- The Bank for International Settlements, nicknamed the bank for central bankers, said in a report that the ballooning levels of public and private debt are creating a ‘trap’ that would be hard to escape.
- Although higher leverage can boost growth in the short run, it comes at the cost of deeper and longer recessions down the road, the BIS said in its 2018 annual economic report.
- It identified specific pockets of the market that leverage has made vulnerable, including the US commercial-real-estate market.
Ten years after a credit crisis drowned the global economy, central bankers are worried about debt.
The Bank for International Settlements, dubbed the bank for central bankers, said in its annual economic report for 2018 that the growing levels of government, corporate, and consumer borrowing create a “debt trap” that policy may not easily untangle down the road. Global debt across governments, nonfinancial corporations and households surpassed $160 trillion as at the end of 2017, according to the BIS.
The BIS placed some of the responsibility at the feet of central banks. It’s true that low interest rates and other policies, some unconventional, helped many economies recover after the financial crisis. But therein lies the trap: because growth and borrowing have become dependent on low rates, the economy, and financial valuations, are more sensitive to higher interest rates. This in turn makes it more difficult for central banks to raise rates, encouraging even more borrowing, the BIS said.
The report noted that since the financial crisis, there has been a continuous rise of public and private debt relative to gross domestic product. “Indeed, a growing body of studies documents how higher leverage, in both the private and public sectors, can boost growth in the short run, but at the cost of lower growth on average, including deeper and prolonged recessions, in the future,” the BIS said.
The BIS looked into how the financial and business cycles interact with the growth of debt. In the good times, like now, leverage boosts asset prices and helps economies grow. However, everyone from households to companies has to face a payback reckoning that gets worse when the cycle turns.
“It is evident [in the chart below] that the downswings of the financial cycle — characterised by high debt service, deleveraging and falling asset prices — are closely associated with the economic downturns that have occurred in these countries since the mid-1980s, with some of these coinciding with serious financial strains,” the BIS said.
Most vulnerable areas
The BIS further pinpointed a number of areas that are most at risk as debt levels rise. It prefaced this by noting that delicate pockets of the financial system exist even though the economy is still in an upswing.
First is nonfinancial corporate debt in the US and UK, especially, and in France and other European countries to a lesser extent.
“In the United States, in particular, corporate leverage today is at its highest level since the beginning of the millennium,” the BIS said, adding that most investment-grade companies are vulnerable to being downgraded.
The BIS also flagged US commercial real estate, where prices have recovered close to pre-crisis highs.
“Values there seem particularly vulnerable to rising long-term yields,” the bank said.
Thirdly, the BIS noted the level of non-bank, foreign-currency borrowing in emerging-market economies, which has doubled since 2008 and stands at $36 trillion. The growth rate of this debt almost tripled last year as the dollar weakened, but the economies are now exposed to a stronger dollar and a reversal of investors’ appetite to take risk.
“While the global economy has made substantial progress post-crisis and near-term prospects are positive, the path ahead is a narrow one,” the BIS said. “The risks highlight the importance of taking advantage of the current upswing to implement the necessary measures to put the expansion on a stronger footing and to rebuild policy buffers.”