Higher debt loads and lower debt servicing capacity make corporates in emerging markets more sensitive to tighter external financing conditions and to a potential reversal of capital flows that could trigger a rise in borrowing costs and a drop in earnings, according to the International Monetary Fund's latest Global Financial Stability Report.
The IMF has conducted an in-depth analysis of emerging market corporate balance sheets, focusing on the share of corporate debt held by weaker, highly leveraged firms, known as “debt at risk”. In a severe and adverse scenario, where borrowing costs escalate and earnings deteriorate significantly, debt at risk could increase by $740 billion, to 35 percent of total corporate debt in the sample.
The impact of any shock could be magnified by a growing “systemic liquidity mismatch.” For example, in some local-currency sovereign bond markets where foreign investors now play a greater role, there is now a stark contrast between the potential scale of capital outflows and the diminished capacity and willingness of international banks to intermediate these flows. This mismatch could magnify the impact of any shock and broaden the impact on asset prices across countries.
"Policymakers in emerging markets need to maintain credible macroeconomic policy frameworks and buffers. They also need to take prudential measures to safeguard both banks and nonbanks. This is particularly relevant in China, where the growth in non-bank lending has boosted corporate leverage," says the IMF.
The Global Financial Stability Report also calls for additional measures to speed up the resolution of nonperforming loans and to improve corporates’ access to credit.
• Policymakers should increase incentives for bank provisioning and write-offs, reform legal frameworks to facilitate timely resolution, and promote a secondary market for nonperforming loans.
• Market regulators could also facilitate the listing of high-yield bonds by smaller corporates, and policymakers should reassess the regulatory impediments to the securitization of loans.
The resulting strengthening of bank and corporate balance sheets should help reinforce the improved optimism in financial markets, and improve the flow of credit to support the recovery.
According to the IMF, investment from advanced economies into EM bonds reached an estimated US$1.5 trillion by the end of 2013. EM corporate debt tripled between 2009 and 2013, with debt levels in countries such as China, Hungary and Malaysia reaching or exceeding 100% of gross domestic product (GDP).