London (Reuters): The International Monetary Fund warned on Tuesday that emerging market firms, which together have amassed a record $ 18 trillion of debt, need careful monitoring as the era of record low global interest rates comes to an end.
In its latest Global Financial Stability report, the fund said the biggest rises in ‘leverage’ - the amount of debt relative to a firm’s equity - had come in “vulnerable sectors” like construction, mining and oil and gas, and were increasingly exposed to currency risk.
Regionally, the most striking shifts had been in China and Latin America where overall corporate leverage was now at almost 120% and 110% respectively, and leverage in their construction sectors close to 275% and 200%.
“The upward trend in recent years naturally raises concerns because many emerging market financial crises have been preceded by rapid leverage growth,” the report said.
The IMF also warned that years of record low rates had meant that despite weaker balance sheets, emerging market firms had been able to issue more bonds, and at better terms.
“If rising leverage and issuance have recently been predominantly influenced by external factors (low global rates), then firms are rendered more vulnerable to a tightening of global financial conditions,” the report added.
“Similarly, a decline in the role of firm- and country-level factors in recent years would be consistent with the view that markets may have been underestimating risks.”
Slumping commodity prices, the threat of rising US interest rates, exacerbated in some cases by ugly national politics, have whipped up a near perfect storm for emerging markets this year.
The IMF called for countries to keep a careful eye on their big firms as the global backdrop begins to change. More data was needed, particularly in areas such as how much debt firms had in currencies other than their own.
Many major emerging market currencies have dropped between 20-40% against the dollar over the last year which will make paying back any ‘unhedged’ dollar debt far more expensive. “As advanced economies normalize monetary policy, emerging markets should prepare for an increase in corporate failures.”
“Monitoring vulnerable and systemically important firms, as well as banks and other sectors closely linked to them, is crucial,” the report said.