Global imbalances: sustainable for now
As risk assets continue to rise amid slowing global growth it is important to understand which countries and sectors have the largest debt vulnerabilities and whether the triggers exist for them to unwind in the near term. The IMF’s Financial Stability Report divides the world into five systemically important regions – the United States, Euro Area, Other Advanced Economies, China and Other Emerging Markets – and the key sectors within them such as non-financial corporations, households, sovereigns and banks. It then compares leverage for each year since 2000 with its average over the period. Sector leverage is deemed acute when it is in the top 20% of the post-2000 average for all advanced or emerging economies.
The good news is that there are few imbalances in systemically important regions that are both acute and have a high likelihood of correcting this year. In the US, the sovereign sector is over-levered but low interest rates should allow that to be sustained. Excesses in the leveraged loan market are a bigger problem but are more likely to amplify the next downturn than cause it. In the Eurozone, no sector is acutely over-levered although non-financial corporate and sovereign leverage are above average and the aggregate picture masks imbalances in individual countries. The Eurozone is also vulnerable to imbalances unwinding elsewhere because of its dependence on external demand. Meanwhile, household leverage has reached excessive levels in Other Advanced Economies and in particular Australia, Canada and the Nordic countries, although they are not large enough economies to precipitate a global recession.
Other Emerging Markets are in a strong position compared with their histories, with no sector in aggregate having leverage in the top 40% of the post-2000 average. China is another story, with the non-financial sector especially over-levered, while household leverage has also been rising rapidly. Of all the global imbalances, it is China’s that worries us the most. However, China does benefit from its debt build up having been internally financed and the sovereign’s ability to socialize significant private sector defaults.
The key takeaway is that although there are pockets of severe imbalances in the global economy, they are either concentrated in non-systemically important countries or unlikely to unwind in the near-term, especially if the world’s major central banks keep policy rates low and remain highly sensitive to economic and financial conditions. As the largest single driver of global growth over recent years, it is China’s imbalances that are the biggest risk to the global expansion and it is there our attention is most keenly focused in case an aggressive and destabilizing deleveraging cycle commences.
Chart 1: Private sector imbalances vary considerably across countriesBubble size determined by economies GDP based on PPP valuation of country GDP in billions of international dollars.
Source: Haver, IMF WEO, BIS (as of Q3 2018)