The International Monetary Fund (IMF) warns various emerging economies and bond markets that they should be prepared for the increase of corporate failures when the US Federal Reserve and major central banks in the advanced economies start to increase their rates.
The increase of the global interest rates may start a new credit crunch in emerging markets, as these businesses that took advantage of cheap financing are pushed into a financial crisis, according to the IMF.
According to the bi-annual Global Financial Stability Report released by the IMF, the debts of these non-financial corporations in the emerging market may have quadrupled; from having $4 trillion in 2014 to more than $18 trillion in 2015.
Chinese corporations have actually led the credit spree; however businesses in other countries, such as Chile and Brazil, also increased their debts; thereby, making them vulnerable to the rise of interest rates.
This can create distress among the local banks that have relied much of this new debt, which may cause them to rein in lending in a vicious cycle similar to the credit crisis that happened in 2008 to 2009.
IMF warns, “Shocks to the corporate sector could quickly spill over to the financial sector and generate a vicious cycle as banks curtail lending. Decreased loan supply would then lower aggregate demand and collateral values, further reducing access to finance and thereby economic activity, and in turn, increasing losses to the financial sector.”
The Annual World Financial Meeting in Peru
The IMF actually urged the Fed to wait until 2016 to increase their rates for the first time in almost 10 years, and others also expressed concern about their dollars-worth of debts and the potential effects if the rates would increase. This issue will probably be the most discussed in next week’s annual meetings of the IMF and the World Bank which will be held in Lima, Peru.
According to the Managing Director of International Monetary Fund, Christine Lagarde, there’s a reason to be worried.
“The prospect of rising interest rates in the US and China’s slowdown are contributing to uncertainty and higher market volatility,” said Lagarde. “There has been a sharp deceleration in the growth of global trade. And the rapid drop in commodity prices is posing problems for resource-based economies.”
The IMF is set to release financial forecasts for the world economy this coming Tuesday. It is likely to reflect the future of the emerging market economies, whose grief have overshadowed the financial crisis happening in Greece and Ukaraine.
Andreas Dombret, a member of the executive board of Bundesbank (the Central Bank of Germany), said, “It is difficult to gauge the possible negative confidence effects on the other emerging-market economies and the global economy as a whole.”
What happens to Emerging Markets
According to the Organization for Economic Cooperation and Development, “Economic recovery is progressing in the world’s advanced economies, but stagnating world trade and deteriorating conditions in financial markets are curbing growth prospects in many of the major emerging economies.”
The idea of US raising their rates would boost their returns on their investments and this has raised concerns from the IMF and the World Bank. They are worried that this might lure investors to change funding out of emerging economies and into the US. Aside from that, this would also strengthen the dollar which is the currency in which corporate debts are based.
The World Bank warned, “They would do well to buckle their seat belts in case the ride gets bumpy.”
Despite all of these, many financial leaders may find reasons to go to Peru where the IMF-World Bank Annual meetings will be held.