Category: Asia (Emerging)

“Update required – Part II”

Five economies to watch – elevated private sector debt risks

The key chart

Trends in selected economies’ private sector debt ratios (% GDP)
(Source: BIS; CMMP)

The key message

While the private sector is deleveraging (passively) at the global level, elevated risks remain in Sweden, France, Korea, China and Canada. Unfortunately, these risks may be overlooked in a world that sees public sector debt as a problem but largely ignores private sector debt. That would be a mistake.

Why focus on Sweden, France, Korea, China and Canada?

First, their levels of private sector indebtedness exceed the “peak-bubble” level seen in Japan (214% GDP, 4Q94) and, in the cases of Sweden and France, the peak-bubble level seen in Spain (227% GDP, 2Q10) too. Potential warning sign #1.

Second, in contrast to other economies that exhibit high levels of private sector indebtedness (eg, the Netherlands, Denmark, and Norway) affordability risks are also elevated in these five highlighted economies. Their debt service ratios are not only high in absolute terms (>20% income), they are also elevated in relation to their respective 10-year, average affordability levels. Potential warning sign #2.

Note, finally, that among these five economies, Sweden, Korea and Canada have over-indebted NFC and HH sectors, while the risks in France and China relate more, but not exclusively, to their NFC sectors. When it comes to private sector debt dynamics, the world is far from a homogenous place…

Update required – Part II

Trends in global private sector debt ($tr) and debt ratio (% GDP, RHS)
(Source: BIS; CMMP)

Global private sector indebtedness (debt % GDP) fell between 2Q21 (172% GDP) and 2Q22 (160% GDP) according to the latest BIS data release (5 December 2022).

This was a form of passive deleveraging ie, total debt increased over the period (from $142tr to $143tr) but at a slower pace that nominal GDP (see chart above). Both corporate (NFC) and household (HH) debt ratios fell over the period.

Private sector debt ratios (% GDP) as at the end of 2Q22
(Source: BIS; CMMP)

While China ($39tr) and the US ($38tr) collectively account for 54% of total private sector debt, they rank only #9 and #22 in terms of indebtedness. As noted many times before, debt and indebtedness are not the same things.

The most indebted private sectors among the BIS reporting economies are Luxembourg, Hong Kong, Switzerland, Sweden, the Netherlands, France, Denmark, South Korea, China, Canada. Norway and Singapore. In each case, private sector credit exceeded 200% of GDP at the end of 2Q22 (see chart above).

HH debt ratios (% GDP) plotted against NFC debt ratios for 2Q21 and 2Q22
(Source: BIS; CMMP)

This highlighted group of relatively indebted private sectors are far from homogenous, however:

  • Luxembourg, Hong Kong, Singapore and Switzerland have unique “financial roles” that differentiate them from the other economies, for example;
  • Among the remaining nations only China and South Korea experienced increases in both NFC and HH indebtedness between 2Q21 and 2Q22;
  • All of them have relatively indebted NFC sectors (NFC debt >90% GDP), but Switzerland, the Netherlands, Denmark, Korea and Canada also have “overly-indebted” HH sectors (HH debt > 85% GDP)
  • In contrast, France, China, Norway and Singapore have “overly indebted” NFC sectors, but less elevated HH debt ratios
Trends in selected economies’ private sector debt ratios (% GDP)
(Source: BIS; CMMP)

Returning to the theme of history repeating itself and/or rhyming, I have chosen to highlight private sector dynamics in Sweden, France, South Korea, China and Canada for two reasons – their level of private sector indebtedness in relation to trends observed during debt bubbles in Japan and Spain, and their associated and elevated affordability risks.

Private sector debt levels peaked at 214% GDP in Japan and 227% GDP in Spain at the height of their respective private sector debt bubbles (in 4Q94 and 3Q10 respectively).

At the end of 2Q22, private sector debt levels in Sweden (269% GDP) and France (231% GDP) exceeded the peak levels in both Spain and Japan while the private sector debt levels in Korea (222% GDP), China (220% GDP) and Canada (220% GDP) exceeded the peak level in Japan but remained below the Spanish peak.

Note again that among these five economies, Sweden, Korea and Canada have over-indebted NFC and HH sector, while the risks in France and China and relate more, but not exclusively, to their NFC sectors.

Debt service ratios – deviation from 10Y ave versus current level as at end 2Q22
(Source: BIS; CMMP)

Private sector debt service ratios in Sweden, Canada, South Korea, France and China are not only high in absolute terms (ie, > 20%), but they also exceed their 10-year average levels. In contrast, while DSRs in the Netherlands, Norway and Denmark appear relatively high in absolute terms, there are below their respective 10-year averages. Note that due to comparability issues between DSR calculations, the BIS prefers to focus on deviations from LT averages when assessing affordability risks.

Conclusion

While the private sector is deleveraging (passively) at the global level, elevated risks remain in Sweden, France, Korea, China and Canada. Unfortunately, these risks may be overlooked in a world that sees public sector debt as a problem but largely ignores private sector debt. That would be a mistake.

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

“Update required – Part I”

History rhymes – but this chart still needs refreshing

“The key chart”

Trends in Japanese, Spanish and Chinese private sector debt % GDP ratios (Source: BIS; CMMP)

The key message

I published this chart for the first time in 2017 to ask whether history was repeating itself in terms of private sector indebtedness – was China following in the footsteps of Japan and Spain?

