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Beware the next Asian debt crisis

Rising US interest rates are starting to bite over-borrowed companies and households

| Southeast Asia

The U.S. Federal Reserve's latest interest hike this week is an uncomfortable reminder to Asian borrowers about the risks of financial complacency.

Businesses and households in the region have for too long appeared oblivious of the danger of a new debt crisis, despite growing warnings of such risks -- and the fact that even after two hikes already in 2018, the Fed is signaling there are more to come before the year is out.

Can Asian debtors have been lulled into a false sense of security by steps taken after the 1997 Asian crisis to prevent a recurrence, or is it just that debt crises are rarely foreseen until it is too late?

Corporate and personal debt has reached record levels around the world, including in Asia, in terms of absolute amounts of money involved. Moreover, in a number of Asian economies (China, South Korea and Japan stand out) the ratio of debt to gross domestic product is well in excess of that in most economies elsewhere.

Multilateral institutions, notably the International Monetary Fund, are sounding the alarm. But clear signs of distress are already evident closer to home.

In India, the government-owned State Bank of India, the largest lender, has just reported its biggest ever quarterly loss of $1.1 billion owing to bad loans. In China, bad loan ratios are low relative to those elsewhere but the government and state-controlled lenders have been cracking down heavily -- and publicly -- on companies seen as over-borrowed, such as property group Dalian Wanda Group.

These developments predate the upward run in U.S. interest rates, which is pushing up borrowing costs across Asia -- notably in Indonesia where the central bank has hiked rates to defend a fragile rupiah. Malaysia and the Philippines raised rates earlier in the year. India followed suit with an increase this month.

Across Asia, corporate borrowers are feeling the squeeze from rising borrowing costs. Investors in Asian companies' high-yield bonds are now demanding a 6.8% yield against 5.1% in January and the spread over U.S. high-yield bonds has widened to 0.7 percentage points from negligible levels. Emerging market borrowers, especially in China, South Korea and India, face high refinancing risks this year and next as debts are rolled over.

The Asian crisis should have made this region ultra-sensitive to the danger of debt crises. Instead, there seems to be an unwarranted degree of complacency that all is well, and debt continues to pile up, having surged especially in 2017.

Worldwide, debt reached a record $237 trillion by the end of 2017 according to the Institute of International Finance (IIF). Most of this ($174 trillion) is in advanced economies but emerging markets (in Asia especially) have been plunging ever faster and deeper into debt and that is why the IMF, the World Bank, and the IIF have all expressed concern lately.

In China,for example, gross corporate debt has soared to 166% of GDP -- and China's GDP is of course now the world's second largest after the U.S. In Japan and South Korea, the ratio is 100% of GDP. (Hong Kong and Singapore also have very elevated corporate debt ratios but that is partly because of the relatively small size of their economies).

Huge debt is not the sole prerogative of the corporate sector in Asia. Household debt has soared to 95% of GDP in South Korea, nearly 70% in Thailand and 68% in Malaysia according to the IIF. Debt is at more alarming levels as a proportion household income -- 180% in the case of South Korea for example, according to data from the Organization for Economic Cooperation and Development.

South Korea stands out too in terms of financial sector debt (82% of GDP) while in Japan the ratio is 145%, reflecting in part how Japan's banks have gone on an overseas lending binge, notably in Asia, to compensate for sluggish loan demand at home. Government debt in Japan has meanwhile hit 222% of GDP, matched only among other major economies by the U.K. at near 180%.

Debt liabilities are offset by assets. As far as companies are concerned, corporate cash balances are currently high in general, at least among large groups. But how much of this is freely available to potentially pay down debt varies among companies. Gross debt is not always an accurate indicator of the scale of the problem but it does signify vulnerability to interest rate rises especially when borrowing is in foreign currency.

South Korean corporates top the list of foreign currency borrowers in Asia on a GDP-relative basis with a ratio of 18.3%, closely followed by Malaysia at 18.1%, Thailand 11.4%, Indonesia 10.4% and India 9%. For China, however, the ratio of foreign currency borrowing is just 7.8%.

Some companies are already under financial pressure. In India, for example, Reliance Communications, a telecom operator, defaulted on its bank debt and subsequently on its dollar bonds during 2017.

Aircel, a rival, filed for voluntary bankruptcy in February this year. Both developments were triggered by erosion of revenues and profitability -- problems specific to an intensely -- competitive sector. But they highlight what happens when debt-laden companies run into operational problems.

Meanwhile, in China the commercial banks' nonperforming loan ratio is a fraction of the figure for India -- it steadied at 1.74% at the end of December, unchanged from the end of the third quarter, the China Banking Regulatory Commission said last month. But many analysts suspect Chinese banks are carrying much more bad debt than is disclosed.

As Asia marked the 20th anniversary of the Asian crisis last year, concerns were heard from some government officials and multilateral institutions that the region could be courting the risk of renewed crisis.

But these were assuaged by assurances that this time "things are different." Why are things supposedly different now? Because, it is argued, in 1997 many Asian business corporations had borrowed dollars to finance their business when their revenues were in local currency. When the dollar rose against Asian currencies, debt repayment at fixed exchange rates imposed a savage squeeze.

Nowadays, by contrast, companies have avoided heavy dollar-borrowing and using too many short-term loans to finance long-term investment. Governments have also built up much larger dollar reserves.

Some optimists argue too that the size of the current debt mountain (or "iceberg" as the IIF terms it) in Asia and elsewhere is not something to worry about in itself. It would only matter if interest rates were to rise far off their historic floor, and that is unlikely to happen anytime soon given the benign outlook for inflation.

These are only partial consolations, however. The very fact that interest rates are likely to remain subdued for now will very likely encourage businesses, households, financial institutions and governments to continue borrowing so long as economic activity holds. This means that the reckoning, when it comes, could be even costlier.

Debt is sustainable as long as revenues are healthy. Once they decline, the positive "gearing" effect of debt goes in to reverse, as the example of Indian telecoms highlights. A small capital base can support strong business activity if supplemented by debt but capital can shrink fast when fixed debt repayments have to be made from declining revenues. That is when crises are likely.

Why would business revenues erode? The upturn in global economic activity since early 2017 has been supported mainly by a recovery in world trade, and this rosy scenario is clearly under threat now from spreading trade protectionism led by U.S. President Donald Trump.

In this respect, too, Asia is more vulnerable than other regions, because of its deep dependence on trade with the U.S. If a trade war coincides with further increases in interest rates, the over-borrowed will be exposed. If there are enough such distressed debtors, the next crisis will be upon us.

Anthony Rowley is a Tokyo-based journalist who has been covering the Japanese economy and politics since 1993. He is a former business editor and international finance editor of the Far Eastern Economic Review, and a former Tokyo correspondent of the Singapore Business Times.

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