The stage is set for another global credit downturn, but the next crisis, if any, is unlikely to be as dramatic as in 2008-2009. While global debt levels are higher than a decade ago, contagion risk is lower, according to a special report titled "Next Debt Crisis: Will Liquidity Hold?" published by S&P Global Ratings.
The report discusses the latest trends in the credit cycle and opines on whether we are heading for another full-blown crisis. S&P Global Ratings compared the debt-related metrics of corporates, governments, and households with those recorded during the 2008-2009 global financial crisis to reach its conclusions.
"Global debt is certainly higher and riskier today than it was a decade ago, with households, corporates, and governments all ramping up indebtedness," said S&P Global Ratings credit analyst Terry Chan.
"Although another credit downturn may be inevitable, we don't believe it will be as bad as the 2008-2009 global financial crisis. That's because the increased debt is largely driven by advanced-economy sovereign borrowing and domestic-funded Chinese companies, thus mitigating contagion risk," Terry Chan added.
Dealing with debt
Total global debt has surged by about 50 percent since the last global financial crisis, led by major-economy governments and Chinese nonfinancial corporates, while global debt-to-GDP ratios have risen to more than 231 percent, compared with 208 percent in June 2008.
Despite higher leverage, the risk of contagion is mitigated by high investor confidence in major Western governments' hard currency debt. The high ratio of domestic funding for Chinese corporate debt also reduces contagion risk, because we believe the Chinese government has the means and the motive to prevent widespread defaults.
In looking at nearly 12,000 corporates globally, we found the proportion of companies having aggressive or highly leveraged financial risk profiles has risen slightly, to 61 percent. The higher risk is partly driven by Chinese corporates, which now make up about two-fifths of debt we categorize as aggressive and highly leveraged.
While we believe contagion risk is lower than in 2008-2009, risks are elevated. Due to extremely low-interest rates, the past decade has seen a migration of investor flows into speculative-grade and non-traditional, fixed-income products. These markets tend to be less liquid and more volatile and could seize in the event of a financial shock or panic.
Even within the investment-grade arena, there is also now a much higher issuer concentration in the 'BBB' rating category, with issuer ratings trending down globally over the past decade. Other risk areas include derivatives, exchange-traded funds, private debt, leveraged finance and certain types of infrastructure. About 80 percent of leveraged loans outstanding are now "covenant-lite"–indicating protection for investors has decreased – and this is up from 15 percent a decade ago.
While default risks have been low in recent years, this could change as money costs increase and global economic growth tapers. Our economists recently revised their assessment of the risk of a U.S. recession in the next 12 months to 20 percent-25 percent, from 15 percent-20 percent late last year.
"A perfect storm of realized risks across geographies and asset classes could trigger a systemically damaging downturn. This downside scenario reflects an increased reliance on global capital flows and functioning secondary market liquidity," said S&P Global Ratings analyst Alexandra Dimitrijevic.
Other key findings
- In absolute terms, among governments, the U.S. led the way by growing debt by US$10.6 trillion over the past decade; China was next at $5 trillion, and the Eurozone, at US$2.8 trillion.
- Household leverage decreased in the U.S. and the Eurozone while China's surged; at this pace, China could catch up to advanced-economy levels on household indebtedness within three years.
- Financial-sector leverage declined globally, led by sharp reductions in the U.S. The Eurozone saw a marginal increase and China, again, a big jump from a lower base.
- Chinese corporate indebtedness grew by two-thirds, to 155 percent of GDP, over the past decade.