It was also an opportunity to flag the rapid rise in household (HH) debt in China (see also, “Too much, too soon“), and to highlight the risks associated with rapid rates of growth in debt (see also, “Beyond the headlines“)

These trends and risks are understood better today (and the same chart has been reproduced many times by different people) – but the chart is in urgent need of an update. The reasons will be revealed later today when the BIS releases its 2Q22 update of global credit…

“Three key aspects – reinforced!”

China data reinforces three key aspects of global debt dynamics

The key chart

The chart from 2019 – China’s HH credit growth outstripping GDP growth despite the fact that the HH debt ratio was close to the average for all BIS reporting countries (Source: BIS; CMMP)

The key message

This week’s news of weaker-than-expected economic growth in China and on-going challenges in the country’s property sector reinforces three key aspects of global debt dynamics:

  1. Conventional macro thinking is flawed to the extent that it typically ignores the risks associated with private debt (while seeing government debt as a problem)
  2. The “EM-debt” story has, for some time, been replaced by the “China-debt” story – strip out China and EM’s share of global debt is largely unchanged since the GFC
  3. The level of any country’s debt needs to be considered in relation to its rate of growth (and its affordability and structure).

In an early 2019 CMMP Analysis report (“Too much, too soon?“), I concluded that:

“The risks associated with excess HH credit growth in China remain elevated and this analysis presents a relatively extreme example of the importance of considering the level of debt together with its rate of growth. History suggests that current trends in China are unsustainable. The most benign outcome is that the rate of growth in HH borrowing slows more rapidly with negative implications for consumption and aggregate demand. In short, China’s increasing HH debt burden represents a key headwind in the transition to a consumption-driven economy.”

Debt dynamics matter, a lot, but conventional approaches to understanding them need updating.

“The India debt story”

Seven features that define India’s debt dynamics

The key chart

Total debt ($bn) and debt ratios (% GDP) for EM’s five largest debt markets (Source: BIS; CMMP)

The key message

Following recent analysis of global and emerging market (EM) debt dynamics and in advance of the Indian government’s announcement of its annual budget on 1 February 2022, this post summarises seven key structural features of Indian debt dynamics.

India is the third largest EM debt market in terms of total, private sector (PSC), corporate (NFC), and household (HH) debt after China and Korea and ahead of Brazil and Russia. Beyond absolute size, the key features of Indian debt dynamics include:

  • PSC accounts for a relatively low share (51%) of total debt. In this context, India ranks #15 among our sample of 21 EM economies
  • In terms of the private versus public sector breakdown, India is similar to Brazil but very different to Russia, Korea and China
  • This matters because risks associated with elevated private sector debt are greater than those associated with public sector debt
  • While Indian debt markets are large in absolute terms, the level of indebtedness is relatively low. Both the NFC (55% GDP) and HH (36% GDP) debt ratios are below both EM averages and BIS threshold limits
  • Indian debt ratios are also relatively low in an historic context. HH indebtedness peaked at 43% GDP in 3Q07 while NFC indebtedness peaked at 71% GDP in 4Q12 (n.b. debt levels and levels of indebtedness are very different measures!)
  • India has experienced periods of elevated risks associated with excess credit growth in the (not-so-distant) past – first in the NFC sector (until 4Q14) and then in the HH sector (since 3Q19). Current risks are moderate, however, in both sectors with RGFs below recent peaks
  • Affordability risks in India are also relatively low in EM, global and historic contexts. India’s PS debt service ratio of 10% is well below its 10Y average of 13%

These features re-enforce the conclusion of “Global Debt Dynamics – V” that it is time to “replace the EM debt story with individual EM country debt stories.” Debt dynamics and their implications for policy, investment decisions and financial stability differ markedly even among EM’s five largest markets.

In short, India scores relatively well in terms of the risks associated with structure, indebtedness, growth and affordability of debt.

The India debt story

Size

Total debt ($bn) and debt ratios (% GDP) for EM’s five largest debt markets (Source: BIS; CMMP)

India is the third largest EM debt market in terms of total ($4,656bn), PSC ($2,550bn), NFC (£1,540bn) and HH debt ($1,011bn) after China and Korea and ahead of Brazil and Russia (see chart above).

Structure

PSC debt as % of total debt for EM’s five largest debt markets (Source: BIS; CMMP)

A key feature of the structure of Indian debt is the relatively low share of private sector debt (51% total). In this context, India ranks #15 among the 21 BIS EM reporting economies. In other words, the private versus public sector breakdown of India debt is similar to Brazil but very different to Russia, Korea, and China (see chart above).

This matters because risks associated with elevated private sector debt are greater than those associated with elevated public sector debt.

Indebtedness

HH and NFC debt ratios for EM economies (Source: BIS; CMMP)

While India is a large debt market in absolute terms, the level of indebtedness is relatively low in an EM context (see above). In terms of PSC (90% GDP), NFC (55% GDP) and HH (36% GDP) debt ratios, India ranks #11, #12, and #10 respectively. Both the NFC and HH debt ratios are below the EM averages (dotted blue line) and the BIS threshold limits (dotted red line).

Trends in Indian PSC, NFC and HH debt ratios (% GDP) (Source: BIS; CMMP)

Indian debt ratios are also relatively low in an historic context. The HH debt ratio of 36% GDP is 7ppt below the 43% GDP peak reached back in 3Q07. The NFC debt ratio of 55% GDP is 16ppt below the 71% GDP peak reached in 4Q12, the point at which the PSC debt ratio also peaked at 106% GDP (see graph above).

