How much debt is too much? It is tempting to designate a certain debt level as too high or unsustainable, but in truth, there is no inherent limit by which debt can rise in a given economy. China’s debt-to-GDP ratio is nearing 200 per cent. But in theory, there is no reason why it couldn’t rise to 300 per cent or 400 per cent.
History tells us that higher debt is riskier, but there is a wide variation across individual economies. Nevertheless, there are observations we can make. Debt-to-GDP ratios relative to per capita income tend to rise as economies develop. So if countries develop by leaps and bounds, as they do in Asia, the ratio rises unusually quickly too.
However, a high ratio of debt to per capita income compared with other markets could signal an excessively fast build-up in leverage. Debt-to-GDP ratios are high in Asia relative to per capita income compared to the typical evolution of economies across the world. China, Thailand and Malaysia have particularly elevated debt levels compared with economies that have similar levels of income per head.
But it is not sufficient to look at debt levels to measure true financial risks in an economy. The pace of increase historically provides a more reliable guide to subsequent financial stress.
History tells us that higher debt is riskier, but there is a wide variation across individual economies
Vietnam, Indonesia, the Philippines and India have low debt-to-GDP ratios and there has been almost no rise in leverage over the past five years. These countries thus seem to be less at risk from a debt crisis. Yet, during 2013, Indonesia and India came under much more pressure than, say, Thailand or Malaysia, which had higher overall debt but less need for external funding.
Whether looking at total debt or leverage in different sectors, Malaysia, Thailand, China and, with certain caveats, Singapore, have seen the most worrying build-up in debt in recent years. By contrast, Vietnam, the Philippines, India and Indonesia appear more robust.
The reason for focusing on the speed with which debt increases, rather than its level, is that the former shows a stronger association with ensuing financial stress. Asia’s rising debt-to-GDP ratios in recent years are not in doubt, but how does the acceleration compare with the past or with other markets that experienced debt crises?
China, Hong Kong, Singapore and Thailand have seen their debt ratios rise more than markets that have gone through financial crises. Malaysia, too, has witnessed a particularly speedy rise in its leverage compared to history. Elsewhere, the picture is more reassuring, with below-trend rises in India, Indonesia and Vietnam.
So while Asia has leveraged up, there are considerable variations across countries. Overall, the increase in debt-to-GDP ratios, whether absolute or relative to trend, exceed risk thresholds in only a few economies.
None of this is to say that financial stress will become inevitable, but new forms of financing can carry greater risk. There is no smoking gun, but the region looks less sturdy than it once was.
This research was first published on 10 October 2013.