The right lesson

Emerging market debtor crisis likely and needless

There may not be an emerging market corporate debt crisis when the world's central banks finally get around to raising policy interest rates. But that's not the way to bet, according to a chapter of the latest Global Financial Stability Report from the International Monetary Fund.

The organisation's researchers found that companies have taken full advantage of the post-crisis years of ultra-low interest rates in developed markets. Between 2008 and 2014, the ratio of corporate debt to GDP in emerging economies increased by 26 percentage points to 74 per cent. The proportion of borrowing raised through bonds, which are less flexible than bank loans, has almost doubled to 17 percent.

Also, lower quality borrowers are paying relatively less while companies in more cyclical industries are borrowing more. The study's only good news is that the amount of currency mismatch, debt denominated in a different currency from the borrower's cashflow, does not seem to have increased. The IMF does not quantify another key debt risk, loans ultimately financed by flighty foreign portfolio investors, but that has almost certainly increased since the 2008 crisis.

The stage is set for a classic debt crisis. When interest rates in developed markets actually rise, the debt burden becomes heavier and funds flow out of emerging markets, GDP stalls, companies fail and banks are squeezed.

The IMF authors basically tell the authorities to get ready by tailoring bank regulation to discourage further debt buildup. They note the many advantages of borrowing from domestic investors, if they can be found.

They also suggest reducing the reliance on debt financing in the medium term. Hear, hear. Equity is both more flexible and more permanent than debt. Equity market crashes shouldn't do much damage to the overall economy.

For financial stability, shares are the way to go.

The hope looks forlorn: debt still finances most economic growth. Besides, many emerging markets are not ready for an equity culture, which requires companies that are trustworthy in their financial reporting and dividend policies. Unfortunately, the next emerging market debt crisis - whenever it comes - is unlikely to be the last.