NFC snapshot

NFC sector snapshot (Source: BIS; CMMP)

At the end of 2Q21, the level of outstanding NFC debt was $1,540bn, $39bn below the peak level recorded in the previous quarter. As noted above, India is the third largest NFC debt market in absolute terms with a market share of 4%. In terms of NFC indebtedness, however, India ranks #12 among the EM universe. NFC’s share of total debt (31%) is also relatively low. In this context, India ranks #14 among the EM universe.

HH snapshot

HH sector snapshot (Source: BIS; CMMP)

The level of outstanding HH debt was $1,010bn at the end of 2Q21, again £26bn below the peak level recorded in the previous sector. India is the third largest HH debt market in our EM universe with a market share of 6%. In terms of indebtedness, however, India ranks #10 among our EM universe. HH debt represents a relatively low 20% of total debt. In this context, India ranks #12 among our EM universe. In other words, the HH and NFC sectors share a number of similar characteristics.

Excess credit growth

PSC relative growth factors plotted against PSC debt ratios (Source: BIS; CMMP)

In terms of risks to macro policy, investment decisions and financial stability, the lesson from EM history is that the rate of excess credit growth can be as important as the level of indebtedness.

The risks associated with excess credit growth in India are relatively low in an EM context (see chart) above and in an historic context. The latest PSC RGF of 1.8% is lower than the EM average of 6.0% and the levels for China (2.3%), Korea (5.8%), Brazil (6.2%) and Russia (2.2%), countries with higher of similar (Brazil) PSC debt ratios.

Trends in HH, NFC and PSC relative growth factors (Source: BIS; CMMP)

In the post-GFC period, India has experienced periods of elevate growth risks, first in the NFC sector and then in the HH sector. Over the past five years, these risks have been concentrated in the HH sector but rose more recently in the NFC sector again (see chart above). Note however, the rates of excess growth rates have peaked in both cases (and remain modest in absolute terms).

Affordability

EM debt service ratios (x-axis) and deviations from LT average (y-axis) (Source: BIS; CMMP)

Affordability risks in India are also relatively low in an EM and global context and in an historic Indian context. The chart above plots the latest debt service ratios (DSR) for BIS reporting economies (x-axis) and the deviation of each DSR from its LT average. As can be seen India has a relatively low DSR of 9.8%, well below its 10-year average of 12.5% (see also chart below).

Trends in Indian PSC debt service ratio (Source: BIS; CMMP)

Conclusion

These features re-enforce the conclusion of “Global Debt Dynamics – V” that it is time to “replace the EM debt story with individual EM country debt stories.”

Financial stability heatmap for EM’s five largest debt markets (Source: BIS; CMMP)

Debt dynamics and their implications for policy, investment decisions and financial stability differ markedly even among EM’s five largest markets, for example (see the summary heatmap above).

In short, India scores relatively well in terms of risks associated with structure, indebtedness, growth and affordability of debt (n.b. the lack of red shading in the heatmap above in relation to India).

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

“Global debt dynamics – V”

Emerging market debt dynamics

The key chart

Trends in EM private sector debt ($bn) and debt ratio (% GDP) since the GFC (Source: BIS; CMMP)

The key message

In this fifth post in my “Global Debt Dynamics” series, I consider the hypothesis that the “EM-debt” story has been replaced by the “China-debt” story.

At its simplest, the EM-debt story refers to the sharp increase in the EM share of global private sector credit (PSC) and the narrowing of the gap between the aggregate PSC debt ratios for advanced (DM) and emerging (EM) economies since the global financial crisis (GFC).

The EM share of global PSC has increased sharply from 16% in 2Q08 to 38% in 2Q21. Over the same period, the gap between the PS debt ratios has narrowed from 86ppt to only 8ppt. This represents a remarkable structural shift from DM to EM economies.

Strip out China, however, and the EM share of global PSC is largely unchanged since the GFC. China has accounted for 20ppt of the 22ppt increase in market share described above and currently accounts for almost 70% of total EM PSC alone. For added perspective, China’s outstanding stock of PSC ($37tr) is c.10x and c.14x the outstanding stock in Korea and India respectively, the second and third largest EM PSC markets. Viewed from the narrow perspective of relative size and growth, there is some support for the hypothesis that the China debt story has replaced the EM debt story, or at least overtaken it.

There are two problems with this conclusion however: (1) it relies on an overly narrow view of global debt dynamics; and (2) in truth, there is no such thing as an EM debt story in the first place.

The EM universe includes a group of over 20 economies with very heterogeneous debt dynamics in terms of the level of indebtedness, the rate of excess credit growth and affordability of debt:

  • For most EM economies, the “potential-growth” story remains in both the NFC and HH sectors
  • Some of the fastest rates of excess credit growth are occuring in EM economies that already exhibit relatively high levels of indebtedness
  • Elevated affordability risks in a number of EM economies is of concern given the expected future direction of global rates

While the EM classification remains convenient, it is increasingly less relevant in terms of understanding the impact of debt dynamics on macro policy, investment decisions and financial stability.

Replace the EM debt story with individual EM country debt stories not just the China version.

EM debt dynamics

At its simplest, the so-called, “EM-debt” story refers to the sharp increase in EM’s share of global PSC and the rapid narrowing in the gap between the average PSC debt ratios in advanced (DM) and EM economies since the Global Financial Crisis (GFC).

Trends in private sector debt ($tr) and debt ratio (% GDP) since the GFC (Source: BIS; CMMP)

The outstanding stock of EM PSC has grown from $14tr in 2Q08 to $54tr in 2Q21, a nominal CAGR of 11.5% (see graph above). Over the same period, the outstanding stock of DM PSC has risen from $71tr to $87tr, a nominal CAGR of only 1.5%.

