The Coming Emerging-Market Debt Squeeze

SANTIAGO – Consider the following scenario, one that has played out time and again in emerging-market countries. Local banks and firms go on a borrowing binge and pile up dollar-denominated debt – debt that pundits consider perfectly sustainable, as long as the local currency is strong. Suddenly, something (an increase in United States interest rates, a drop in commodity prices, a domestic political conflict) causes the local currency to drop in value against the dollar. The debt burden, measured in domestic currency, is now much higher. Some borrowers miss interest payments; others are unable to roll over principal. Financial mayhem ensues.

This is how the Latin American debt crisis of the 1980s, the Mexican Tequila crisis of 1994, the Asian debt crisis of 1997, and the Russian crisis of 1998 unfolded. It was also how the financial crisis of 2008-2009 transmitted itself to emerging markets. Every time, borrowers and lenders claimed to have learned their lesson.

Not only could it happen again today; it could happen on a much larger scale than in the past. Taking advantage of ultra-low interest rates in advanced countries, emerging-market banks and firms have been borrowing like never before. A recent paper by the Bank of International Settlements shows that since the global financial crisis, outstanding dollar credit to non-bank borrowers outside the US has risen by half, from $6 trillion to $9 trillion.

The bulk of that debt is in Asia, with China alone accounting for approximately $1 trillion. Other big dollar borrowers include Brazil (over $300 billion) and India ($125 billion). Countries such as Malaysia, South Africa, and Turkey, plus Latin America’s more financially open economies, also have rising foreign-currency debts.