Global Debt Costs Are Soaring. Here’s Where It Will Hurt Most
With borrowing becoming pricier, risks abound for overleveraged consumers, companies and countries.
(Bloomberg Businessweek) -- The world is emerging from the cheap-money era with a mountain of debt that’s now getting painfully expensive.
All around the globe, there are borrowers deeper in the red than ever before. The total owed by households, businesses and governments stands at $290 trillion, up by more than one-third from a decade ago, according to research by the Institute of International Finance.
Although the world’s debt has declined from a pandemic-driven record early this year, the risks it poses to economies and financial markets are intensifying. That’s because many borrowers face a relentless increase in their interest payments, as the Federal Reserve and other central banks raise rates at the fastest pace in decades to subdue inflation.
Many loans were locked in when rates were low, so the bills won’t all come due at once. Still, at a minimum there’ll be a squeeze on economies already struggling with a cost-of-living crisis. At worst, something in the global financial system may break. Recent history is rich in examples of large debt piles that turned bad, from Japanese corporations in the 1990s to US homebuyers and European governments in the following decades.
As higher debt payments begin to strain personal, corporate and government budgets, investors are scanning the planet for potential weak links—from the balance sheets of Canadian households to Italy’s public finances to private credit markets in the US.
Rising interest costs are “a slow-moving train for consumers and companies, just like for governments,” says Sean Simko, global head of fixed-income portfolio management at SEI Investments Co. “At some point you are going to be watching it slowly creep up. And then all of a sudden it’s going to be in your face. And then it’s going to be too late.”
Rich countries can generally afford to pay more interest on their government debt for a while, though investors worry about Italy, and the UK suffered a bond-market scare a few weeks back. The danger is more acute for developing economies, especially those that borrowed in dollars. As for corporations, signs of a credit squeeze are already showing up in pockets of global finance.
Housing debt dominates consumer balance sheets, so that’s where the dangers are biggest—and there’s a particular mix of ingredients that identifies the places where trouble is brewing.
They’re often countries that dodged a housing or banking crash in the Great Recession—so households kept adding debt instead of paring back— and have a large share of floating-rate mortgages, which means that higher central-bank rates are rapidly transmitted to borrowers. Canada, Australia and South Korea fit one or both categories.
“Just think back to ,” says Dario Perkins, an economist at TS Lombard in London, referring to the book and movie about a group of investors who got rich betting on the US subprime mortgage collapse. “They basically were trying to time the reset in borrowing costs. There isn’t that ticking time bomb in the US anymore. But there is in other countries.”
Toronto-based real estate lender Romspen Investment Corp. recently halted redemptions on its largest mortgage fund after a number of borrowers stopped making payments. Canadian households are among the most indebted in the world.
Also ranking high on that list are northern European countries. In the UK, where rates on most mortgages reset after two or three years, debt payments are on track to exceed 10% of all household income (not just for mortgage borrowers). In the Netherlands, Sweden and Norway, they’re already well above that threshold—and heading toward 15% if central banks keep hiking as they’re expected to.
Homeowners in Asian countries including Korea, Malaysia and Thailand are also set to get squeezed, says Jonathan Cornish, head of bank ratings for the Asia-Pacific region at Fitch Ratings.
Businesses (outside the finance industry) are neck-and-neck with governments as the biggest borrowers of the cheap-money era, according to the IIF—and they don’t get to print their own money as a way out of debt troubles.
This year’s surge in borrowing costs may add to the ranks of businesses that only earn enough cash to service their debts—sometimes labeled “zombie companies,” even though they employ lots of people and produce goods and services that consumers want. By some measures, about one-fifth of publicly traded corporations already fit that definition when interest rates were low. With debt costs now surging, more companies are likely to join them. And some that were already in the zombie category may go bust.
“This looks a lot to me like the internet bubble,” Scott Minerd, global chief investment officer at Guggenheim Investments, said on Bloomberg Television. Even though plenty of companies now are making money, “we have a lot of companies that aren’t.”
Worldwide, Moody’s Analytics Inc. reckons that default rates on what it calls “speculative grade” debt—what the financial world calls “junk”—will almost double next year. In the $6.7 trillion market for high-grade US corporate bonds, there are signals that defaults could be by far the worst of the past five decades, according to an analysis by Barclays Plc.
Investors are even more worried about Asia, where the dollar’s strength has made dollar-denominated debt more expensive. Prices of bonds issued by real estate developers in Vietnam and Indonesia have swooned, while defaults in China’s property sector are at record levels. In South Korea, the company that built the local Legoland theme park missed a debt payment in October, a rare event in that country.
For smaller businesses in the US, which tend to borrow from banks at floating rates, the worst is yet to come, says Aneta Markowska, chief financial economist at Jefferies LLC. They’ll likely be forced to lay off workers as the Fed’s rate hikes peak early next year. “It’s in the first quarter when I’d expect to see more cracks, as these small businesses start to see the pain of higher rates,” she says.
Markowska sees another risk in private credit markets, where investments often involve borrowed capital. “A lot of large leveraged deals went through in recent years,” she says. “And when those deals were underwritten, nobody ever expected the funds rate would get close to 5% in the lifetime of those deals.”
Minutes of November’s meeting of the Fed’s rate-setting committee, released last week, show that several policymakers also flagged “hidden leverage” in the nonbank sector as potentially disruptive to the function of large global markets.
Governments in rich economies that borrow in their own currencies generally don’t face the kind of immediate constraints that households or businesses do when interest rates rise. That doesn’t mean they’re invulnerable, as Britain recently demonstrated. Ex-Prime Minister Liz Truss’s plan to cut taxes backfired, triggering a rout in government bonds as investors panicked about the extra debt it would incur. Truss is gone and UK markets have steadied, but the new government still faces a doubling of interest costs next year.
Among developed economies, Italian public debt worries investors the most. The government’s interest payments are on track to exceed 7% of gross domestic product by 2030, an unsustainable figure, Bloomberg Economics estimates. The European Central Bank has backstopped Italian debt in the past, but doing so again would likely face opposition from other European Union governments.
The US may be headed for political headaches over debt, too. With Republicans poised to take control of the House of Representatives in January, there’s potential for another market-roiling fight over raising the federal debt ceiling.
Many developing countries are already in the middle of sovereign debt crises. Sri Lanka and Zambia have defaulted, while Egypt or Pakistan are among a handful of others at risk of following suit. The world’s emergency lender to governments, the International Monetary Fund, estimates that more than half of low-income countries are in debt distress or on the brink of it. The fund has been pumping out rescue packages like never before. “If you think that you need a buffer, we’re here for you,” IMF chief Kristalina Georgieva said last month in Washington.
Borrowers have some resources to ward off the effects of higher debt costs. Emerging economies have boosted their foreign exchange reserves, and many households were able to save money in the pandemic while businesses posted strong earnings during the recovery. Policymakers have learned from past crises and have tools to intervene when stresses build.
The extent of the damage is likely to depend on how high central banks push interest rates. A quickish victory over inflation, or a decision to settle for prices that are somewhat above target, would allow them to stop tightening. For now they look set to keep going, while the full impact of what they’ve already done has yet to hit.
“Before they get to the destination, I think it’s likely that they are going to create a lot of damage to the economy and financial markets,” Minerd says.
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