Breakdown of global PSC (% total) since the GFC (Source: BIS; CMMP)

The EM share of global PSC has increased sharply from 16% in 2Q08 to 38% in 2Q21, while the DM share of global debt has fallen from 84% to 62% (see chart above). As discussed in “Global Debt Dynamics –II”, this structural shift from DM to EM is one of the two key structural changes that have taken place in the global PSC market since the GFC (the other being the shift away from HH to NFC debt).

Trends in PSC debt ratios (% GDP) since the GFC (Source: BIS; CMMP)

The gap between the average DM and EM PSC debt ratio (debt % GDP) has also narrowed sharply since the GFC. At the end of 2Q08 the respective PSC debt ratios were 172% GDP and 86% GDP, a gap of 86ppt. At the end of 2Q21, the respective PSC debt ratios were 175% GDP and 167% GDP, a gap of only 8ppt (see chart above).

Trends in share of global PSC since GFC (Source: BIS; CMMP)

Strip out China, however, and the EM share of global PSC is largely unchanged since the GFC (see green line in chart above). China has accounted for 20ppt of the 22ppt increase in the increase in market share described above. As result, China’ share of EM PSC has risen from 36% to 68% over the period (and from 6% to 26% of global PSC).

China’s share of EM debt by category of debt (Source: BIS; CMMP)

China accounts for 64%, 68%, 71% and 61% of total, PSC, NFC and HH debt in EM respectively (see chart above). China’s outstanding stock of PSC ($37tr) is c.10x and c.14x the outstanding stock in Korea and India respectively, the second and third largest EM PSC markets (see chart below).

Relative size of PSC in largest EM PSC markets (Source: BIS; CMMP)

So in terms of relative growth, outstanding stock and relative size there are grounds for accepting the hypothesis that the EM story has been replaced by the China debt story. However, a key theme of CMMP analysis is that debt dynamics are not simply about the size/level of outstanding debt. There are other “chapters” to EM debt story including the levels of indebtedness, the growth rate in debt and the affordability of debt, for example.

EM HH debt ratios plotted against NFC debt ratios (Source: BIS; CMMP)

For most EM economies (as classified by the BIS) the potential “EM-growth” story remains. NFC and HH debt ratios in 16 EM economies remains below the 90% GDP and 85% GDP maximum threshold levels identified by the BIS (see chart above), for example. In contrast, elevated debt levels exist in both sectors in Hong Kong and Korea and in the NFC sector in China, Singapore and Chile.

NFC RGF plotted against NFC debt ratio (Source: BIS; CMMP)

As in DM, some of the fastest rates of excess credit growth are occurring in EM economies that already exhibit relatively high levels of indebtedness (for an explanation of the methodology, see here). In the NFC sector, for example, relatively high levels of excess credit growth have occurred in Hong Kong, Singapore, Korea, Chile and Saudi Arabia (see chart above). Similarly, relative high levels of excess HH credit growth have occurred in relatively indebted HH sectors in Korea, Hong Kong, Thailand, Malaysia and China (see graph below).

HH RGF plotted against HH debt ratio (Source: BIS; CMMP)

Elevated affordability risks in a number of EM economies is of concern given the likely future direction of global rates. Private sector debt ratios are not only high in absolute terms, but they are also above respective LT averages in Hong Kong, Turkey, China, and Brazil. Note in contrast the relatively low levels of affordability risk in CEE, Russia and India (see chart below).

Global DSR (x-axis) and deviations from LT averages (y-axis) (Source: BIS; CMMP)

Conclusion

In truth, there is no such thing as an EM debt story. The EM universe includes a group of economies with very heterogeneous debt dynamics. My financial stability heatmap summarising the debt dynamics of the 10 EM economies that account for over 90% of total EM PSC illustrated this clearly (see below).

Financial stability heatmap – top 10 EM economies (Source: CMMP)

So while the EM classification remains convenient, it is increasingly less relevant in terms of understanding the impact of debt dynamics on macro policy, investment decisions and financial stability.

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

“Structure matters too”

How the structure of global debt is changing and why this matters

The key chart

Share of government and household debt in global debt since December 2008 (Source: BIS; CMMP)

The key message

With attention focusing mainly on post-pandemic highs in the level of global debt/debt ratios, it is very easy to ignore key changes in the structure of global debt, and why these changes matter.

  • There has been a marked shift away from household (HH) debt to government debt, at the global level. While HH (and other types of private debt) typically cause crises, government debt typically ends them/reduces their severity. Government deficits also increase the supply of money and depress rates (contrary to popular opinion)
  • The structure of US and UK debt is now the mirror image of the pre-GFC period. This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, as currency issuers, become insolvent
  • A similar but more muted shift has occurred in the euro area (EA) where the structure of debt also differs significantly across the EA’s largest economies
  • As currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated
  • These trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (note also that EM debt is increasingly a “China-debt” story)

Global debt dynamics are a key element of CMMP analysis. It is natural to focus initially on the impact of responses to the pandemic on the level of debt. However, a failure to incorporate analysis of the structure, growth and affordability of debt at the same time can lead to false conclusions regarding investment implications. The post-COVID world is very different from the post-GFC world.

Structure matters too

Trends in global debt and the global debt ratio since 2005 (Source: BIS; CMMP)

Much attention has focused on the impact of the public and private sector responses to the COVID-19 pandemic on the level of global debt and global debt ratios across all sectors (see chart above). All recorded new highs at the end of 4Q20. Less attention has focused, however, on the changing structure of global debt particularly in relation to the pre-GFC period. This posts sets out to correct this by highlighting five key structural changes in global debt and explaining their significance.

