[Djamester Simarmata] Corporate debts cause worry amid global uncertainty

The latest news on the global economic situation seems bittersweet, especially in relation to the impact of low unemployment in the U.S. An improvement in the U.S. economy has two side effects: a positive one in the potential rise in imports from emerging markets and a negative impact in the potential rise in interest rates.

Fears of Chinese banking debt, of Japan, of the euro area and more are resurfacing, and predictions from the International Monetary Fund have indicated a negative tone. The prospective growth for those dominant economies is in doubt.

Meanwhile, corporate exposure to foreign debts in many Asian economies, including Indonesia, is worrying.

Kyle Bass, the owner and founder of an investment corporation, is more afraid of losses in the Chinese banking system, which he estimates to be of the order of $3 trillion. The portion of nonperforming loans could be larger than 10 percent, based on previous credit cycles.

Other observers were concentrating more on the Chinese capital market. But if the banking system and the capital market are in crisis, the combined effect would be greater for the region, in this case ASEAN.

As a comparison, some estimated prospective losses for the Chinese banking system are higher than the U.S.’ bank losses during the last subprime mortgage crisis.

Other hedge fund managers say that Chinese bank assets have risen about 400 percent since 2007, to $31 trillion as of September 2015, far higher than its gross domestic product of $10 trillion.

A recent edition of The Economist sounded the same warning. Deja vu? Nonetheless, a view evolves, suggesting that the Western view will lead to the wrong conclusion regarding China’s economy. But the global economy is currently evaluated based on the Western view.

Which prediction will prove true? Let us wait and see.

The IMF recently revised down its global economic prospects, including for the eurozone, which was previously predicted to see positive growth this year. The latest publication from the IMF, titled “Too Slow for Too Long,” predicts faltering growth, justifying the thesis that the world economy is over-exposed to risk.

This means that in the coming years, there is a risk of economic distress. This is disappointing, because people are expecting positive results from the big economic stimulus injected through quantitative easing.

By tracking the flow of money, it has been found that QE has been allocated to inappropriate institutions in many advanced economies.

Most of the funds were used for deleveraging existing debts, in financial institutions or corporations, as well as in households, rather than for loans to support recovery.

According to existing data, the inequality in advanced economies is rising following the financial crises. This means there was a misallocation of QE funds.

This is one of the reasons for the new proposal that “helicopter” money replace QE.

In line with global prospects, economic growth for the ASEAN-5, namely Malaysia, Indonesia, Thailand, Singapore and the Philippines, is also estimated to decline in 2016 and 2017.

Traders in the U.S. have estimated that China will trigger a sell-off of U.S. stocks.

The prospect of a deteriorating Chinese stock market would spill over to other countries in the region, which could drive economic growth down further.

The 1997 crisis in East Asia pushed countries to embrace an export-led paradigm, with the objective of accumulating foreign exchange reserves, considered a hedge against a currency crisis. The deep depreciation of the rupiah in 1997, for example, pushed up the volume of commodity exports, and led to a steep rise in foreign exchange revenues.

The periods of 2003-2008 and 2010-2014 were boom eras for commodities in general. Energy products had high price indexes between 2011 and 2014, leading an income boom for several countries in ASEAN.

But after 2014, the prices of commodities fell substantially due to the economic malaise in many developed countries, especially China. Lately, ASEAN currencies in general are quite depreciated.

Today the effect of currency depreciation is different to what it was in 1997, when it drove up commodities exports and increased dollar revenues, leading to a significant increase in foreign exchange reserves.

Now the depreciation of currencies faces a different situation, where many corporations in ASEAN are substantially indebted in U.S. dollars. The demand for commodities is very low due to the failure of economic recovery in advanced countries.

The continuing weakness of the economies of advanced countries had incited them to employ unusual monetary policy, resulting in interest rates close to zero. That low interest rate attracted firms in ASEAN countries to borrowing from advanced countries.

Regarding the above situation, one very important issue is the status of corporate debt in the region.

Corporate debt in U.S. dollars will cause damage to the corporate balance sheet if the relevant local currency depreciates sharply - as happened recently.

The appreciation of the creditor currency would also result in the increase of corporate debts, if their borrowings were unhedged.

As corporations outside the financial sector are usually tightly integrated with the rest of the real economy, banks’ nonperforming loans can easily proliferate when those corporations fall victim to a bad economic situation.

According to the Asia Development Bank’s report in 2015, companies in Indonesia and Vietnam were the most indebted firms in ASEAN, with more than 65 percent of that debt in U.S. dollars.

The ADB survey found that the revenues of corporations in Vietnam, Indonesia and the Philippines were mostly from local currencies. This is one indicator of the vulnerability of those firms in the face of exposure to foreign currency debt.

The ADB’s data shows the proportion of Indonesian dollar debts reaching maturity in 2017 is more than 30 percent, followed by the Philippines, where the proportion is less than 20 percent.

Hence, Indonesia is the most vulnerable country in ASEAN in terms of corporate foreign debt.

Have Indonesian companies forgotten the lessons from the 1997 crisis? Short-memory syndrome?

By Djamester Simarmata

Djamester Simarmata is a lecturer at the University of Indonesia’s School of Economics in Jakarta. -- Ed.

(Asia News Network/The Jakarta Post)