McKinsey sounds warning over brewing Asian debt crisis

22 August 2019 Consultancy.asia

McKinsey & Company have sounded a warning over a looming debt crisis in Asia – with many corporates in the region under significant stress to service their obligations.

Barely a month after McKinsey & Company highlighted Asia’s remarkable economic growth over the past thirty years – the region now on track to account for 50 percent of total global GDP by 2040 – the world's leading management consultancy has now sounded a warning over a looming regional debt crisis, describing the signs as ominous. The warning comes after McKinsey assessed corporate financial data from 2017 against 2007 – the year of the crippling Asian Financial Crisis.

McKinsey altogether analysed the balance sheets of close to 40,000 companies spread across eleven countries in the Asia Pacific together with the US and UK, finding that growing numbers of firms in many parts of Asia are under significant stress in fulfilling their debt-service obligations. This is in stark contrast to trends in the UK and US, where McKinsey’s analysis shows that the share of corporations struggling to repay debt has fallen sharply since 2007.Long-term debt levels of companies in AsiaTo compile their report, the analysts from McKinsey looked into the selected countries’ current share of long-term debt (such as senior bonds, notes, and term loans) held by corporations with an interest coverage ratio of less than 1.5 (that is, earnings before interest and taxes over interest expense, with 1.5 the level where corporations are using a predominant share of their earnings to repay their debt) compared to data from 2007, describing the results as ‘sobering’.

All of Australia, China, Hong Kong, India, and Indonesia had more than 25 percent of long-term debt held by companies within this bracket – with the share in all bar Hong Kong having grown materially since 2007, China and India by more than 20 percent. In addition, at least 40 percent of long-term debt was held by companies in Malaysia, Singapore, South Korea and Thailand with interest coverage ratios of less than 3; a level where McKinsey states corporations are likely to struggle to repay their debt.

The UK, too, had greater than 25 percent of long-term debt held by companies with interest coverage below 1.5, yet the share has fallen by 10 percent since 2007, while the figure in the US dropped by 20 percent over the period to a 17 percent share – a ratio which McKinsey classifies as low in terms of the extent of stress. Contrary to other parts of Asia, Japan and the Philippines featured just 2 percent of long-term debt held by the 1.5 bracket, the share having also fallen in both since 2007.Rising Asian share of cross-border capital flowsThe growing debt squeeze is however just one element of McKinsey’s concern. In warning of the ominous signs of an Asian financial crisis redux, the firm cites three other factors; rising household debt (which in Australia and South Korea has now reached 123 percent and 97 percent of GDP); vulnerability in the Asian financial system, with lower margins, higher risk costs, and continued dependence on banks and shadow-banking institutions; and surging capital inflows into Asia.

While global cross-border capital inflows have declined 66 percent since their 2007 peak preceding the global financial crisis, inflows into Asia have surpassed pre-crisis levels, dramatically increasing Asia’s share to around 36 percent from ~12 percent in 2007 and so heightening the region’s vulnerability to any external shocks – such as weakened global economic growth. Any crisis originating in Asia, McKinsey warns, could also send ripple effects across the globe.

“Whether cumulatively these conditions are enough to trigger a new crisis remains to be seen, of course,” concludes the firm. “Since 1997, financial regulators have become wary and safeguards have been put in place. Yet, governments and businesses need to monitor potential triggers carefully, like defaults in repayment of debt, liquidity mismatches, impact of higher interest rates, or large fluctuations in exchange rates, and take adequate preventive action.”


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