A move to raise interest rates in the United States and other advanced economies could spell trouble for emerging markets where companies have bulked up on cheap debt, the International Monetary Fund warned Tuesday.
In a report released ahead of next week’s annual meetings of the IMF and World Bank in Peru, the fund noted that corporate debt of nonfinancial firms across major emerging markets has quadrupled from about $4 trillion in 2004 to well over $18 trillion in 2014. Over the same period, the average ratio of emerging market corporate debt to gross domestic product grew by 26 percentage points.
If and when the Federal Reserve and other central banks in advanced economies begin raising interest rates, the IMF said, emerging economies and bond markets need to prepare for an increase in corporate failures as debt-bloated firms struggle with souring growth and rising borrowing costs.
“A key risk for the emerging market corporate sector is a reversal of post-crisis accommodative global financial conditions,” the report said, adding that “Corporate distress could be readily transmitted to the financial sector, generating a vicious cycle as banks curtail lending.”
The IMF has urged the Fed to wait until next year to raise rates for the first time in almost a decade, expressing concern about the surge in dollar-denominated debt in emerging economies and the potential impact that a sudden increase in rates would have.
The report released Tuesday also noted that the composition of emerging market debt has changed, with the share of bonds nearly doubled over the past decade, reaching 17% in 2014.
“Although greater leverage can be used for investment, thereby boosting growth, the upward trend in recent years naturally raises concerns because many financial crises in emerging markets have been preceded by rapid leverage growth,” the IMF said.
The fund recommended that policymakers in emerging markets should respond to a rise in interest rates by monitoring “vulnerable and systemically important firms, as well as banks and other sectors closely linked to them” and, where needed, reform insolvency regimes.