This article was first published in Nikkei Asia on January 18, 2024.
Up to 40% of region’s corporate bonds due to mature within three years
East Asian companies are more leveraged than their global counterparts.
For the 10 member states of ASEAN, the ratio of corporate debt to gross domestic product stood at 80.7% as of March 2023. For mainland China, Hong Kong, Japan and South Korea as a group, the figure was 171.6%. In both cases, the ratios were significantly higher than those of peer economies in other regions.
Companies usually take on debt to finance expansion, research and development or other growth initiatives. But poorly managed leverage and challenges from the external environment, including elevated interest rates, can make this approach riskier.
East Asian companies are subject to greater financial strains from increased borrowing costs in an elevated interest rate environment than companies elsewhere. Excessive debt may threaten financial stability and hinder economic growth by distorting resource allocation and dragging on demand. As Warren Buffett has said, “I do not like debt and do not like to invest in companies that have too much debt.”
Before the COVID-19 pandemic, East Asia experienced robust growth thanks to rapid industrialization and easy financial conditions that encouraged lending by banks. However, output across the region has not yet returned to the pre-pandemic trajectory. Yet even easier access to funding and extensions of credit at a reduced cost level have led to a fresh surge of corporate borrowing.
Corporate debt in the “ASEAN+3” region is concentrated largely in the manufacturing, property and raw materials sectors. While manufacturing and raw materials companies appear profitable for the most part, those in the property sector have displayed relatively mediocre returns on assets. A growing share of property-related entities carry “speculative” ratings from credit agencies.
The concentration of debt could spell trouble should property companies come under further stress. Moreover, their troubles could have spillover effects for other sectors, including banking, due to the companies’ large size and diversified business activities.
Regional companies are also more exposed to market risk than before as their borrowing has shifted toward bond issuance from bank loans as East Asian debt markets have deepened. This trend was previously observed in the U.S. and Europe.
Around 30% to 40% of outstanding corporate bonds in the ASEAN+3 area are due to mature within about three years. There could be serious consequences if this wave of maturities coincides with a drying up of bond market liquidity due to systemically important companies running into financial distress, as has been seen with bonds from property companies in China and Vietnam.
The good news is that there are steps the authorities can take now to reduce the chance of a blowup later.
Macroprudential policies can be the first line of defense against risk emerging from corporate borrowings. Research by the ASEAN+3 Macroeconomic Research Office has shown that such policies can keep excessive credit growth in check. For example, national authorities could consider adopting sectoral limits on lending to keep financial institutions from overly concentrating their portfolios.
There is also a need to safeguard against spillover risks to other entities stemming from governance issues. For instance, banks should clearly separate their management and ownership structures to minimize potential conflicts of interest that might arise involving loan applications from companies that are also their shareholders.
In some economies, it is not unusual for banks to have conglomerates as significant shareholders. Absent effective safeguards, the banks can end up providing disproportionately more loans to subsidiaries of their shareholders, compounding risk.
Finally, while increased market financing exposes companies to higher market risks, corporate bond market deepening can help lower borrowing costs and reinforce financial stability by building a more diverse investor base.
National authorities could provide fiscal incentives to encourage more companies to obtain ratings from credit rating agencies as preparation for issuing bonds into the market.
However, there is a need to strike a balance with safeguards. To contain risks stemming from companies venturing into new business areas, enhanced and more comprehensive disclosure regimes to ensure adequate risk assessment should be implemented, based on company and balance sheet size. The authorities should also collaborate with credit rating agencies to jointly seek to improve overall market surveillance, which could provide early warning of tail-risk events.
ASEAN+3 economies have deployed a range of unconventional tools to address risks associated with real estate developers, including encouraging banks to restructure loans, deferring taxes, injecting liquidity by relaxing restrictions on proceeds from presales and waiving rules that prioritize first-time homebuyers.
Maintaining an open mind and a willingness to adopt innovative measures will be critical for mitigating financial distress and instability around the region. When confronted with the risk of financial distress from excessive debt, ASEAN+3 economies have demonstrated an ability to think outside the box.
While the spirit of employing novel approaches is commendable, it is always important to think long-term and ensure that prudential standards are not significantly undermined.