Text size

There is much they quarrel about. But there is one thing most investment strategists and economists can agree on: The world is drowning in debt.

Global debt has grown to $244 trillion—three times the size of the global economy—according to the Institute of International Finance, a Washington, D.C.-based organization representing the global financial industry, which just released a report on debt. A rapid buildup in household debt in China and other emerging markets, and a record amount of debt coming due in the next two years, are high on the group’s list of concerns.

Global debt has grown 12% since interest rates started rising and hit 318% of global gross domestic product last year, up from 170% in 2000, according to the IIF. Two of the biggest sources of the increase: developed market governments that borrowed rather than paid down deficits during the global economic recovery, and emerging market companies that took advantage of investors eagerly willing to lend to them in return for yield. Now, higher interest rates and slowing growth makes all that debt more burdensome.

Read more:The Biggest Emerging Market Debt Problem Is in America

Here are some of the ways to think about the global debt load and what investors should be most concerned about.

Household debt in emerging markets. As emerging market countries continue to develop, it’s natural for household debt to pick up. But there has been a sharp rise in household debt as a percentage of GDP in emerging markets since 2016 as the U.S. Federal Reserve was raising interest rates. Such debt has risen 30% since 2016 to $12 trillion, with China accounting for half. Other countries with sharp increases: India, Mexico, Korea, Malaysia, and Chile. The debt can be a drag on consumption and for capital markets if sentiment sours, Emre Tiftik, deputy director of the IIF’s Global Capital Markets, said on a conference call Tuesday.

Dollar-based liabilities for foreign banks. This one falls into the one-to-watch category. While many banks do a lot of business in dollars, the concern here is the gap between dollar-based liabilities and dollar-based assets for European and Japanese banks, with $13.3 trillion in dollar-based liabilities at foreign banks. For example, Japanese banks are looking at a roughly $800 billion gap between their dollar-based liabilities and dollar-based assets. If the dollar strengthens significantly or there is more tightening in monetary policy, that could lead to problems. “It needs to be monitored more carefully. During stress episodes, dollar-funding becomes a key driver of sentiment,” Tiftik said.

China. In 2017, the country’s efforts to reduce the debt that had helped its rapid growth could be seen in the data. But in 2018, corporate borrowers in China started to increase their debt, suggesting they were focusing elsewhere. Does that suggest China is failing in its deleveraging push? “No, it’s more of a shift in emphasis,” Sonja Gibbs, managing director of Global Policy Initiatives at the IIF, said on the conference call.

Redemption time. A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020. Most of the redemptions in 2019 will be outside of the financial sector, mainly from large corporate borrowers in China, Turkey, and South Africa. The question will be if they can refinance the debt. The IIF doesn’t see a crisis, but does note that these companies will have to refinance the debt at a higher cost, hurting their growth prospects.

Editor's Choice

This is one reason emerging markets are so sensitive to whether the Federal Reserve is leaning toward a more dovish or hawkish stance. Higher rates makes this debt costlier to refinance.

Contagion. Concerns that the troubles in Argentina and Turkey would ripple across emerging markets loomed over investors last year. The IIF doesn’t see a systemic crisis, but does see more trouble ahead in places where debt buildup has been especially rapid, such as Saudi Arabia, Lebanon, and other Middle Eastern and African countries that could be hit hard as debt comes due at a time of slower global growth and higher rates. Another potential wild card that could complicate the refinancing: oil prices.

The uncertainty about the direction of capital inflows casts doubt over whether emerging markets borrowers can service and manage debt. Plus, high debt levels divert resources from more productive investments, casting a pall over long-term growth, Gibbs said.

After losing 5.5% in 2018, the iShares J.P. Morgan USD Emerging Market Bond exchange-traded fund (EMB) has had a reprieve, up almost 2% so far this year. But if the latest debt statistics are any indication, that calm may belie more volatility ahead.

Write to Reshma Kapadia at reshma.kapadia@barrons.com