10.11 Weekly Viewpoint : The risk of credit bubbles is far greater in China than in the advanced countries

Based on BIS estimates of the credit gap, the risk of credit bubbles is far greater in China than in the advanced countries were monetary accommodation has been more aggressive………

However, other indicators outline signs of credit hardships among growing companies even in countries still in an expansionary phase and with very low interest rate levels. This suggests that monetary accommodation should be removed more cautiously, rather than the opposite.

Despite years of aggressive monetary stimulus, credit growth in advanced countries is mostly still far from generating concerns tied to possible excesses. With the exception of Canada, for all G7 countries, BIS credit gap measures point to overall credit levels in relation to GDP not far off the trend. This is despite the compression of credit risk premia caused in Europe by the ECB’s corporate bond purchase programme, persistently low medium and long-term rates in nominal and real terms, and the launching of programmes, such as the TLTROs, which provided incentives to banks that exceeded specific benchmarks for credit growth. Modest credit growth could mostly be a result of weak demand, as the slow trend of fixed investments in recent years also seems to suggest. However, on the supply side as well, there could be hitches tied to stricter regulations put in place by supervisory authorities and pressures towards the strengthening of capital ratios. In effect, ECB data show some evidence of disintermediation in the banking system in the financing of European non-financial firms: before the crisis, issuance did not exceed 5% of the flow of new financial debt, as opposed to a 25% share at present. At the global level, the liabilities of non-financial firms have decreased in relation to GDP compared to 2007, whereas the liabilities of financial firms and of households have increased.

While volumes show no evidence of excesses, some more concerning indications of financial stress seem to emerge from data on the interest coverage ratio of nonfinancial corporates. This is more the case with the emerging economies, than with the advanced countries. In its latest global report on debt, the IIF highlights a significant increase in the share of companies with a smaller EBIT than financial costs in a several countries. The percentage is in excess of 20% in Brazil, India, and Turkey, and close to 15% in China. In some cases, the negative statistics may simply reflect the tail effects of a recessive phase and/or a weak exchange rate (a significant share of debt is denominated in foreign currency), and could therefore soon improve. In other cases (China), the low ICR add to the alarming signals sent by other measures of aggregate financial risk. The credit gap in China is 22%, and combines with signals of an excessively strong credit trend in Hong Kong as well (credit gap: 35%).

However, it is not reassuring to see that financial stress is growing also in countries that are enjoying long phases of positive economic growth and low interest rates, such as the United States, Canada, France, and Germany. Here, the share of financially distressed companies is much lower (<10%), but still much higher than it was in 2010. On the other hand, the IIF is not recording a worsening in Italy. Therefore, in many countries an increasingly large share of businesses seems not to benefit from the current economic expansion. At the very least, there seems to be increasing dispersion of economic results among companies (due to sector trends? Or to other structural changes?) Such an increase in financial stress, however, is a problem which certainly does not require a change in pace in monetary policy management: in fact, it strengthens the need to remain cautious in removing stimulus.

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Source: BONDWorld