Bank flows and the state of EM
The Bank for International Settlements (BIS) recently released its quarterly update, including a plethora of statistics on lending across borders. We take this opportunity to examine which emerging markets (EM) may be building up credit risks, and which countries are helping to finance them.
Dividing EM into broad regions, it is clear that capital flows have increased far more rapidly to Asia and Latin America than to the Europe, Middle East and Africa (EMEA) region. This would indicate a build up of risks is more likely in the first two regions than in the latter. China, as ever, is in a league of its own, with cross-border flows at one point over seven times their March 2009 levels.
Over the last 18 months, however, all regions have seen these flows decline,with a combination of Federal Reserve (Fed) and China worries likely drivers. Whilst encouraging in that this indicates that deleveraging and a reduction of risk may be underway, it will also serve as a drag on regional activity. Arguably there is scope for a rebound in EMEA lending at least, given that current activity is below 2009 levels.
Data on flows to China still opaque
As for China, it turns out that 42% of foreign bank claims on the country come from banks located in Hong Kong, with Taiwanese banks in a distant second at 9%. Capital controls in China likely mean that Hong Kong banks are used as channels for overseas capital, so we should also consider the overseas claims on Hong Kong.
Lending to China is most probably a fairly global industry. 60% of claims on China are made on the banking sector, implying a sizeable chunk going to non-banks, but the data does not reveal whether the remainder is channelled towards non-bank financial institutions (shadow finance) or non-financial corporates.
Either way, the rapid build up is troubling for what it says about China’s growing reliance on foreign capital, which is much harder to control than domestic flows. However, we would note that the rapid decline since mid-2015 (when the authorities devalued the currency and sparked a wave of FX repayments by firms nervous about further increases in the cost of their FX debt) has reduced vulnerabilities somewhat, even if there is much further to go.
Thailand stands out in Asia, after China
In Asia, the focus is almost always on China when it comes to debt. While, China is literally on another scale compared to the rest of EM, there are other economies in Asia which have seen sizeable increases in foreign claims.
Thailand, in particular, stands out for the rate of increase. Indonesia and Malaysia are also notable for their above average growth in reliance on foreign banks. Perhaps unsurprisingly, Japan is a more active lender in the region than other major economies, accounting for 37% of foreign bank claims on Thailand and 20% of claims on Indonesia. Interestingly, Hong Kong banks rank second for Thailand and Indonesia, and actually have the biggest share of claims on Malaysia, at 15%.
Colombia bucks the declining trend despite a negative backdrop
As a major commodity exporter, it seems fairly apparent that Colombia was forced to borrow to make up for collapsing export earnings, and this is reflected by the current account deficit, which has expanded from 2.2% of GDP in 2009 to around 5% today – though we have seen improvements recently. Though the recent OPEC agreement on cutting production offers some hope of a modest recovery in oil prices, a return to pre-shale pricing seems very unlikely, and so the ongoing growth in cross border claims (in contrast to the prevailing trend for the rest of EM) is a cause for concern.
The question then is, which country is bankrolling this spree? The country’s largest international lender is the US, whose banks accounted for 39% of all cross border claims in Q1 2016, and while this share has climbed slightly over the last two years, the more significant increase has been led by Eurozone banks (16% of cross border claims, up from 7% in 2009). This diversification can provide some mitigation of risks, but 80% of the claims are still denominated in USD, so tighter dollar liquidity remains a big risk.
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