How can Asia avoid fallout if COVID-19 triggers a debt crunch?

How can Asia avoid fallout if COVID-19 triggers a debt crunch?

- CYNYOUNG PARK

The coronavirus (COVID-19) pandemic raises the spectre of another global debt crisis.

The global economy is deep in debt—to the tune of an estimated US$ 250 trillion in 2019—after a decade of historically low interest rates. Global debt-to-GDP hit a record high of over 320 percent, according to the Institute of International Finance.

A pandemic-induced economic slowdown implies lower corporate earnings and greater debt servicing burdens on companies. This would lead to increasing defaults, plunging investor confidence and potentially a widespread credit crunch.

How policymakers respond now will be crucial in avoiding this worst-case scenario and deciding whether the recovery path will be V, U or L-shaped.

Warning

Economists have warned for years of the risks posed by massive debt accumulation. While the corporate sector ratcheted up its borrowing, financial engineering also played a role in expanding and leveraging loans. Leveraged loans are a type of loan extended to companies with below investment grade credit ratings (i.e. subprime corporate borrowers). Ten years of very low-interest rates enticed investors to buy them, as they typically pay higher interest rates.

The Bank for International Settlements has estimated that outstanding leveraged loans worldwide reached US$ 1.4 trillion at end-2018, more than double the amount a decade ago.

Yet the Bank of England has estimated this figure at around US $ 2.2 trillion. For comparison, the stock of the U.S. mortgages at the time of the U.S. subprime mortgage crisis was estimated at about US$ 2.3 trillion, of which subprime mortgages were US$ 1.3 trillion.