Keeping bad company
Generals usually fight the last war, not the current one. Investors have a similar mindset. In Asia, a market sell-off has raised concerns about a re-run of the financial calamity of 1997-98. Though most of the region’s economies are in better shape this time, corporate leverage has risen quickly, and it looks like some companies have forgotten the lessons of history.
Asia is much better prepared for capital outflows than it was in 1997. Exchange rates which were then mostly fixed are now largely floating. Current accounts that were in deficit are now in surplus – with the notable exceptions of India and Indonesia. Central banks have larger foreign currency reserves. And while debt levels have increased, most of the borrowing has been in domestic currencies, making devaluations less painful than 16 years ago.
Companies are still a cause for concern, however. Asian corporate debt as a multiple of EBITDA at the end of 2012 was higher than in any other part of the world, according to Morgan Stanley analysts. Rising funding costs and growing bad loans are prompting banks to rein in new lending. The bond market, which now accounts for over a third of corporate borrowing, is also vulnerable to rising rates and skittish investors.
Tighter monetary policy in the United States need not trigger an immediate corporate crisis. Much of the increased borrowing has been done by Chinese companies, which mostly depend on the country’s closed and largely state-controlled financial institutions, not flighty international investors. Companies that have issued bonds recently will not have to repay or refinance them for several years. And those companies that have borrowed in dollars or euros may have hedged their exposure, or have foreign earnings to help service their debts.
Yet the troubling part of Asia’s corporate debt pile is the speed at which it has grown. The tide of cheap, plentiful liquidity that has washed over the region’s companies for the past four years is now receding. The combination of higher interest rates, slowing growth and falling currencies is bound to leave some companies painfully exposed.