“Sustainable debt dynamics” – Asia private sector credit

The key chart

Summary

In “The Changing Face of Global Debt”, I argued that global finance was shifting East and towards emerging markets. In this post, I summarise my analysis of the sustainability of current Asian PSC trends. The key points:

• Classifications of Asian economies as either “advanced” or “emerging” economies are over-simplistic and unhelpful
• Relative growth factor (RGF) analysis provides a simple, first tool for assessing the sustainability of debt dynamics
• The risks associated with “excess credit growth” across EM are much lower than in previous cycles
• The striking feature in Asia, however, is the fact that the highest levels of “excess credit growth” have occurred in economies that already exhibit high debt levels (Hong Kong, China, Korea and Japan)
• In Hong Kong and China, these risk are compounded by debt service ratios that are close to peak levels and well above LT averages (“affordability risk”)
• RGF-related risks appear relatively low in Asia’s two large and “genuine emerging markets” – India and Indonesia
• Relatively high excess HH growth rates in India and China remain a key focus point.

Time for new classifications?

The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and New Zealand) and eight “emerging” economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).

Such broad classifications are unhelpful, at best, and inaccurate, at worst. The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to HH (Australia and New Zealand) and NFC (Japan) debt dynamics.

The grouping of China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand together as emerging economies is more troublesome as it ignores the wide variations in market structure, growth opportunities, risks and secular challenges.

I prefer to consider China, Korea, Hong Kong and Singapore as unique markets. China is unique in terms of the level, structure and drivers of debt and in terms of the PBOC’s policy responses. Korea is unique in terms of having NFC and HH debt ratios that exceed both advanced economy averages and the BIS thresholds above which debt becomes a drag on future growth. Hong Kong and Singapore are both distinguished by their roles as regional financial centres but have different HH debt dynamics.

Malaysia and Thailand can be considered intermediate markets given that either both HH and NFC debt ratios (Malaysia) or one debt ratio (Thailand HH) exceed the average for emerging markets ex China. This leaves India and Indonesia as genuine emerging markets among the BIS reporting economies, with debt ratios below the emerging markets ex China average and well below BIS threshold levels (see Figure 2 above).

RGF analysis – “excess credit growth”

The theory

I have used the simple concept of relative growth factor (RGF) analysis since the early 1990s as a first step in analysing the sustainability of debt dynamics. In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy.

The three year CAGR in debt is compared with the three year CAGR in nominal GDP to derive a relative growth factor. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).

The concept is simple – one would expect relative high rates of “excess credit growth” in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage.

Low average risk in EM

Figure 3 above, illustrates rolling 3-year RGF trends for EM economies highlighting previous unsustainable levels that peaked in 1Q04, 3Q09, 4Q11 and 2Q15. The current excess growth rate of 1.3% suggests, however, that EM sustainability risks are relatively low. If anything, the lack of growth/slowing growth are more immediate challenges

How does Asia stand out?

Spotlight on Asia’s unique markets

A striking feature across Asia has been that some of the fastest rates of excess credit growth have occurred in economies where debt levels are already very high – Hong Kong, China, Korea and Japan (see Figure 4 above).

The level of excess credit growth is already slowing sharply in Hong Kong and China from peak levels in excess of 6% (Figure 5). With debt service ratios in both economies close to peak levels and well above LT averages (Figures 6 and 7) a return to recent periods of excess growth is (1) unlikely and/or (2) would be associated with high levels of risk.

In contrast, Japanese PSC growth is recovering from sustained periods of deficient credit demand, helped by relatively low debt service ratios that are well below their LT averages (Figure 8 below). The recent uptick in excess Korean growth is unlikely to be sustainable, however, given that both HH and HFC debt levels are above BIS thresholds (Figure 2 above)

Asia’s intermediate and emerging markets

RGF factors for intermediate and emerging Asian markets indicate relatively low levels of sustainability risk. Both India and Indonesia have been through periods of adjustment from previous phases of excess credit growth.

In the former case, there are very different dynamics between the rapidly growing HH and slow growing NFC sector. The risks associated with excess credit growth in the HH sector (from a low base) are rising but remain relatively low in the NFC sector which is still in an adjustment phase.

Indonesia’s growth rates have adjusted from the 2000-14 period of “super-charged” growth which was driven largely by exogenous factors including the commodities super-cycle and portfolio inflows during the period of global QE and record low US interest rates.

In summary, the risk associated with excess credit growth across EM are lower than in previous cycles. Asia stands out, however, because the highest rates of growth have occured in economies that already have high debt ratios. In China and Hong Kong, these risks are compounded by high debt service ratios indicating rising “affordability” risks. RGFs in both economies are adjusting sharply lower in response. Risks in intermediate and emerging Asian economies appear lower, but the relatively high excess HH growth rates in India and China remain a key focus point.

Please note that the summary comments above are abstracts from more detailed analysis that is available separately.