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A new credit crunch threatens to squeeze global economy

Their economies are very exposed to potential downturn in credit conditions and policymakers may find themselves stumped for a solution

PUBLISHED : Sunday, 04 October, 2015, 5:55pm
UPDATED : Sunday, 04 October, 2015, 5:55pm

Bad news tends to come in threes, so the saying goes. The world economy weathered hardships recovering from the US housing-market-triggered "credit crunch" of 2008-9 and the euro-zone financial storm in 2010-12. But it is not the end of the story. A bigger crisis may be brewing.

World financial markets are now in grave danger of another breakdown in asset values which could mark another lurch into a global credit crunch. This time emerging market economies are in the forefront of the deepening crisis - one that could leave global policymakers seriously stumped trying to solve.

Emerging market economies are extremely exposed to any potential downturn in credit conditions. After a decade-long corporate borrowing binge, fuelled by a flood of cheap money surging into the global economy, emerging markets have ended up highly indebted.

The IMF is particularly worried. According to the International Monetary Fund's Global Financial Stability Report, corporate borrowing in emerging market economies quadrupled from US$4 trillion in 2004 to more than US$18 trillion in 2014. Business debt as a share of gross domestic product has risen close to 75 per cent, from about 50 per cent in 2004.

In the IMF's view, this is unsustainable, especially given world trade flows are down 10 per cent from a year ago, commodity prices close to 25-year lows and the US Federal Reserve continues to sabre-rattle for higher rates. The emerging markets' ability to weather falling revenues and rising debt costs at the same time could prove a toxic combination.

It could easily trigger a major funding crisis. With the Fed threatening to raise interest rates at any time, the IMF warns emerging markets must be prepared for a rash of corporate failures as firms struggle to meet rising debt commitments.

Contagion risks could run high. Shocks to the corporate sector could quickly spill over into the financial sector, sparking a vicious cycle as banks rein in lending with negative connotations for economic confidence and growth. It would mark a grim rerun of the credit crisis of 2008-9 that could rapidly spread across the globe.

The downturn in trade flows, the collapse in global commodity prices, fragile stock market sentiment, the weakening business investment picture and the apparent peaking in employment growth in big nations are symptomatic of a deeper economic disturbance unfolding.

Global policymakers still have time to stop the rot. International efforts to rekindle recovery and stoke up stronger growth need to be coordinated to head off the impending crisis. The IMF, Organisation for Economic Cooperation and Development, World Bank and the Group of Seven should become stronger policy forums to figure out ways to shore up the sagging global economy.

For now, major central banks must maintain the policy bias towards easing. Thankfully, it looks like global markets have a temporary stay of execution from higher US rates after weaker than expected US employment data in September. The Fed now looks more likely to stall plans to tighten policy if US growth threatens to stumble.

There may be a growing need for more countries to join Switzerland, Sweden, Denmark and the euro zone to press for negative interest rates to encourage consumers and businesses to spend rather than save in an effort to boost growth.

More countries need to start printing money too. In the last 61/2 years, central banks have pumped about US$7 trillion of cash into the global monetary system thanks to quantitative easing initiatives in the US, Japan, Britain and the euro zone. But fresh impetus is needed on building global liquidity.

The culture of government austerity needs to be set aside in favour of more deficit spending to help jump-start recovery. Increased government spending on infrastructure, transport and telecommunications investment could provide a vital spark to economic revival worldwide.

Interventionist policies might be anathema to liberal-minded policymakers, but without them, the slide towards credit crunch, increased financial stress and greater market disorder becomes inevitable. By pulling together in a constructive and coordinated fashion, world policymakers can meet the challenge to secure sustainable global growth for the long term.

David Brown is chief executive of New View Economics