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Global Weekly: Upcoming U.S. Tightening Cycle, Emerging Market Corporate Debt, and Currency Depreciations

Global Macroeconomics Team's picture

The approaching liftoff in U.S. policy rates and subsequent tightening are expected to proceed smoothly but will take place in an environment marked by weak growth, rising debt and substantial currency pressures in many emerging and frontier economies. Currency depreciation could strain corporate balance sheets in countries where private leverage has increased and a significant share of the debt is denominated in U.S. dollar.

  • The upcoming U.S Federal Reserve tightening cycle will take place in a challenging environment for emerging and frontier economies (EFEs). Global trade has been subdued in recent years, commodity prices have experienced a substantial decline, and the U.S. dollar has been appreciating significantly. Domestically, productivity growth in EFEs has slowed while corporate leverage increased substantially in the post-crisis period (Figure 3), particularly in parts of East Asia and Latin America. Public debt has also increased in some EFEs, and countries facing bank asset quality problems have seen little improvement.
  • Weakening EFE growth could reduce resilience over time. This year will mark the slowest pace of EFE growth since the global financial crisis, with particularly challenging conditions for commodity exporters facing deteriorating export and fiscal revenues. Credit ratings have on average deteriorated since the taper tantrum in 2013 and EFE growth is at present significantly lower than at the start of previous Fed tightening cycles (Figure 4), barring 1999, which followed the Asian and Russia debt crises. Concerns about growth prospects in major emerging markets and reduced credit worthiness could potentially raise the risk of capital outflows associated with tighter global financing conditions.
  • Currency pressures could strain corporate balance sheets. Significant currency depreciation in countries where private leverage has increased substantially in recent years could heighten debt refinancing pressures. While a large number of corporates were able to issue debt denominated in their own currencies in the post-crisis period, the U.S. dollar still accounts for the bulk of corporate debt issuance in most countries. As a result, private external debt remains sizable in several EFEs and balance sheet exposure to the U.S. dollar is significant. A further appreciation of the U.S. dollar and concomitant depreciation of EFE currencies could amplify debt rollover and interest rate risks, potentially increasing corporate default rates. Banking sectors generally remain well capitalized, but corporate debt represents a significant share of their assets. Rising non-performing loans could erode their capital buffers and lending capabilities.


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