Five key changes

Share of government anf household debt in global debt since December 2008 (Source: BIS; CMMP)

First, at the global level, there has been a shift away from HH debt to government debt (see chart above). This matters because (1) while private sector debt typically causes crises, public sector debt typically ends them/reduces their severity and (2) contrary to mainstream teaching, government deficits increase rather than decrease the supply of money and drive rates down.

Trends in the share of US and UK government and household debt since 2008 (Source: BIS; CMMP)

Second, following this shift, the structure of US and UK debt is the mirror image of the pre-GFC structure (see chart above). This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, if currency issuers, become insolvent.

Trends in shares of EA government, HH and NFC debt since 2008 (Source: BIS; CMMP)

Third, more muted shifts have occurred in the euro area (EA) where the structure of debt still differs significantly across the EA’s largest economies. HH debt accounted for 27% of total EA debt in 1Q08 versus 42% in the US and the UK (see chart above). This share fell to 21% in 4Q20 versus 27% in the US and 30% in the UK respectively. Government debt has increases from 31% to 39% of EA debt versus 45% in the US and 44% in the UK respectively. At the country level, however, the share of government debt in total debt ranges from 60% in Italy to only 20% in the Netherlands (see chart below).

Changes in structure of debt across EA’s largest economies (Source: BIS; CMMP)

Fourth, as currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated.

Trends in shares of EM government, HH and NFC debt since 2008 (Source: BIS; CMMP)

Fifth, these trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (see chart above). Note also that EM debt is also increasingly a “China-debt” story. At the end of 4Q20, China accounted for 67% and 70% of total EM and EM NFC debt respectively (see chart below).

China’s share of EM total and NFC debt since 2008 (Source: BIS; CMMP)

Conclusion

Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in the global debt levels and debt ratios across all sectors, it is also important not to miss the important messages associated with changes in the structure, growth and affordability of global debt.

The shift in the structure of global debt from HH debt to government debt has important implications for the severity of recessions, monetary dynamics, inflation, rates and investment risks. The nature of these implications also vary depending on whether governments are currency issuers (eg, US and UK) or currency users (eg, EA governments). The risks of a return to pre-pandemic policy mixes remain in all areas, however. Finally, EMs face very different challenges largely associated with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.

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

“Beyond the headlines”

Growth, affordability (and structure) matter too

The key chart

Are the risks associated with excess growth re-emerging? Excess credit growth versus penetration rates (Source: BIS; CMMP)

The key message

Risks associated with “excess credit growth”, which had been declining in the pre-Covid period, have re-emerged during the pandemic.

Some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed maximum threshold levels (Singapore, France, Hong Kong, South Korea, Japan, Canada).

Affordability risks are also increasing within and outside (Sweden, Switzerland, Norway) this sub-set despite the low interest rate environment.

Risks are more elevated in the corporate (NFC) sector than in the household (HH) sector but are not unique to either the developed market (DM) or emerging market (EM) worlds – one more reason to question the relevance of the current DM v EM distinction

Much of the debate relating to global debt focuses exclusively on the level of debt and, to a lesser extent, on the debt ratio (debt as a percentage of GDP). This analysis highlights how the addition of growth and affordability factors provides a more complete picture of the risks associated with current trends and their investment implications.

Introduction

As noted above, much of the recent debate about global debt has been restricted to its level in absolute terms or as a percentage of GDP. The addition of other factors – the rate of growth in debt, its affordability and, in the case of many EMs, its structure – provides a more complete picture, however.

In this post, I add condsideration of the rate of growth in global debt to my previous analysis in “D…E…B…T, Part II.” The approach is based on the simple relative growth factor (RGF) concept which I have used since the early 1990s as a first step in analysing the sustainability of debt dynamics. I also link both to the affordability of debt as measured by debt service ratios (DSRs).

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 RGF. 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 levels 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 or when excess credit growth continues beyond previously observed levels.

The key trends

Rolling private sector RGF for all BIS reporting, developed and emerging economies (Source: BIS; CMMP)

In the pre-COVID period, the risks associated with excess credit growth had been declining in developed (DM) and emerging (EM) economies (see chart above illustrating rolling RGF trends). In response to the pandemic, however, credit demand has risen while nominal GDP has fallen sharply. As a result, the RGF (as at the end of 3Q20) for all economies, DM and EM have risen to 3%, 2% and 4% respectively. As can be seen, these levels are elevated but remain below those seen in previous cycles during the past 15 years.

Private sector credit snapshots

Excess PS credit growth versus PS debt ratios as at end 3Q20 (Source: BIS; CMMP)
Top ten ranking of private sector RGF by country (Source: BIS; CMMP)

Importantly, out of the top-ten economies experiencing the highest rates of excess private sector credit, six have private sector debt ratios higher than the threshold levels above which debt is considered a constraint to future growth – Singapore, France, Hong Kong, South Korea, Japan and Canada. In the graph above, and in similar ones below, the orange bar indicates where debt ratios exceed the threshold level.

Excess PS credit growth versus PS debt ratios as at end 3Q20 in LATEMEA (Source: BIS; CMMP)

Argentina and Chile have the highest private sector RGFs among the sample of LATEMEA economies. The associated risks are higher in the case of Chile than in Argentina given the two economies debt ratios of 169% GDP and 24% GDP respectively. As highlighted below, the risks in Chile relate primarily to excess growth in the NFC sector.

