By Mehreen Khan at The Telegraph
The world’s credit boom is beginning to show dangerous signs of unraveling, ushering in a period of fresh turmoil for the over-indebted global economy, the Bank of International Settlements has warned.
The globe’s top financial watchdog called time on the world’s debt binge, noting that debt issuance and cross border flows in emerging economies slowed for the first time since the aftermath of the global credit crunch at the end of last year.
With financial markets thrown into fresh paroxysms in 2016, oscillating between extremes of “hope and fear”, the over-leveraged world was finally approaching a day of reckoning, said Claudio Borio, the bank’s chief economist.
“We may not be seeing isolated bolts from the blue, but the signs of a gathering storm that has been building for a long time”, he said.
The Swiss authority – known as the “central bank of central banks” – has long rang the alarm bell over the state of global indebtedness, warning that unprecedented monetary policy was storing up problems in a world which still lumbers under weak productivity, insipid growth, and has no appetite for major reforms.
In its latest quarterly review, the BIS said some of its starkest warnings were now coming into fruition.
It noted that international securities issuance turned negative at the end of last year to the tune of -$47bn – the sharpest contraction since the third quarter of 2012. The retrenchment was largely driven by the financial sector, said the BIS.
- BIS quarterly review
Meanwhile emerging market debtors – who have embarked on a $3.3 trillion dollar denominated debt spree in the wake of the financial crisis – saw issuance ground to a halt in the second half of the year.
This provided a “telltale” sign that the financial conditions were reaching an inflection point, accompanied by large depreciations in emerging market currencies and slowing domestic growth.
“It is as if two waves with different frequencies came together to form a bigger and more destructive one”, said Mr Borio.
Global debt now stands at over 200pc of GDP, exceeding levels seen before the financial crash in 2007.
Any turning in the credit cycle risks imperiling debtor companies and governments, raising the chances of default and corporate bankruptcies, said the BIS.
“If they persist, tighter global liquidity conditions may raise stability risks in some countries, especially those where other indicators already point to a heightened risk of financial stress”, they said.
Ahead of the US Federal Reserve’s landmark decision to raise interest rates for the first time in eight years last December, the BIS had forewarned of an “uneasy market calm” that could quickly turn to debtor distress.
This prophecy is seemingly playing out in the first three months of 2016.
“The tension between the markets’ tranquility and the underlying economic vulnerabilities had to be resolved at some point,” said Mr Borio.
“In the recent quarter, we may have been witnessing the beginning of its resolution.”
Debt binges have also been exacerbated by a historic collapse in oil prices. Energy companies from Brazil to Russia are scrambling toservice $3 trillion of dollar debt as prices languish at around $30 a barrel – a 70pc decline since late 2014.
Corporate defaults among the world’s speculative grade companies are now set to rise by more than 30pc this year – their highest level since the aftermath of the crash in 2009, according to Moody’s.
Fiercely critical of the record low interest rates and mass quantitative easing schemes, the BIS said even the world’s overburdened central bank’s could not stop the credit cycle from unwinding.
Instead, measures to impose negative interest rates were creating huge distortions in global bond markets.
Noting that commercial banks had yet to fully pass on the costs of negative rates to customers, BIS said there was “great uncertainty about the behavior of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period”.
Japan’s shock move to become the fifth major central bank to venture into sub-zero rates in late January sparked a flight for safety which saw the universe of negative yielding sovereign bonds expand from $4 trillion to more than $6.5 trillion in a matter of days. Around 60pc of all Japanese sovereign debt traded below zero in early February.
The European Central Bank is expected to unleash a fresh wave of stimulus into the moribund eurozone later this week, slashing its deposit rate further into negative territory and expanding QE.
But “confidence in central banks’ healing powers has – probably for the first time – been faltering” said Mr Borio.
“Policymakers too would do well to take notice.”