The Covid-19 pandemic, supply-chain bottlenecks, deficits and inflation: As economic conditions continue to deteriorate, global debt has reached a record US$305 trillion. According to the Institute of International Finance, in the first quarter of 2022, China and the US added $2.5 trillion and $1.5 trillion respectively in credit. The good news is that the global debt-to-GDP ratio dropped 15% (year on year) to 348%.
As the data suggest, corporate debt outside banks and government borrowing were the largest sources of the increase in borrowing, with debt outside the financial sector rising above $236 trillion, some $40 trillion higher than two years ago when the Covid-19 pandemic hit.
Given the recent spike in commodity prices, governments’ need for financing may increase. In other words, countries will be forced to increase government spending to prevent social unrest.
The question then becomes, what will happen to the bond market?
Traditionally, as central banks tighten monetary policy, investors go into sell-off mode, pushing real yields up to the skies. In the case of China, for example, foreign investors reduced investments in Chinese bonds in April by 108.5 billion yuan ($16.1 billion). Foreign investors held a total of 3.768 trillion yuan ($559 billion) in bonds of Chinese issuers at the end of April, the lowest since last July.
It is also true that the drop in interest in Chinese bonds could have been triggered by geopolitical risks, the weakening of the yuan, and concerns about the impact on the economy of the zero-tolerance Covid policy. On top of that, Chinese bond yields dipped below US Treasuries last month for the first time in more than a decade. Goldman Sachs expects China’s economy to grow by 4% in 2022.
As for the stock market, we might see not only declining multiples but also a wave of corporate bankruptcies. Thus the worse is yet to come.
JPMorgan, for example, predicts that the EM-wide default rate would now reach 8.5%, more than double the 3.9% expected at the start of the year before the war in Ukraine broke out. By comparison, the figure was 10.5% in 2009. The overall default rate in Eastern Europe could reach a record 21.1%. That could come from an expected default rate of 98.8% in Ukraine and 27.3% in Russia.
The volume of risky high-yield bonds of emerging-market companies that trade at the distressed level currently exceeds $166 billion. In 2022, JPMorgan expects 29 Chinese real-estate developers to default on $32 billion – a rate that will reach 31% in this market.
It was reported recently that Chinese real-estate developer Sunac China Holdings Ltd paid bond coupons in local currency a day after defaulting on dollar-denominated bonds. This story shows a divergence in investor attitudes. The majority of defaults by Chinese companies in 2022 were on offshore promissory notes.