DSR and deviations from 10-year averages (Source: BIS; CMMP)

Within this subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are also relatively high in France, Hong Kong, South Korea, Japan and Canada despite the low interest rate environment. Outside this subset, affordability risks are relatively high in Sweden, Switzerland and Norway where DSR’s are relatively high in absolute terms and in relation to each economy’s history.

NFC credit snapshots

Excess NFC credit growth versus NFC debt ratios as at end 3Q20 (Source: BIS; CMMP)
Top ten ranking of NFC RGF by country (Source: BIS; CMMP)

Similarly, out of the top-ten economies experiencing the highest rates of excess NFC credit, seven have NFC debt ratios above the threshold level (90% GDP) – Singapore, Chile, France, Canada, Japan, South Korea and Switzerland.

DSR and deviations from 10-year averages (Source: BIS; CMMP)

Within this second subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are relatively high in France, Canada, Japan and South Korea. Despite lower rates of excess NFC credit growth affordability risks are also relatively high in Sweden, Norway and the US. (Note that the availability of sector DSRs is more restricted than overall private sector DSRs).

HH credit snapshots

Excess HH credit growth versus HH debt ratios as at end 3Q20 (Source: BIS; CMMP)
Top ten ranking of HH RGF by country (Source: BIS; CMMP)

In contrast, out of the top-ten economies experiencing the highest rates of excess HH credit, only two have HH debt ratios above the threshold level – Hong Kong and Singapore. This is not surprising given that HH debt ratios are lower than NFC debt levels in general. Of the 42 BIS reporting countries, 11 have HH debt ratios above the 85% GDP HH threshold level whereas 20 have NFC debt ratios above the 90% GDP NFC threshold level.

Rolling HH RGFs for China and Russia (Source: BIS; CMMP)

That said, experience suggests that the current levels of excess HH credit growth in China and Russia indicate elevated risks, especially in the former economy. In “Too much, too soon?“, posted in November 2019, I highlighted the PBOC’s concerns over HH-sector debt risks – “the debt risks in the HH sector and some low income HHs in some regions are relatively prominent and should be paid attention to.” (PBOC, Financial Stability Report 2019). Excess credit growth remains a key feature nonetheless.

DSR and deviations from 10-year averages (Source: BIS; CMMP)

Within this third subset, the debt service ratio in absolute terms and in relation to respective 10-year averages is relatively high in South Korea. Again, despite lower rates of excess HH credit growth, affordability risks are also relatively high in Sweden and Norway.

Conclusion

This summary post extends the analysis of the level of global debt and debt ratios to include an assessment of the rate of growth in debt and its affordability. Together, these factors provide a more complete picture of the sustainability of current debt trends.

Risks associated with excess credit growth are re-emerging and will be a feature of the post-COVID environment going forward. The two key risks here are: (1) some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed threshold levels; and (2) affordability risks are increasing within (and outside) this sub-set despite the low interest rate environment.

To some extent, little of this is new news – I have been flagging the same risks in an Asia context for some time – and the implications are the same. Despite recent market moves, the secular support for rates remaining “lower-for-longer” remains, albeit with more elevated sustainability risks in the NFC sector.

“D…E…B…T, Part II”

Revisiting the level and structure of global debt six months on

The key chart

What are the implications of new highs in global debt and debt ratios? (Source: BIS; CMMP)

The key message

Global debt hit new highs in absolute terms ($211tr) and as a percentage of GDP (277%) at the end of 3Q20, driven largely by government ($79tr) and NFC debt ($81tr).

Public sector and NFC debt ratios both hit new highs above the maximum threshold level that the BIS considers detrimental to future growth.

These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability risks in the NFC sector.

The US and China account for nearly 50% of global debt alone and more than 75% with Japan, France, the UK, Germany, Canada and Italy – but only Japan and France are included in the top-ten most indebted global economies.

The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio increased to 179% GDP.

China’s accumulation of debt has eclipsed the “EM catch-up story”. Chinese debt now accounts for just under 70% of EM debt and EM x China’s share of global debt has remained unchanged over the past decade.

The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics.

New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. From this more appropriate foundation, further analysis can be made of the growth and affordability of debt…

D…E…B…T, Part II

Breakdown of global debt and trend in debt ratio since 2008 (Source: BIS; CMMP)

Global debt hit new highs in absolute terms and as a percentage of GDP at the end of 3Q20, driven largely by public sector debt and NFC debt. According to the BIS, total debt rose from $193tr at the end of 1Q20 to a new high of $211tr. Within this:

  • Government, NFC and HH debt all hit new absolute highs of $79tr, $81tr and $51tr respectively
  • The global debt ratio increased from 246% GDP in 1Q20 to a new high of 278% GDP
  • The public sector debt ratio increased from 88% GDP to 104% GDP and the NFC debt ratio increased from 96% GDP to 107% GDP over the same period. In both cases, the debt ratio was a new high and above the maximum threshold level of 90% above which the BIS considers the level of debt to become a constraint on future growth
  • The HH debt ratio also increased from 61% GDP to 67% but remains below its historic peak of 69% (3Q09) and the respective BIS threshold level of 85% GDP.

These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability especially in the NFC sector.

3Q20 ranking of BIS reporting economies by total debt and cumulative market share (Source: BIS; CMMP)

The US and China account for nearly 50% of global debt, but neither is ranked in the top-15 most indebted economies. At the end of 3Q20, total debt reached $61tr (29% global debt) in the US and $42tr in China (20% global debt). In absolute terms, these two economies are followed by Japan $21tr, France $10tr, UK $8tr, Germany $8tr, Canada $6tr and Italy $tr. In other words, the US and China account for almost a half of global debt and together with the other six economies account for over three-quarters of global debt. Note, however, that only two of these eight economies rank among the top-ten most indebted global economies (% GDP).

