Surging Debt Will Make Asian Central Banks Cautious on Rates

(Bloomberg) -- Years of cheap money across Asia have left a legacy of surging debt that will force the region’s central bankers to be cautious when they eventually follow in the footsteps of South Korea by raising interest rates.

In South Korea, whose borrowing costs were boosted on Nov. 30, household debt has ballooned to about 150 percent of disposable income. It’s an even larger 194 percent in Australia. In China, it’s companies feeling the strain with corporate debt equating to about 160 percent of gross domestic product.

Years of unprecedented stimulus have swollen the Bank of Japan’s balance sheet to almost the size of the economy. Given the 2 percent inflation target is still in the distance, a tightening of monetary policy remains a long way off, so that debt pile is set to keep on swelling.

With the Federal Reserve set to lift its benchmark rate this week and forecast to do so three more times next year, investors’ taste for Asian assets is set to be tested. If and when Asian monetary authorities follow suit next year, the region’s mountain of debt will mean each incremental move packs an ever greater punch.

"Asia’s high debt leaves it exposed to a global repricing of credit risk, possibly triggered by inflation surprises," economists at Nomura Holdings Inc. led by Rob Subbaraman, head of emerging markets economics and Asia ex-Japan fixed income research, wrote in a note.

Varying Vulnerabilities

The vulnerabilities vary and not every central bank in the region will be raising interest rates. But it may not be a coincidence that one of the nations with low household debt -- the Philippines -- may be one of the most aggressive in raising interest rates next year. Subbaraman said he expects four increases.

At the other end of the spectrum is Australia. The central bank there left its official rate unchanged at a record low 1.50 percent on Dec. 5 and warned that growth in housing debt is outpacing growth in income.

South Korea’s household debt, including loans and purchases on credit, surged to 1,419.1 trillion won ($1.3 trillion) at the end of September, despite efforts from the government to cool the property market. Considering that about 70 percent of financial institutions’ loans to households are floating rates, a 25 basis points increase in lending rates would lead to an overall 2.3 trillion won rise in interest payments per year, according to Bank of Korea estimates.

Malaysia -- which some tip may be next to tighten in Asia -- also faces hurdles. Household debt of about 88 percent of GDP is high for a developing nation and Bank Negara Malaysia Governor Muhammad Ibrahim has said any adjustment would be a “normalization” rather than a tightening.

The People’s Bank of China is expected to refrain from raising open-market interest rates in line with the Fed, according to a Bloomberg survey. Rather than higher interest rates, it’s keeping a lid on debt with macro-prudential policies, which cut leverage without causing an economic shock. 

India -- with total government debt at nearly 70 percent of GDP -- must also tread lightly. The central bank has been tightening liquidity by mopping up excess funds in the banking system. That move, along with expectations that official interest rates are close to bottoming and inflation is likely to head higher, have pushed up bond yields.

Soumya Kanti Ghosh, chief economist at State Bank of India, says a rise in bond yields of 40 to 50 basis points would translate into an additional interest cost of 32 billion rupees ($496 million). While that’s a fraction of the 21 trillion rupees budget size for India, a sustained rise in rates could choke off a nascent recovery and discourage companies from borrowing.

For Japan, one of the most indebted nations in the world, few are expecting any near-term tightening. That leaves the Bank of Japan as a major player in government bonds, exchange-traded funds, real estate investment trusts, corporate bonds and commercial paper. It owns more than 40 percent of Japan’s outstanding bonds and holds more than 70 percent of ETFs.

Collectively, Asia’s swollen debt pile will keep a lid on any tightening cycle, said David Mann, chief economist at Standard Chartered Plc.

"It will be harder to raise rates knowing the sensitivity must be higher," said Mann. All of that debt "doesn’t matter until it suddenly does."

To contact Bloomberg News staff for this story: Enda Curran in Hong Kong at ecurran8@bloomberg.net, Jiyeun Lee in Seoul at jlee1029@bloomberg.net, Anirban Nag in Mumbai at anag8@bloomberg.net, Yinan Zhao in Beijing at yzhao300@bloomberg.net, Toru Fujioka in Tokyo at tfujioka1@bloomberg.net.

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Henry Hoenig

©2017 Bloomberg L.P.

With assistance from Enda Curran, Jiyeun Lee, Anirban Nag, Yinan Zhao, Toru Fujioka