Beware the weak debt tail wagging emerging markets

A guard seen outside the Yes Bank branch on October 3rd, 2012 in Jaipur, Rajasthan, India. Photograph: Sanjit Das for Bloomberg


It’s not often that the International Monetary Fund (IMF) warns of a risk to global financial stability at its spring meeting in Washington, and almost immediately evidence jumps out of a bank earnings report in Mumbai.
That’s what happened on Wednesday. The IMF released analysis showing an alarming buildup of vulnerable corporate debt — the kind where operating profit is falling short of interest payments — in India, Indonesia, China, Turkey and Brazil. And right on cue, Yes Bank Ltd., an Indian lender that raised fresh money from equity investors only last month, reported a near-doubling of its gross nonperforming assets to 1.52 percent at the end of March, from 0.85 percent in December.
India has many troubled state-run lenders; Yes Bank is not one of them. The spike in its soured loans is due to the cement units of Jaiprakash Associates Ltd. The builder of India’s sole Formula One track is a distressed borrower with a US currency bond due in September that’s trading below 42 cents on the dollar. Its cement assets are in the process of being sold to billionaire Kumar Mangalam Birla, so Yes will probably get repaid after all.
Still, corporate leverage is a worry for emerging markets like India precisely because a disproportionately large chunk of it can be found on rickety balance sheets like Jaiprakash’s. The obligations of companies that have an interest coverage ratio of less than one account for 22 percent of total debt in India, 17.5 percent in Indonesia, and almost 13 percent in China.
Worse, as the IMF notes, a rise in global risk premiums alone would add $135 billion to this weak tail of debt distribution. Protectionism is the other way for the back end to get longer. The Trump administration’s trade policies should matter less to commodity exporters such as Russia or Saudi Arabia, but China’s corporate debt profile could weaken sharply.
Luckily for Indonesia, its banking system is in reasonably good shape. India, South Africa, Russia and China face a double whammy. Their lenders may not have enough profit — or capital — to absorb a further souring of corporate debt. After making additional loan-loss provisions, between 45 and 77 percent of corporate loan assets in these markets would be with banks that have Tier 1 capital ratios below 10 percent.
When it comes to company profitability, the weak tail of debt is already wagging the dog in India. If it grows any longer because of risk premiums or protectionism, other emerging economies may not be all that safe either.
— Bloomberg

Andy Mukherjee is a Bloomberg
Gadfly columnist covering industrial companies and financial services

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