3Q20 ranking of BIS reporting economies by total debt as % GDP (Source: BIS; CMMP)

The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio rose to 179% GDP, close to its all-time-high. Following the GFC, the private sector debt ratio in advanced economies had fallen from a peak of 181% GDP in 3Q09 to 151% in 1Q15. It had then stabilised at around the 160% of GDP level.

Private sector debt in advanced economies in absolute terms and as % GDP (Source: BIS; CMMP)

As discussed in “Are we there yet?”, this had direct implications for the duration and amplitude of money, credit and business cycles, inflation, policy options and the level of global interest rates. In subsequent posts, I will examine the implications of these recent trends on the sustainability and affordability of private sector debt in advanced economies.

Trends in China’s private sector debt and share of EM private sector debt (Source: BIS; CMMP)

China’s accumulation of debt has eclipsed the “EM catch-up story”. Fifteen years ago, China’s debt was just under $3tr and accounted for 35% of total EM debt. At the end of 3Q20, China’s debt had increased to $33tr to account for 67% of total EM debt. The so-called EM catch-up story is in effect, the story of China’s debt accumulation. Excluding China, EM’s share of global debt in unchanged (12%) over the past decade.

China and EMx China’s share of global debt (Source: BIS; CMMP)

The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics. The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and NZ) and eight emerging economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).

Asian NFC and HH debt ratios (Source: BIS; CMMP)

The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to NFC (Japan) and HH (Australian and New Zealand) debt dynamics.

The remaining grouping 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 and Hong Kong stand out for having NFC and HH debt ratios that exceed BIS maximum thresholds. Hong Kong and Singapore are distinguished by their roles as regional financial centres but have different HH debt dynamics. Malaysia and Thailand can be considered intermediate markets which leaves India and Indonesia as genuine emerging markets among Asian reporting countries (see “Sustainable debt dynamics – Asia private sector credit”).

Global NFC and HH debt ratios (Source: BIS; CMMP)

New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. In this case, excess refers to levels that are above the BIS thresholds. Among the BIS reporting economies (and excluding Luxembourg) there are:

  • Eight economies with excess HH and NFC debt levels: Hong Kong, Sweden, the Netherlands, Norway, Denmark, Switzerland, Canada and South Korea
  • Eleven economies with excess NFC debt levels: Ireland, France, China, Belgium, Singapore, Chile, Finland, Japan, Spain, Portugal, and Austria
  • Three economies with excess HH debt levels: Australia, New Zealand, the UK
  • The RoW with HH and NFC debt levels below the BIS thresholds

These classifications provide a more appropriate foundation for further analysis of the other, key features of global debt – its rate of growth and its affordability. These will be addressed in subsequent posts.

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

“D…E…B…T”

Five insights from the latest BIS data

The key chart

Time for new terms of reference when analysing global debt levels (Source: BIS; CMMP analysis)

The key message

Last week’s data release from the BIS provides five important insights into the “macro-state-of play” at the end of 1Q20 – the point at which the Covid-19 pandemic intensified globally:

Insight #1: the pandemic coincided with a new peak in global debt ($192tr), with the global debt ratio coming within 0.2ppt of its previous 3Q16 and 1Q18 peaks. Up to this point, the split between private ($122tr) and public ($69tr) was broadly unchanged at 64% and 36% respectively (n.b. I have deal with the subsequent impact of global policy responses on public sector debt levels in previous posts).

Insight #2: the long-term trend of passive deleveraging by the private sector in advanced economies continues with direct implications for: the duration and amplitude of money, credit and business cycles; inflation; policy options; and the level of global interest rates.

Insight #3: China’s catch-up story has replaced the wider emerging market (EM) catch up story. EM debt accounts for 36% of global debt but with China accounting for 68% of EM debt now compared with only 30% twenty years ago – strip out China and EM debt is now a slightly smaller share of global debt than it was five years ago.

Insight #4: the traditional distinction between emerging and developed/advanced economies is less relevant and/or helpful, especially when analysing Asia debt dynamics.

Insight #5: it is more helpful to begin by distinguishing between economies with excess household and/or corporate debt and the RoW and then consider the rate of growth and affordability of debt in that context. More to follow on both…

In the meantime, the key message is the importance of distinguishing between the “event-driven” effects of the Covid pandemic and longer-term “structural-effects” associated with the level, growth and affordability of different types of debt.

Five key charts

Insight #1: The pandemic coincided with a new peak in global debt (Source: BIS; CMMP analysis)
Insight #2: the LT trend of passive deleveraging by the private sector in advanced economies continues (Source: BIS; CMMP analysis)
Insight #3: China increasingly dominates the “EM catch-up” story (Source: BIS; CMMP analysis)
Insight #4: traditional distinctions between EM and advanced economies are less relevant, especially when analysing Asian debt dynamics (Source: BIS; CMMP analysis)
Insight #5: the key chart repeated – new terms of reference are needed as the starting point for analysing global debt (Source: BIS; CMMP analysis)

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

“August Snippets – Part 2”

Revisiting the foundations of CMMP analysis

The key message

In “August snippets – Part 1”, I highlighted the importance of disciplined investment frameworks. In this second snippet, I revisit the foundations of my CMMP Analysis framework. I start by describing how I combine three different time perspectives into a consistent investment thesis (“three pillars”). I then explain how the core banking services (payments, credit and savings) link different economic agents over time to form an important fourth pillar – financial sector balances. Finally, I present examples of how these four pillars combine to deliver deep insights into policy options and responses.

