A Closer Look At The Region's Credit Cycles

BMI View: It is often useful to take a step back from the barrage of high-frequency data and instead inspect the magnitude and trajectory of a country's broader credit cycle. In this article, we take a closer look at commercial loans as a share of GDP across a number of Asian economies. Our findings show that there is not one singular trend that defines the region, with a number of countries (such as China, Indonesia and Singapore) exhibiting overextended credit cycles, while others (Vietnam and India) are in the midst of cyclical downturns.

While the unrelenting flow of high-frequency economic data are useful in their own right, they often serve to provide a myopic view of where an economy in heading. With this in mind, it is often useful to take a step back and inspect the magnitude and trajectory of a country's broader credit cycle. In this article, we take a closer look at commercial loans as a share of GDP across a number of Asian economies, as this is a broad measure calculated across the region with decent historical data. Specifically, by using a simple time-series regression, we observe how far the credit cycle has deviated from its long-term trend.

Clearly, there are some shortcomings in such an approach, given that the trend used will be time-sensitive (and thereby somewhat subjective in nature). Additionally, it does not inform us of whether the underlying trend is sustainable or not. Still, our findings are useful in providing a more structural backdrop to our specific country views given that there is not one singular trend that defines the region. Below, we flesh out some of the key themes.

Flying Too Close To The Sun
China - Credit-To-GDP Ratio Versus Underlying Trend

A Closer Look At The Region's Credit Cycles

BMI View: It is often useful to take a step back from the barrage of high-frequency data and instead inspect the magnitude and trajectory of a country's broader credit cycle. In this article, we take a closer look at commercial loans as a share of GDP across a number of Asian economies. Our findings show that there is not one singular trend that defines the region, with a number of countries (such as China, Indonesia and Singapore) exhibiting overextended credit cycles, while others (Vietnam and India) are in the midst of cyclical downturns.

While the unrelenting flow of high-frequency economic data are useful in their own right, they often serve to provide a myopic view of where an economy in heading. With this in mind, it is often useful to take a step back and inspect the magnitude and trajectory of a country's broader credit cycle. In this article, we take a closer look at commercial loans as a share of GDP across a number of Asian economies, as this is a broad measure calculated across the region with decent historical data. Specifically, by using a simple time-series regression, we observe how far the credit cycle has deviated from its long-term trend.

Clearly, there are some shortcomings in such an approach, given that the trend used will be time-sensitive (and thereby somewhat subjective in nature). Additionally, it does not inform us of whether the underlying trend is sustainable or not. Still, our findings are useful in providing a more structural backdrop to our specific country views given that there is not one singular trend that defines the region. Below, we flesh out some of the key themes.

China

We have long warned about the unsustainable nature of China's credit boom and, as the accompanying chart shows, the credit cycle now stands at over two standard deviations (+2SD) above its long-term trend. With corporates and local government facing serious cash crunches, we believe that China is fast approaching its 'Icarus moment' in terms of a credit cycle inflection point.

Flying Too Close To The Sun
China - Credit-To-GDP Ratio Versus Underlying Trend

As the banking sector becomes increasingly unable and unwilling to extend additional financing, this will trigger a rise in bad debt in the banking system. Moreover, asset prices will start to fall, which will reinforce the credit down-cycle, leading to much slower economic growth in the future. We are forecasting real GDP growth to average 6.1% per annum over our 10-year forecast period, versus 10.4% in the previous decade.

India

India's credit cycle has been cooling for a number of years, which is a major explanatory factor behind the country's investment slumber since 2010. However, we have yet to see a discernible drop in credit aggregates as a share of the economy, which suggests that further deceleration is likely. This is further evidenced by the country's loans-to-deposit ratio, which, despite weakening credit growth, continues to sit near cyclical highs of 0.80x.

