UBS: Economist Insights: Easy come, easy go

It is called easy money for a reason. When interest rates are unusually low and credit easy to come by, you do not have to work very hard to justify your borrowing. So you will tend to borrow more. That is why central banks try to create ‘easy money’ conditions when the economy is weak. But what if the easy money comes from external, rather than domestic factors?

Plenty of emerging markets (EM) have experienced easy money in the wake of the financial crisis. With low interest rates in developed markets (DM) and quantitative easing (QE) programmes flooding the financial markets with cash in search of a home and a higher yield, a lot of that money inevitablyheaded towards emerging markets. All this money flowing into EM tended to put upward pressure on exchange rates, so many central banks kept their monetary policy loose to counter the upward pressure. But this added domestic easy money to foreign easy money, so whichever way EM corporates turned, cash was freely available. Sure enough, EM corporates increased their debt level, and EM corporate debt has tripled since the years preceding the financial crisis.

The easy money from domestic sources has dominated, with the foreign currency denominated share of EM credit actually lower now than it was in the early 2000s. The fear would normally be that a rise in foreign currency borrowing would create a currency mismatch, so that as soon as the local currency depreciated, firms would be unable to service their debt. The absolute level of foreign debt is indeed higher, but with the lower share this is not so much of a concern. 

But as the IMF points out in its biannual Global Financial Stability Report, since global monetary easing encouraged easier domestic financial conditions, a tightening of global financial conditions could be problematic for EM. The IMF finds that EM domestic macroeconomic conditions have deteriorated since the crisis. On top of this, firm-level fundamentals (such as profitability, liquidity and solvency) have also worsened. So that leaves global factors as the most likely explanation for the rapid growth in EM corporate debt.

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