Friday, February 5, 2016

Emerging markets may be facing tighter liquidity - BIS

    Emerging market economies may be facing tighter liquidity conditions as cross-border lending to emerging economies, especially China, shrank in the third quarter of 2015 and U.S. dollar borrowing by non-bank companies in those economies was flat for the first time since 2009, according to the Bank for International Settlements (BIS).
    BIS General Manager Jaime Caruana said global liquidity - a term that captures the ease of financing in global financial markets -  shows that the stock of U.S. dollar-denominated debt of non-bank borrowers outside the U.S. was unchanged at $9.8 trillion from June to September and dollar borrowing by non-banks in emerging economies also was steady at $3.3 trillion.
    An even clearer sign that global liquidity conditions for emerging markets may have peaked comes from a decline in cross-border lending to China, Brazil, India, Russia and South Africa. In the third quarter of last year lending shrank by $38 billion to $824 billion from the second quarter, Caruana said in a speech at the London School of Economics (LSE).
    The shift in global financing conditions comes as growth in emerging market economies is declining, the U.S. dollar is rising against emerging market currencies, and commodity prices, especially oil, has plunged, hitting commodity producers.
    While these three headwinds may appear unconnected at first sight, Caruana said they are deeply connected and share common factors.
    "Rather than being exogenous "shocks," they are manifestations of a major realignment of economic and financial forces associated with the long-anticipated shift of global monetary forces," he said.
    Although total global debt has continued to rise since the global financial crises, the growth in emerging markets has been dramatic as compared to that of advanced economies, Caruana said.
    Since 2009 the average level of private credit in emerging economies as a proportion of Gross Domestic Product has jumped to 125 percent from around 75 percent and the debt of non-financial emerging market firms as a proportion of GDP has grown so fast that it exceeds that of advanced economies.
    Companies that produce commodities as well as non-tradable goods were attracted to a relatively weak U.S. dollar and low interest rates since 2009 and as a rule of thumb, 1 percent depreciation of the dollar has been associated with a 0.6 percentage point increase in the quarterly growth of dollar-denominated cross-border lending outside the U.S. 
    The increased leverage facing companies in emerging markets would be less of a concern if the debt had been used to finance productive investments that eventually boost profits.
    "However, the profitability of EME non-financial companies has fallen," Caruana said, noting that traditionally they had been more profitable than their peers in advanced economies but their profitability has been falling in recent years and is now below that of advanced economies.
    Although many firms in emerging markets have dollar cash flows to help service debt and much of the debt has maturities of over 10 years, Caruana said the challenges of deleveraging and a depreciation of the local currency should not be underestimated.
    "The feedback loop has started to impact the broader economy in EMEs now that the dollar has started to appreciated, " he said.
    And while many emerging markets economies now have large foreign exchange reserves in contrast to the crises in the 1980s and 1990s, Caruana said this may not necessarily prevent slower growth as there is no real mechanism for transferring foreign exchange reserves to private firms with dollar debts, which end up curtailing their operations as they reduce leverage.
    The impact of the fall in commodity prices has not only hit oil producers in emerging economies but also U.S. shale producers, with both types of firms borrowing heavily from both banks and markets against oil reserves and projected revenue.
    The value of outstanding bonds from oil and gas companies rocketed to $1.4 trillion in 2014 from $455 billion in 2006 and syndicated loans amounted to $1.6 trillion in 2014, up from $600 billion in 2006.
    A large part of the borrowing was from state-owned oil companies in emerging markets whose firms paid large dividends to their governments, helping finance spending.
    "As with any leveraged sector, the combination of falling oil prices and higher leverage can lead to financial strains for oil-related firms," Caruana said.

    Click to read Caruana's speech "Credit, commodities and currencies."



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