Debt build-up sets back hopes of recovery in H2: MAS chief

THE accumulation of debt - seen in emerging markets and around the world - is likely to be the "number-one aftermath" of the Covid-19 outbreak to be dealt with from as early as next year, with expectations of a recovery in the second half of this year set to be "severely tested", said Ravi Menon, managing director of the Monetary Authority of Singapore (MAS).

This sharp concern over debt comes as it is "almost inevitable" that renewed outbreaks and secondary waves of infections will come to pass, given the highly infectious nature of Covid-19, said Mr Menon in a podcast conducted by the Institute of International Finance (IIF) in late May.

MAS is "absolutely" watching the big increase in corporate debt among emerging markets in this region, said Mr Menon, in response to a question on the trend in this current cycle.

"One of the risks we are quite concerned about is renewed capital outflows from emerging market economies. They remain vulnerable if there is a round of secondary waves of infections," he said in the transcript of a May-28 podcast that was released on Thursday by MAS.

"How we deal with these secondary waves is going to matter a great deal. Different countries will respond differently and they have different capacities."

IIF data showed that emerging markets added more than US$3.4 trillion to the global debt pile last year, with total emerging market debt exceeding US$71 trillion. With that, the ratio of emerging-market debt to their GDP hit a fresh high of 220 per cent of GDP in 2019, up from 147 per cent in 2007.

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Overall, global debt hit a new record high of US$255 trillion in 2019, with a surge in debt accumulation seen last year alone at US$10.8 trillion compared to that of US$3.3 trillion in 2018. Global debt is now 322 per cent of global GDP, 40 percentage points higher than in 2007.

Mr Menon pointed to the "mismatch" between market expectations and how the economies are likely to emerge from this crisis.

"I think the market expectation that there's going to be a recovery in the second half of this year and then we'll all gradually get out of this over the course of 2021 is going to be severely tested," he said.

"There are going to be setbacks. It's going to be a fits-and-starts kind of recovery. That could trigger renewed capital outflows from emerging economies, because of a renewed rush into liquid and safe assets. That's never a good scenario for emerging markets - tighter financial conditions and corporate refinancing risks."

While the ace in hand now is having banks in better shape than before - given stronger capital and liquidity buffers they now hold following the global financial crisis just over a decade ago - the "weak card" in the financial system currently is that the high level of corporate debt before the pandemic hit, is set to rise further in many parts of the world.

"If the Covid-19 situation is not contained, that debt is going to continue to grow and credit risks will start to mount," said Mr Menon.

"Once all these loan deferments and forbearance is over, because you only can do so much, then you're going to have more corporate distress. I think that is going to be a big problem we have to deal with."

This comes as well as there will be an exacerbation of existing stresses once increased deterioration in credit quality comes through, with ratings downgrades due soon.

Mr Menon said this is especially the case in the US and Europe, where there are many corporate bonds "at the borderline" of between investment grade and below.

"All these BBB rated bonds, if they cross that threshold, we could have fire sales, large outflows, and sell-offs. This could exacerbate some liquidity risks," he said.

"So corporate downgrades is something we're looking at carefully, which is why I think it's important that emergency measures that all governments and central banks have taken cannot be carried on for too long. We need an exit strategy before this debt accumulates to a point where we have to deal with it for years after."