{"id":118,"date":"2015-10-03T20:48:35","date_gmt":"2015-10-04T01:48:35","guid":{"rendered":"https:\/\/sites.bu.edu\/perry\/?p=118"},"modified":"2019-01-17T12:26:11","modified_gmt":"2019-01-17T17:26:11","slug":"the-imf-worries-about-eme-corporate-leverage","status":"publish","type":"post","link":"https:\/\/sites.bu.edu\/perry\/2015\/10\/03\/the-imf-worries-about-eme-corporate-leverage\/","title":{"rendered":"The IMF worries about EME corporate leverage"},"content":{"rendered":"

Hot on the heels of the BIS<\/a>, now comes the IMF Global Financial Stability report, “Corporate Leverage in Emerging Markets–A Concern?”<\/a>. \u00a0Yes, a concern, and just in time for the annual meeting<\/a> in Peru next week.<\/p>\n

The report is a difficult read, most likely a too-many-chefs problem that muddies the flavor of what could have been a promising dish. \u00a0But there are some good ingredients here; let’s see what can be made of them.<\/p>\n

The fact is that emerging market corporate leverage has increased, quite dramatically, in the last few years. \u00a0That worries the IMF because in the past “mounting emerging market leverage has typically been associated with a subsequent reversal of capital flows…To dampen adverse macroeconomic consequences, the policy response could include, if warranted, exchange rate depreciation and the use of monetary policy and reserves” (p. 105-106). \u00a0This is standard IMF framing.<\/p>\n

But the rise in leverage is anything but standard, and the IMF’s own research shows it.<\/p>\n

Most significant is the decline in cross-border bank lending, which is apparently being driven largely by regulatory changes. \u00a0A key outcome of the financial crisis has been clarification that each country is responsible for its own banks, wherever they may be operating in the world. \u00a0Regulatory changes have subsequently provided strong incentive for global banks to divest their foreign branches, typically by selling to a local competitor.<\/p>\n

To a significant extent, the contraction of global bank lending has been replaced by expansion of capital market lending, through an expansion of bond issuance. \u00a0Also, ex-China, an increasing fraction of bond issuance is in foreign currency, mainly dollars but also euros. \u00a0Thus, the location of foreign exchange risk has now shifted out of the banking sector and into the corporate sector, where it is largely invisible<\/strong>. \u00a0Have the EME corporates hedged that risk, or haven’t they? \u00a0No one knows.<\/p>\n

That’s why the IMF calls for “collection of data on corporate sector finances, including foreign currency exposures, [to] be improved.” \u00a0They are telling us that no one knows what the exposures are, but they are clearly worried that the exposures have not been hedged. \u00a0Indeed the BIS study, cited above, presents data that suggests the exposures have\u00a0deliberately not been hedged<\/strong>, as corporations have used their borrowing capacity to engage in a carry trade, borrowing in cheap dollars and lending (or investing) in higher yielding domestic currency assets. \u00a0The IMF report emphasizes that most of the borrowed funds have been used for capital investment, but this is not really counter to the BIS study since capital investment is just a different kind of carry trade.<\/p>\n

All of this–the shift from bank lending to capital markets, and the shift of foreign exchange risk from bank balance sheets to corporate balance sheets–has only been accelerated by the recent period of extraordinary low interest rates and quantitative easing in the developed world. \u00a0Just so, the IMF report cites regression evidence linking increased leverage to negative “shadow interest rates” in the US. \u00a0They are worried, clearly, that the shift to higher interest rates globally will push overleveraged EME corporates into bankruptcy, that consequent defaults on remaining domestic bank loans will undermine EME banking systems causing massive credit crunch, which will require massive policy response with or without the aid of the IMF. \u00a0They are worried, let it be plainly said, about the last crisis not the next one.<\/p>\n

Given the two shifts, it is not at all clear why the IMF is so focused on crisis transmission through a domestic banking credit crunch. \u00a0The more obvious transmission would seem to be to holders of EME dollar- and euro-denominated bonds, the price of which has already plummeted as everyone knows. \u00a0And the more obvious pressure for policy intervention concerns EME central bank defense of the exchange rate. \u00a0EME corporates have been profiting from a very nice carry trade on an interest rate differential, but are now poised to lose more or less everything they gained as EME currencies depreciate against the dollar. \u00a0The de facto hedge on which the EME corporates have been relying, so it appears, is with the EME central banks. \u00a0It’s a political thing, not an economic thing, and we’ll have to see how it plays out.<\/p>\n

The central problem is with the FX risk associated with the market-based credit issued to EME corporates. \u00a0But the IMF is stuck in the usual frame of over-leverage. \u00a0Hence it calls for limiting “corporate sector leverage intermediated by banks” and “bank stress tests related to foreign currency risks”, as if the problem is too much bank lending. \u00a0They should read their own report.<\/p>\n","protected":false},"excerpt":{"rendered":"

Hot on the heels of the BIS, now comes the IMF Global Financial Stability report, “Corporate Leverage in Emerging Markets–A Concern?”. \u00a0Yes, a concern, and just in time for the annual meeting in Peru next week. The report is a difficult read, most likely a too-many-chefs problem that muddies the flavor of what could have […]<\/p>\n","protected":false},"author":15789,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/118"}],"collection":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/users\/15789"}],"replies":[{"embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/comments?post=118"}],"version-history":[{"count":3,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/118\/revisions"}],"predecessor-version":[{"id":363,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/posts\/118\/revisions\/363"}],"wp:attachment":[{"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/media?parent=118"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/categories?post=118"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/sites.bu.edu\/perry\/wp-json\/wp\/v2\/tags?post=118"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}