It’s not Europe: Credit issues in emerging markets  

May 21, 2012

In emerging markets both the banks and the regulators are often subject to the whims of the state. So the size of the credit problems that actually lurk on their balance sheets may eventually make Europe’s problems look quite small

William Gamble

It’s all about Europe. Every day we read and hear in a never-ending stream about the problems in Greece. If the story is not about Greece, then it is about bad debts in the periphery countries of the EU (European Union) including Spain, Portugal, Italy and Ireland. The sovereign debts of these countries are supposed to be shaky and the holders of their debt, including many banks, could be in real trouble.
 
Isn’t it all a bit passé? I mean we have been hearing about this since I wrote my first column over two years ago. One has to ask whether these problems were any better or worse six months ago last fall? I doubt it. Despite the European problem markets all around the world have done rather well. The S&P index has increased over 10% even with its recent correction. The German index, the DAX, is up 23% since its lows of last September. There are debt problems lurking in the world economy, but they are somewhere else.
 
The best way to track a potential credit crisis is to look for a recent credit splurge. A good place to start would be Asia. Asia certainly has had its share of credit recently. It helped fund a period of exceptionally high growth, but like the housing bubble in Spain, high growth tends to mask problems.
 
To find the largest problems it is perhaps best to start with the region’s largest economy, China. China’s real estate bubble has been threatening for a long time. It has between 10 to 65 million vacant properties. Whole cities are vacant and unused. In addition, there are an estimated $464 billion worth of bad loans to local governments. Bad debt ratios for Chinese banks could be as high as 30%. But China is not alone.
 
The Chinese economy has an enormous impact throughout Asia especially on commodities producing countries like Australia. According to Societe Generale strategist, (uber-bear) Albert Edwards, “Australia, at its simplest, is a credit bubble built upon a commodity boom dependent for its sustenance on an even greater credit bubble in China.” Australia has not had a recession since 1991. Like the housing bubble in the US, Australians have assumed that the past growth in housing prices will continue indefinitely into the future. The result is house prices have risen 300% since 2000, 100% more than in the US at its peak. Unlike the US, Australian house prices have not corrected.
 
But it is not just East Asia. India’s problems with high commodities prices, a falling rupee, and high interest rates are severe. According to a survey of 100 bankers by the Reserve Bank of India (RBI), bad loans are the most significant risk to the financial system. No bank is more exposed than India’s largest bank, the State Bank of India. Like other state-owned banks in emerging markets it invested in infrastructure at the encouragement of its political owners. Infrastructure is invariably a pit of corruption and waste.
 
The economic boom in Brazil has slowed, but the credit growth of over 25% per year has left many problems. Last year Brazil reported the highest default rate in nine years. One of the largest Brazilian banks, Itaú Unibanco, increased its provisions for bad debts by 38%.
 
Turkey’s credit has been growing at more than 30% which helped fuel its economic expansion. But now households are stuck with a debt to disposable income ratio that has risen from 35% to 45% in the past two years.
 
Not to leave anyone out, last year the Russian state and a large state-owned bank bailed out the Bank of Moscow to the tune of $14 billion. Even in Kenya credit to private households has increased by 32% in 2011, creating another potential credit bubble in one of the world’s poorest countries.
 
This is a globalized world. So a problem in Asia or in emerging markets is not just a problem for local banks. Citigroup in the US gets more than half of its profits from emerging markets. The Spanish bank, Banco Santander, has a large presence in Latin America and recently had a 32% surge in loan losses in Brazil. Both Standard Charter and HSBC have large exposures to Asia.
 
Many analysts are quick to assure investors that banks in emerging markets are well capitalized and there isn’t anything to worry about, but how do they know? Banks in Europe have gone through two stress tests to determine their risks, yet estimates of bad loans keep rising. The regulators in Europe are reasonably honest and independent from politicians. In addition, they are regulating mostly private banks. In emerging markets both the banks and the regulators are often subject to the whims of the state. So the size of the credit problems that actually lurk on their balance sheets may eventually make Europe’s problems look quite small.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected]).