was larger now than it was during the so-called "taper tantrum" in 2013. BIS data show the stock of dollar denominated debt rose to $9.8 trillion (£6.5 trillion) in the second quarter of 2015, with dollar credit to borrowers in emerging markets doubling since 2009 to more than $3 trillion.
Tighter US policy and a stronger dollar would highlight financial vulnerabilities among domestic and foreign currency borrowers, the BIS said. According to the watchdog, total non-financial corporate debt in emerging markets, including dollar borrowing, currently stands at $23.5 trillion.
"Weaker financial market conditions combined with an increased sensitivity to US rates may heighten the risk of negative spillovers to emerging market economies when US policy is normalised," the BIS warned in its quarterly report.
Fed policymakers are widely expected this month to raise interest rates in the world's largest economy for the first time since 2006.
"Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years."
BIS quarterly report
The BIS noted that markets had quickly recovered from this summer's stock market sell-off, while volatility had declined despite expectations of imminent tightening.
"On the face of it, the turbulence turned out to be more like a brief summer storm than autumn thunder heralding the arrival of a long winter," said Claudio Borio, head of the economic department at the BIS.
However, Mr Borio also highlighted the "perennial contrast" between "hectic" financial markets and the slow burn of "deeper economic forces that really matter".
The BIS said debt and debt servicing ratios in the so-called BRICS of Brazil, Russia, India, China and South Africa had climbed to levels that traditionally signalled financial crises, despite the low interest rate environment.
Debt service ratios have soared in the BRICS"Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years," the BIS said.
Financial vulnerabilities had far from "gone away", said Mr Borio, who said investor reaction to the European Central Bank's (ECB's) latest stimulus plan showed markets remained hooked on "every word and deed" of central banks.
Expectations of further ECB easing had led traders to place that bets on the euro that caused huge market swings when the central bank was perceived as failing to deliver.
"Against this backdrop, it is hard to imagine how the calm could be anything but uneasy. There is a clear tension between the markets’ behaviour and underlying economic conditions.
"At some point, it will have to be resolved. Markets can remain calm for much longer than we think. Until they no longer can," said Mr Borio.
Analysis published by the BIS suggested total non-bank dollar denominated debt in emerging markets could be around $600bn higher than its official estimate of $3.8 trillion because BIS data do not take into account forward sales of dollars.
The authors also highlighted key differences in dollar borrowing in emerging markets, suggesting some countries were more exposed to a rising dollar than others.
For example, policymakers in Korea enacted laws in 2010 that encouraged dollar bonds over dollar bank loans, which have a longer maturity than interbank deposits. This reduced the risk of "sudden massive outflows" seen in previous years.
The International Monetary Fund (IMF) warned in October of a looming corporate credit crunch in emerging markets.
A quadrupling in total corporate debt to $18 trillion in the decade to 2014 had been accompanied by weaker balance sheets, making companies more vulnerable to US rate rises.