The prospect of faster rate hikes in the US has unnerved emerging markets in recent weeks. The low delinquency rates for US households and the higher capital ratios of banks (vis-à-vis 2007/08) suggest that the US economy has room to enjoy a strong expansion lasting a minimum of three to four years. This and rising defaults in Chinese corporate bonds could exert further pressure on EM assets heading into the New Year.
The defaults in the Chinese corporate bond market have largely been concentrated in old sectors (steel, construction, chemical and textiles). The rapid shift towards high value sectors suggests that many of the companies in ‘mature’ industries need to restructure and downsize. A shakeout in the Chinese corporate bond market and a possible devaluation will unnerve equity markets globally and may trigger a correction.
However, the pace of innovation in China is accelerating. Displaced workers have been able to find jobs in expanding services. Xiaomi’s impressive new tech park, for example, will consist of eight buildings and will be completed by 2018. The construction will be spread across a total of 22 million square metres. In this respect, comparisons between China today and the Japanese bubble of the late-1980s are wrong. When property prices started to slide in 1990, the government did not have a plan B: R&D spending was relatively low, and Japan was slow to shift into new sectors and tardy in its debt write-offs. Defaults in the Chinese corporate bond market should be welcomed. They will speed up China’s transition.
Summary
- However, longer term risks to global equities and EMs must be kept in perspective
- Defaults in the Chinese corporate bond market should be welcomed: they will speed up China’s transition
- The potential for technology to accelerate growth in EMs should not be underestimated either
