Monetary Policy Normalisation in the United States: Implications for Corporate Solvency in Emerging Market EconomiesAndrew McLean,1 Queen Mary University of London, London, UK
With strengthening employment and the likely arrival of fiscal stimulus under the Trump Administration, inflationary pressures are mounting in the United States. The actions of a progressively more hawkish US Federal Reserve ('Fed') pose a significant threat to the solvency of non-financial corporates ('NFC') across many emerging market ('EM') economies. This article offers (a) an explanation of how such firms have become particularly vulnerable to changes in Fed policy, and (b) an analysis of how tightening US monetary policy may affect EM NFCs.
Unprecedented monetary policy and expanding EM corporate balance sheets
In response to the 2007/08 financial crisis, the Fed cut interest rates to near-zero and enacted a vast programme of asset purchasing. Whilst designed to provide expansionary pressure to the stricken US economy, the emergence of this monetary consensus amongst advanced economies propagated an unrivalled expansion in the amount of debt held by NFCs in EMs. Between 2004 and 2014, NFC debt quadrupled.
Similarly, NFC debt in major EMs grew from below 60 percent of GDP in 2006 to 110 percent by 2016.
Coinciding with the immensely accommodative financial environment, EM NFCs’ financing decisions have increasingly been shaped by global dynamics rather than national or firm-specific determinants. Therefore as the cost of borrowing in US dollars ('USD') fell, NFCs borrowed heavily, oftentimes with little regard for their own profitability or capacity to invest borrowed monies in productive ventures. Speaking to the Wall Street Journal, Neil Macdonald, law firm Kirkland & Ellis’ head of restructuring in Asia, stated that the typical NFC was ‘never robust enough to carry the kind of debt that got put on their balance sheet.’
Moreover, institutional investors – seeking higher returns than those available in advanced economies – further enabled profligacy by providing demand to EM firms issuing bonds: resultantly, bond issuance quintupled between 2005 and 2014. However, due to the disparate nature of bondholders, this method of corporate financing lacks strong monitoring standards, thereby doing little to discourage spurious borrowing. Revealingly, NFCs’ interest coverage ratios (a measure of insolvency) have grown on average, indicating a greater likelihood of default.