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posted on 03 October 2015

Corporate Leverage In Emerging Markets - A Concern?

from the International Monetary Fund

The corporate debt of nonfinancial firms across major emerging market economies quadrupled between 2004 and 2014. At the same time, the composition of that corporate debt has been shifting away from loans and toward bonds. Although greater leverage can be used for investment, thereby boosting growth, the upward trend in recent years naturally raises concerns because many financial crises in emerging markets have been preceded by rapid leverage growth.

This chapter examines the evolving influence of firm, country, and global factors on emerging market leverage, issuance, and spread patterns during the past decade. For this purpose, it uses large, rich databases. Although the chapter does not aim to provide a quantitative assessment of whether leverage in certain sectors or countries is excessive, the analysis of the drivers of leverage growth can help shed light on potential risks.

The three key results of the chapter are as follows: First, the relative contributions of firm- and country-specific characteristics in explaining leverage growth, issuance, and spreads in emerging markets seem to have diminished in recent years, with global drivers playing a larger role. Second, leverage has risen more in more cyclical sectors, and it has grown most in construction. Higher leverage has also been associated with, on average, rising foreign currency exposures. Third, despite weaker balance sheets, emerging market firms have managed to issue bonds at better terms (lower yields and longer maturities), with many issuers taking advantage of favorable financial conditions to refinance their debt.

The greater role of global factors during a period when they have been exceptionally favorable suggests that emerging markets must prepare for the implications of global financial tightening. The main policy recommendations are the following: First, monitoring vulnerable and systemically important firms, as well as banks and other sectors closely linked to them, is crucial. Second, such expanded monitoring requires that the collection of data on corporate sector finances, including foreign currency exposures, be improved. Third, macro- and microprudential policies could help limit a further buildup of foreign exchange balance sheet exposures and contain excessive increases in corporate leverage. Fourth, as advanced economies normalize monetary policy, emerging markets should prepare for an increase in corporate failures and, where needed, reform corporate insolvency regimes.

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