In a column posted elsewhere earlier this week, we took a look at what rising LIBOR means for China’s currency.
Essentially, Chinese corporates that borrowed in dollars post-crisis are now frantically trying to reduce their debt as the cost to service it is tied to LIBOR. Effectively, that means selling yuan to buy dollars, which, all else equal, should put further pressure on the Chinese currency.
As long as the policy divergence between the Fed and other developed market central banks persists, we need to think very carefully about the extent to which emerging markets have borrowed in dollars. Earlier today, we noted that for their part, Goldman thinks it’s unlikely that the dollar will remain in its current slump for very long unless “the ECB and BoJ wind back their monetary stimulus programs, which is highly unlikely... or the Fed shifts back into outright easing, which is again highly unlikely.”
One of the main concerns for the Fed with regard to international markets is triggering an exodus from EM by hiking rates. In fact, last September’s lift-off punt was in part motivated by the fear of creating a taper tantrum on steroids following the Chinese yuan devaluation.
Particularly problematic is the extent to which emerging market corporates have borrowed in dollars. On Thursday, the Bank for International Settlements - whose board, you’re reminded, is comprised of the world’s top central bankers - was out warning about the buildup of USD debt in emerging economies. Here are some critical excerpts:
“The years since the crisis have seen rapid growth in US dollar credit outside the United States as well as, to a lesser extent, euro-denominated credit outside the euro area. Since the crisis, an increasing share of this has taken the form of debt securities rather than banking claims: the debt securities’ share has grown from 38% in 2008 to 46% at end-2015. And a significant portion has gone to emerging-market borrowers. At end-2015, of $9.7 trillion in US dollar debt outside the United States, a third was accounted for by EME residents.”
“Graph 6 plots the total US dollar-denominated credit to non-bank borrowers (including sovereigns) in three large EMEs – Brazil, Russia and China. Since the Great Financial Crisis, US dollar credit has grown substantially in all three countries (McCauley et al, 2015). Relative to GDP, this credit has doubled from its respective post-crisis lows in China (from 5% to 11%) Russia (from 13% to 26%) and increased even more in Brazil (from 8% to 19%). That said, for Brazil and China, these ratios are still slightly below the peaks reached in the early 2000s.”
(Charts: BIS)
Perhaps more disturbing however, is the following:
(Charts: BIS)
Note the left pane. Basically what that shows is that for one group of countries surveyed by the BIS (see footnote 3), the net corporate currency mismatch has exploded since the crisis. As the bank’s report goes on to note, there’s really no telling how much of that is hedged out.
Ok, so what does all of that mean? Well, it means that the strong inflows EM has seen could be set for a sharp reversal in the event of a Fed policy “error.”
(Chart: Deutsche Bank)
Let’s send you off to the weekend with one final warning from the BIS:
“For one, capital flows can feed on themselves. Inflows can improve the perceived stability and success of the recipient economy, thereby generating more inflows. Symmetrically, outflows, by increasing the perceived riskiness of borrowing economies, can generate further outflows. And this may trigger contagion. For example, internationally active investors may respond to higher perceived risk in one economy by pulling back from others in the same geographic region. Investors may also engage in “proxy hedging” – that is, selling obligations in deeper, more liquid markets in response to risks arising from smaller, less liquid ones.”