A report by Standard & Poor's warns that a series of major economic or political shocks, such as the recent Brexit vote in the UK, could trigger a more system-wide credit contraction. The report, 2016 Global Corporate Debt Demand says that credit quality is decreasing as governments continue with the policy of monetary expansion (keeping interest rates low and in some cases quantitative easing) to prop up growth and inflation. Over-indebted Chinese corporates and US leveraged borrowers are singled out as those most at risk of a credit contraction.

Critical of expansionary monetary policy

The report is highly critical of central banks' expansionary policy, saying this is increasing financial risk. In particular, it notes that corporate borrowing is growing faster that the global economy – a trend that clearly isn't sustainable.

It states: “An increasing proportion of companies are becoming highly leveraged, raising questions over their long-term debt sustainability, despite low interest rates supporting their ability to meet interest payments. In particular, China’s opaque and ballooning corporate debt and the rapid rise of US leveraged finance have developed as key credit risks.”

The report outlines the possibility of a future credit crunch if inflation and interest rates rise as bond prices fall, while a worst-case scenario could be triggered by “several negative economic and political shocks (such as a potential fallout from Brexit) [which] could unnerve lenders, causing them to pull back from extending credit to higher-risk borrowers.”

Challenge for governments

The authors of the report write that central bank monetary policy is causing the build-up of debt in China’s “opaque and ever-expanding” corporate sector and in US leveraged finance. They write: “The Bank of England’s statements since the surprise UK Brexit result are but the latest confirmation of this bias toward monetary easing. The challenge remains, though: how do governments balance this easing while limiting the accumulation of latent non-performing debt in the medium to longer term.”

Corporate debt to hit $62 trillion

• The main figures published in the report were:
• global corporate credit demand (flow) is estimated at $62 trillion over 2016-2020;
• new debt will represent two-fifths and refinancing the rest;
• outstanding debt would expand by half to $75 trillion;
• China's share will rise to 43% from 35%;
• between 43-47% of non-financial corporates (unrated and rated) are highly leveraged, of which 2% to 5% face negative earnings or cash flows, based on a sample of about 14,400 corporates.

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CTMfile take: We have a huge debt problem, from Italy's non-performing loans (NPLs), to the growing size of corporate (and government) debt. It's global, but treasurers would be well advised to flag up the dangers of their own company's debt at board level. Servicing debt during the current low interest-rate environment is one thing but will it still be possible if and when rates rise?