Debt 'gorilla' holding back economic growth

“I think the level of debt is quite concerning. One of the reasons that we have any [economic] growth at all is that interest rates are very, very low” NEIL DWANE Allianz Global Investors

Besides lower productivity output and greying demographics, alarming debt levels in the public and private sectors worldwide are undermining buoyant economic growth prospects, says a senior executive of Allianz Global Investors.

"One of the ways I try to visualise that is, in a financial crisis, the world had an orangutan on its back. If you look at the present, with US$50 trillion more debt in the world, we have swapped an orangutan with a gorilla. If you have a huge thing on your back, you can't run very fast," said Neil Dwane, the managing director and global strategist of the Germany-based company with €500 billion in assets under management.

"I think the level of debt is quite concerning. One of the reasons that we have any [economic] growth at all is that interest rates are very, very low."

Global debt rose to 325% of the world's gross domestic product (GDP) in 2016, totalling $215 trillion, according to the Institute for International Finance. Developed markets accounted for the lion's share, at $160 trillion. Emerging market debt rose substantially to $55 trillion, equal to 215% of their GDP. This was driven mostly by non-financial corporate debt, the report said.

Economic conditions, meanwhile, have become sensitive to interest rates after years of near-zero borrowing costs in major economies. Central banks are thus very cautious about how high they can raise rates, with the US Federal Reserve indicating a ceiling at 3% instead of 5-6% before the 2008 global financial crisis, said Mr Dwane.

Still, the main source of economic growth momentum will remain with emerging Asian economies, led by the region's three most populous countries, as other major economies are improving only modestly, he said.

"You would need [GDP of] India [to grow] at 7.5%, Indonesia at 7%, [and] China at 6% to have any [economic] growth at all," said Mr Dwane.

"Global trade is 37% of the world's GDP and that is why [US President Donald] Trump's trade protectionism is a risk because if you put a spanner in global trade, you would end up with nearly 40% of the world's output not growing."

Amid continuing global uncertainties and the low-interest-rate environment, yield-hungry investors are forced to take some risks to earn their returns.

"I think, particularly here in Asia, at least there are returns in the bond market to be had from the high-yield side, the credit side and sovereign side," he said. "The risks you are taking, of course, are political, currency, and to some extent duration risk, but at least you are being paid to that those risks.

"The fact is that global [economic] growth is quite dull [and] inflation is quite low. Therefore, at the margins, central banks are either neutral or looking to lower [interest] rates to sustain the low growth [conditions]. I think many clients need a return but are also nervous, in which case I think the returns are in emerging markets in Asia, particularly in the bond market."

There are still attractive yields on some investment-grade bonds, with Indonesia and India offering over 6%. These two countries also have decent economic growth figures and are undergoing structural reforms, he said.

The "hunt for income" is going global and remains a strong theme amid global political uncertainties, a muddling global economy, and a lower-for-longer interest-rate environment.

Foreign capital inflows into debt instruments of emerging Asian markets were valued at $23 billion in the first quarter of this year, according to Bloomberg. South Korea and India topped the table with inflows of $11.8 billion and $4.5 billion, respectively. Indonesia and Thailand are also among fund-rally destinations as capital inflows were valued at $4.3 billion for the former and $2.6 billion for the latter.

Since many Asian corporations are using the US dollar as a medium for business operations, considerable fund inflows into Asia have reduced refinancing risks of dollar-denominated corporate debt.

"We think the US dollar is now quite expensive and therefore for many corporates borrowing in US dollars, some of the risks of another sharp appreciation of the dollar are lessening," said Mr Dwane. "Therefore the refinancing risks in Asia are falling away, which would make us more constructive on the US credit side here in Asia because the refinancing risks are disappearing.

"The flipside is we still do not know what President Trump will do. The potential protectionist threat is still there, and obviously one of the taxes that he was going to bring in was very bad for Asia. It could lead to a very sharp rise in the US dollar, so I think it is too early to say that we are out of the risk zone because we just do not what President Trump will eventually do."

Any sign of trade friction between the US and Asian countries would hurt investor sentiment in the short run, he added.

While there have been three positive surprises for the macroeconomy this year -- stronger-than-expected export growth, softer-than-anticipated inflation, and a more benign US dollar environment -- the outlook for Asian emerging markets is not necessarily all rosy, cautions Santitarn Sathirathai, head of emerging Asia economics at Credit Suisse.

"We think the best is behind us for export growth in Asia and that the expansion will moderate from a mid-teens rate to a mid-single digit rate," he said. "The inflation outlook for the rest of the year will likely turn out to be more benign that many observers had feared, and a weaker US dollar will probably generate appreciation pressure on Asian currencies.

"Our US economics team is forecasting a 25 basis points rate hike this year and 50 basis points more in 2018. All these factors will likely result in Asian central banks being more dovish than we had anticipated. In particular, we have recently added a 25-point rate cut in India, and now no longer forecast a rate hike in the Philippines this year."


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