Bank Debt Becomes Government Debt
While Italy’s debt levels are terrible, the table above understates them. Italy’s third largest bank, Monte dei Paschi, was recently taken over by the government. Analysts estimate 20% of the bank’s loans are not performing. That figure overwhelms any capital buffers and leaves the Italian taxpayer with $6 billion in losses to cover. Monte dei Paschi is likely the most problematic bank in Italy, but it isn’t the only one. Italy’s already large debt would be higher if the number included debts the country would likely absorb when recapitalizing banks.
China, whose public debt is only 17.7% of GDP, faces similar challenges. Chinese banks continue to roll over loans to companies rather than forcing restructuring. Many of the problem borrowers in China are state-owned enterprises (SOEs) and the government is loath to pull the plug on its own businesses. While 17.7% looks good, it is widely assumed that the government would step in and cover the problem loans if necessary, thus piling on more debt.
Borrowing in Dollars
The final debt challenge results from a mismatch between debt currencies and home currencies. Many emerging markets, needing capital from abroad, borrow it in U.S. dollars and service their debt by converting taxes paid in their home currencies to dollars. Since the dollar has been rising compared to most global currencies, supporting dollar-based debt has become a larger challenge.
Conversely, Japan continues to run a massive deficit without as much risk because it borrows from its own citizens in yen at very low interest rates. While its debt levels are massive, its risks aren’t as high as in some emerging market countries.
Muddling Through
Even with these challenges, countries will most likely muddle through. While this piece focuses mostly on risk, should any of these countries make the right set of structural reforms, the risk factors above may drop and stock markets could rally. Remember, investing provides its greatest rewards for bearing risks that others don’t want to bear.
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This information is prepared for general information only. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. 2113-CLS-1/11/2017