Emerg­ing mar­ket credit hang­over squeezes firms, eco­nomic growth

The Pak Banker - - MARKETS/SPORTS -

Asian credit mar­kets have be­come a harsher place for bor­row­ers in the past year as widen­ing spreads and fall­ing cur­ren­cies sad­dle firms with el­e­vated debt-ser­vic­ing costs in an­other sign of in­creas­ing stress in emerg­ing economies. The prob­lems in Asia are be­ing felt more acutely in the high yield sec­tor as slow­ing economies mean firms aren't earn­ing enough to cover their cost of cap­i­tal, trig­ger­ing a vi­cious cy­cle of shrink­ing in­vest­ment, lower eco­nomic growth, fal­ter­ing prof­its and de­faults.

The sec­tor has boomed in re­cent years thanks to China, which now ac­counts for roughly 50 per­cent of the out­stand­ing mar­ket in Asia - a dom­i­nance that is now all the more con­cern­ing as its econ­omy cools to its slow­est pace in a quar­ter of a cen­tury. "In an out­look of slow­ing growth and wors­en­ing prof­itabil­ity, the high yield sec­tor is par­tic­u­larly vul­ner­a­ble and most in­vestors we talk to are stay­ing clear of that space," said the head of credit trad­ing at an Asian bank in Sin­ga­pore.

In many ways firms are now pay­ing the price for binging on dol­lar-de­nom­i­nated debt when the U.S. Fed­eral Re­serve launched a burst of liq­uid­ity dur­ing the 2008-09 fi­nan­cial cri­sis last­ing sev­eral years, mak­ing it ex­tremely cheaper to bor­row dol­lars.

Fast for­ward to 2016 and it's a dif­fer­ent story, par­tic­u­larly as a slow­down in China's econ­omy and a turn in Fed pol­icy have tight- ened fi­nan­cial con­di­tions and driven up de­faults. An­a­lysts warn of more cor­po­rate de­faults over the next year, cit­ing widen­ing spreads that typ­i­cally sig­nal grow­ing con­cern about the abil­ity of bor­row­ers to ser­vice their debt.

A JP Mor­gan in­dex of dol­lar-de­nom­i­nated high yield cor­po­rate debt in Asia showed spreads over 10-year U.S. Trea­suries widened to more than 600 ba­sis points at the start of this week, from around 450 ba­sis points in July 2014, ac­cord­ing Thom­son Reuters data.

"While Asia is rel­a­tively bet­ter po­si­tioned among emerg­ing mar­ket peers, spreads are likely to con­tinue to head higher," said Shankar Narayanaswamy, head, credit strat­egy and fi­nan­cials at Stan­dard Char­tered Bank based in Sin­ga­pore.

Data from the Bank of In­ter­na­tional Set­tle­ments showed to­tal credit to the pri­vate non-fi­nan­cial sec­tor in emerg­ing mar­ket economies nearly dou­bled to $32.19 tril­lion at the end of the third quar­ter in 2015, from 2010, ver­sus a mild re­duc­tion to $66.9 tril­lion in their de­vel­oped mar­ket coun­ter­parts. While that strat­egy has paid off rich div­i­dends pre­vi­ously, the com­bi­na­tion of a stronger dol­lar and fall­ing com­mod­ity prices has pres­sured cor­po­rate bal­ance sheets in re­cent months and forced in­vestors to re­duce their ex­po­sure, par­tic­u­larly in emerg­ing mar­kets.

More­over, as growth has slowed - the IMF cut its fore­casts for the global econ­omy to 3.4 per­cent in 2016 - in­vestors have started wor­ry­ing about the abil­ity of some com- pa­nies, es­pe­cially in the min­ing and the oil and gas sec­tors, to meet their debt obli­ga­tions. A anal­y­sis last month of all com­pa­nies on the Shang­hai and Shen­zhen bourses with a mar­ket value of more than $500 mil­lion, showed an av­er­age wait of 59 days for pay­ments by cus­tomers, com­pared with 37 days in 2011.

De­faults have al­ready started ris­ing in the Asian high-yield bond space with the cor­po­rate de­fault rate nearly dou­bling to 6.4 per­cent in 2015 from a year ear­lier, ac­cord­ing to Moody's In­vestor Ser­vices.

Of the 9 de­faults in 2015 - the high­est since 2009 - six of them were Chi­nese is­suers. Over­all, there were 5 de­fault­ers in 2014. The tough mar­ket con­di­tions is seen fur­ther crimp­ing is­suance this year, with over­all sup­ply from the Asian high-yield cor­po­rate sec­tor ex­pected at $13 bil­lion, slow­ing from 2015 and less than half of the $27 bil­lion in 2014, ac­cord­ing to Deutsche Bank es­ti­mates.

"Credit mar­kets may not be sig­nal­ing a full blown re­ces­sion yet but it is go­ing to be a pain point for in­vestors who have blindly chased yields pre­vi­ously," said a bond fund man­ager at a credit fund.

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