The central theme is my belief that the true value in analysing developments in the financial sector lies less in considering investments in banks but more in understanding the implications of the relationship between banks and the wider economy for corporate strategy, investment decisions and asset allocation.

Three perspectives – one strategy

  • As an investor, I combine three different time perspectives into a single investment strategy
  • My investment outlook at any point in time reflects the dynamic between them
  • My conviction reflects the extent to which they are aligned

Pillar 1: Long-term investment perspective

Example chart 1: growth trends in PSC illustrate how global finance is shifting East and towards emerging markets ($bn) (Source: BIS; CMMP analysis )

My LT investment perspective focuses on the key structural drivers that extend across multiple business cycles. Given my macro and monetary economic background, I begin by analysing the level, growth, affordability and structure of debt. These four features of global debt have direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options; investment risks and asset allocation. My perspective here reflects my early professional career in Asia and experience of Japan’s balance sheet recession. The three central themes are (1) global finance continues to shift East and towards emerging markets, (2) high, “excess HH growth rates” in India and China remain a key sustainability risk, and (3) progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The following four links provide examples of LT investment perspectives:

Example chart 2: China’s HH debt ratio continued to rise sharply in 1Q20 – too much, too soon? (Source: National Bureau of Statistics; CMMP analysis)

Pillar 2 – Medium-term investment perspective

Example chart 3: growth rates in M1 and private sector credit demonstrate robust relationships with the business cycle through time and have proved more reliable indicators of recessions risks than the shape of the yield curve (Source: ECB; CMMP analysis)

My MT investment perspective centres on: analysing money, credit and business cycles; the impact of bank behaviour on the wider economy; and the impact of macro and monetary dynamics on bank sector profitability. Growth rates in narrow money (M1) and private sector credit demonstrate robust relationships with the business cycle through time. My interest is in how these relationships can assist investment timing and asset allocation. My investment experience in Europe shapes my MT perspective, supported by detailed analysis provided by the ECB. A central MT theme here is the fact that monetary developments: (1) have proved a more reliable indicator of recession risks than the shape of the yield curve; and (2) provide important insights into the impact, drivers and timing of the Covid-19 pandemic on developed market economies. The following four links provide examples of my analysis of MT investment perspectives:

Example chart 4: headling figures mask a more nuanced message from monthly flow data (Source: ECB; CMMP analysis)

Pillar 3: Short-term investment perspective

Example chart 5: banks played catch up from May 2020, but what kind of rally was this and was it sustainable? (Source: FT; CMMP analysis)

My ST investment perspective focuses on trends in the key macro building blocks that affect industry value drivers, company earnings and profitability at different stages within specific cycles. This perspective is influences by my experience of running proprietary equity investments within a fixed-income environment at JP Morgan. This led me to reappraise the impact of different drivers of equity market returns. I was able to demonstrate the “proof of concept” of this approach when I returned to the sell-side in 2017 as Global Head of Banks Equity Research at HSBC, most notably when challenging the consensus investor positioning towards European banks in 3Q17. A central ST theme is the importance of macro-building blocks in determining sector profitability and investment returns. The following four links provide examples of ST investment perspectives:

Example chart 6: why it was correct to question the conviction behind the SX7E rally during 2Q20 (Source: FT, CMMP analysis)

Pillar 4 – Financial Sector Balances

Example chart 7: Financial sector balances (and MMT!) can be understood easily by starting with the core services provided by banks to HHs and NFCs (Source: Bank of England; CMMP analysis)

In January 2020, I presented a consistent, “balance sheet framework” for understanding the relationship between the financial sector and the wider economy and applied it to the UK. I chose the UK deliberately to reflect the relatively large size of the UK financial system and the relatively volatile nature of its relationship with the economy. I extended this analysis to the euro area later. I began by focusing on the core services provided by the financial system (payments, credit and savings), how these services produce a stock of financial balance sheets that link different economic agents over time, and how these balance sheets form the foundation of a highly quantitative, objective and logical analytical framework. Central themes here were the large and persistent sector imbalances in the UK, why the HH sector in the UK was poised to disappoint and why a major policy review was required in the euro area even before the full impact of the COVID-19 pandemic was felt. The following four links provide examples of FSB analysis:

Example chart 8: Pre-Covid, the UK faced large and persistent sector imbalances and was increaingly reliant on the RoW as a net lender (4Q sum, % GDP) (Source: ONS; CMMP analysis)

Policy analysis

Example chart 9: “Fuelling the FIRE” – split in EA lending over past twenty years between productive (COCO) and less productive (FIRE) based lending (% total loans) (Source: ECB; CMMP analysis)

These four pillars provide a solid foundation for analysing macroeconomic policy options and choices. Since September 2019, I have applied them to identifying the hidden risks in QE, to arguing why the EA was trapped by its debt overhang and out-dated policy rules, and to assessing the policy responses to the COVID-19 pandemic. Central themes have included: (1) the hidden risk that QE is fuelling the growth in FIRE-based lending with negative implications for leverage, growth, stability and income inequality; (2) why the gradual and incomplete progress towards dealing with Europe’s debt overhang matters; (3) why Madame Lagarde was correct to argue that the appropriate and required response to the current growth shock “should be fiscal, first and foremost”; and (4) how three myths from the past posed a threat to the future of the European project. The following four links provide examples of policy analysis:

Example chart 10: failing the “common sense test”. What was the point of running tight fiscal policies when the private sector was running persistent financial surpluses > 3% GDP (Source: ECB; CMMP analysis)

Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately