The International Monetary Fund (IMF) warned that emerging market economies are more vulnerable to a rise in interest rates and an increase in global risk aversion due to their rising corporate debt.
In an analytical chapter of the IMF’s Global Financial Stability Report, the IMF research found that the corporate debt of nonfinancial firms across major emerging markets rose sharply from about US$4-T in Y 2004 to well over US$18-T in Y 2014, due to low interest rates in advanced economies, as well as other global factors, such as investors in advanced economies’ search for higher returns and lower commodity prices.
The emerging market corporate Debt-to-GDP ratio had grown by 26 percentage points in the Y’s 2004 and 2014 frame, with the corporate leverage rising markedly in China and in Turkey. The research also found that the share of bonds in corporate debt has nearly 2X’d over the past 10 years.
Emerging market economies are now more vulnerable to a rise in interest rates, USD appreciation and an increase in global risk aversion, said Gaston Gelos, chief of the global financial stability analysis division at the IMF.
With some advanced economies, such as the US, beginning to raise interest rates and the appreciation of the USD, companies in emerging markets will face rising difficulty in servicing their foreign currency-denominated debts.
The IMF suggested countries should monitor vulnerable and systemically important firms and banks, and adopt macro-prudential policies to limit excessive bank landing and associated increases in corporate sector leverage.
In a separate analytical chapter, the IMF warned of the sharp evaporation of market liquidity in case of market shocks, such as worsening financial conditions.
“In recent years, factors such as investors’ higher risk appetite and low interest rates have been masking growing underlying fragilities in market liquidity,” said Gelos.
If financial conditions worsen or participants become weary of a particular asset class of financial market, market liquidity can quickly evaporate, the IMF warned.
It called on financial supervisors and central banks to enhance their monitor of market liquidity and to prepare for the normalization of monetary policy in some advanced economies.
The IMF is to release the full chapters of the Global Financial Stability Report on 7 October Peru.