Emerging market debt woes need urgent attention to prevent the worst

ONE of the starkest warnings that came out of the recently concluded IMF-World Bank Annual Meetings held in Lima, Peru, was that emerging market economies need to brace for high turbulence when the US Federal Reserve starts to hike interest rates - which may happen either later this year or early next year.

Since 2004 and especially after 2009, emerging market economies have been tapping cheap credit, both through bank borrowings and bond issues, including in foreign currency, notably the US dollar. According to the IMF's latest Global Financial Stability Report, the corporate debt of non-financial firms in major emerging market economies (which include China, India, Russia, Indonesia, Malaysia, Brazil, Russia, South Africa and Turkey) has soared more than four-fold from US$4 trillion in 2004 to over US$18 trillion in 2014. Not all of this has been productive. Jose Vinals, director of the IMF's Monetary and Capital Markets, reckons that there has been overborrowing to the tune of US$4 trillion.

Much of the leverage is concentrated in construction and related industries (including capital goods), as well as oil and gas - precisely the sectors that are already weak because of overcapacity and depressed values. In the event of a hike in US dollar interest rates, hundreds of companies in these economies could find themselves facing serious financial stress. The likelihood of corporate failures would also increase. The resulting impact on local banks could lead to a slowdown in lending, which in turn would depress economic growth and make the problems even worse.