Further Cooling Likely
India - Credit-To-GDP Ratio Versus Underlying Trend

These factors, coupled with the need for further macroeconomic rebalancing in the country, suggest that economic growth will remain rather lacklustre for some time to come. We see economic growth in FY2013/14 (April-March) at 5.0%, the same pace as the previous fiscal year.

Indonesia

Indonesia's short-term credit cycle is stretched, as shown by the fact that it is now more than +2SD above its trend since 2000. Rampant credit growth has been a major reason why the country has experienced overheating pressures in recent years in the form of a widening current account deficit and acute inflationary pressures. This has spurred policymakers into action, with Bank Indonesia delivering an aggressive rate-hiking cycle.

Cyclical Concerns, Structural Strength
Indonesia - Credit-To-GDP Ratio Versus Underlying Trend

The overall impact of tighter monetary conditions will be cooling credit demand, which should see the short-term cycle mean revert (at the expense of weaker headline growth). The good news, as shown by the accompanying chart, is that Indonesia remains within a long-term credit up-cycle, meaning that the current slowdown should be cyclical rather than structural in nature.

Philippines

The Philippines is one of our favourite growth stories in the region, and for good reason going by the shape of its long-term credit cycle. As the accompanying chart shows, not only does the loans-to-GDP ratio stand at just 34%, but after a multi-year downturn, the country appears to be in the nascent stages of secular credit boom.

Early Stage Credit Boom
Philippines - Credit-To-GDP Ratio Versus Underlying Trend

This tells us that the economic growth story, while a little overcooked in the near term with headline expansion punching above 7% year-on-year, can continue to impress over the long term. Should this be accompanied by tangible improvements in the country's business environment (which we are starting to see), the Philippines could well rival Indonesia as South East Asia's top performer.

Vietnam

Vietnam has undergone a multi-year credit downturn, following the bubble period of 2006-2010, and unsurprisingly this has come hand in hand with a much weaker economic performance. We are encouraged, however, by the extent to which the credit-to-GDP ratio has fallen (it is now more than -2SD below its 12-year trend). Further weakness is likely as the banking sector, with the help of the government, cleanses itself of bad debt on its loan books and state-owned enterprises face restructuring.

Creative Destruction
Vietnam - Credit-To-GDP Ratio Versus Underlying Trend

Still, this process is surely setting the stage for a more constructive medium-term growth outlook. Over the coming years, we believe that Vietnam will regain investors' affection, a dynamic that has already started to play out with foreign direct investment (FDI) up 19.5% y-o-y to US$12.6bn over the first eight months of 2013.

Singapore

For a country typically identified with conservatism and a healthy balance sheet, Singapore's credit-cycle is exhibiting some worrying trends. Bank lending as a share of the economy has surged from 83% in mid-2007 to over 150% today (+3SD above its multi-year trend). There are some mitigating factors. Corporate borrowings are low, for instance, while Singapore's position as a major external creditor remains enviable.

An Unlikely Source Of Concern
Singapore - Credit-To-GDP Ratio Versus Underlying Trend

Still, household loans have risen sharply in line with the property market, meaning that borrowers may find themselves in some bother should interest rates rise and/or property market prices fall. Both these factors are likely to play out to some extent over the next couple of years, which will lead to an unwinding of Singapore's credit cycle at the expense of private consumption growth.

South Korea

South Korea's credit cycle has been decelerating since its 2009 peak, but this masks a number of yellow flags, in our view. Firstly, overall leverage amongst Korean firms is one of the highest in the region (at 113% according to the Bank of International Settlements) due to a large corporate debt burden. Furthermore, consumer loans have been rising significantly in recent years, hitting a record high of KRW926.7trn in Q213. This equates to 130% of personal disposable income, higher than the US at the height of its consumer boom.

Consumer Conundrum
South Korea - Credit-To-GDP Ratio Versus Underlying Trend

The government has announced a number of debt-relief programmes to help alleviate such the crippling burden on households, but with incomes unlikely to rise significantly in the near term, further consumer retrenchment appears likely.

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