Asia Goes on a Debt Binge as Much of World Sobers Up

May 23, 2013, 11:02 p.m. ET

Asia Goes on a Debt Binge as Much of World Sobers Up

By ALEX FRANGOS in Kuala Lumpur, Malaysia, and BOB DAVIS in Beijing


A debt-fueled building boom is under way in Kuala Lumpur, Malaysia, above. The country says investing in industry will result in faster economic growth.

In the heart of Kuala Lumpur lies the abandoned foundation of Plaza Rakyat, a never-built skyscraper and shopping mall. Rusty rebar jutting from concrete pilings and fetid green pools of rainwater serve as an unintended monument to the debt crisis that ravaged Asia in the late 1990s.

Today, less than a half mile from the abandoned project, the next boom is under way in the Malaysian metropolis. Construction has begun on a new subway line, and next to one station plans call for a 118-story zigzagging skyscraper that would be the third-tallest building in the world. Cheap credit is fueling the building spree.“We need to have more iconic buildings,” says Kuala Lumpur’s mayor, Ahmad Phesal Talib. The planned office tower, called Warisan Merdeka, is part of a nationwide wave of development that will add new office buildings, train and subway lines, bridges and factories.

Recent decades have seen great fluctuations in public and private debt loads around the globe. Watch how global economic forces have affected debt-to-GDP ratios in various countries.

After eschewing credit for years following the 1990s financial crisis, Asia’s economies are once again amassing debt to fuel growth. The trend is a stark counterpoint to the debt reduction taking place in the U.S. and Europe. Some economists are growing concerned that the Asian debt revival could eventually trigger another crisis, or at least hinder growth in some of the world’s fastest-growing economies.

Few predict an imminent crisis in Asia, and sanguine observers note that rapid economic growth can make debt loads more manageable. Unlike in the 1990s, Asia has for the most part refrained from borrowing in foreign currencies, which can bring trouble if local currencies lose value.

Borrowing has increased all across the continent. State-owned companies and local governments in China are taking on more debt, as are motor-scooter buyers in Indonesia, washing-machine purchasers in Thailand and real-estate investors in Singapore and Hong Kong. Malaysia’s government has borrowed to fund the new subway and to pay for cash handouts to citizens.

Debt loads in Asia’s emerging economies—gauged by public and private debt as a percentage of gross domestic product—now exceed what they were in 1997, when Asia went into a financial crisis that lasted for several years. Much of the run-up has come over the last four years. The overall debt-to-GDP ratio rose to 155% in mid-2012, from 133% in 2008, according to the most recent data from McKinsey Global Institute, a unit of consulting firm McKinsey & Co.

China, the world’s second-largest economy, has led the borrowing binge. China’s debt-to-GDP rose to 183% in mid-2012, from 153% in 2008, according to McKinsey. Some economists, including Nomura Holdings Inc.’s8604.TO +1.82% Zhiwei Zhang, say China’s debt-to-GDP ratio has risen higher and faster, to above 200%, based on government data that more fully incorporate nontraditional “shadow” lending institutions such as trust companies, which operate in parallel to the mainstream banking system.

Increased borrowing by state-backed companies and local governments has some economists and Chinese officials worrying that China could see defaults, or a further slowdown in growth as its economy digests the debt. Economic problems in China have the potential to ripple to its neighbors in Asia and beyond.

“China’s financial system is still fragile and vulnerable,” says Yu Yongding, a Chinese economist who has served as an adviser to China’s central bank. “I don’t think there will be a financial crisis at the moment, but there are a host of land mines ahead.”

There is no simple rule of thumb for how much debt is too much. Economists contend that large developed economies with sophisticated credit markets are capable of sustaining higher debt levels—both public and private—than developing nations. From 2008 to mid-2012, the debt-to-GDP ratio in the U.S. dropped from 367% to 346% as businesses and consumers paid down debt—but still leaving debt levels far higher than in emerging Asia.

What has grabbed the attention of economists is the pace of credit growth in Asia.

Asia’s banks and credit markets are more developed than they were in the 1990s. Economists believe such improvements enable economies to sustain higher debt levels without hampering growth. When used sensibly, credit can help countries invest more in factories, roads and other infrastructure, which can spur growth.

“It’s OK to keep on increasing your debt. You need to keep growing your economy,” says Idris Jala, a Malaysian government minister charged with economic transformation. The bigger the economy, the more debt it can carry, he says. Although he acknowledges that Malaysia’s debts have increased, he says they are “still not as alarming as many other countries.”

In years past, however, some rapid and sustained increases in credit have foreshadowed debt crises. In Europe, increases in debt—some public, some private—proved unsustainable and led to the current economic problems there.

“You don’t want to demonize credit booms per se, but it’s a red flag,” says Giovanni Dell’Ariccia, an International Monetary Fund economist who has studied 40 years of such debt buildups. Mr. Dell’Ariccia and his colleagues have found that credit booms—defined as rapid increases in credit-to-GDP ratios—end in crises about one-third of the time. Another one-third result in below-par growth in ensuing years. In the rest of the cases, growth continues at the same pace or faster.

Following the financial crisis of the late 1990s, Asian nations became known for high savings rates and prudent financial management. They relied on manufacturing and exports to drive growth. Until 2007, private-sector debt grew at roughly the same pace as the economy in Asia.

The financial crisis prompted the U.S. Federal Reserve to cut interest rates to record lows. Asian central banks slashed rates, too. Consumers and businesses in Asia, unlike those in the U.S. where the economy was weaker, were eager to borrow.

A crisis-induced decline in global trade caused economic growth to slow in Asia. But when growth picked up again, Asian central banks were reluctant to increase interest rates aggressively. Foreign investors further fueled the Asian economy by shifting money from slow-growth regions such as the U.S., Japan and Europe to Asian stock and bond markets.

The result: Credit has been unusually cheap in Asia, and nations have been using more of it to fuel growth. So-called developing Asia—which doesn’t include more advanced nations such as Japan and South Korea—notched 8.2% annual growth, on average, between 2010 and 2012, according to the IMF. The world’s developed economies, in aggregate, grew 1.9% a year over that period.

China’s government announced a 4 trillion yuan ($645 billion at today’s exchange rate) stimulus program in the wake of the 2008 financial crisis. Chinese banks increased lending by 33% in 2009, up from 15% average annual growth over the previous six years. Between 2008 and 2010, when much of the world was in recession or recovering slowly, China’s GDP grew by 9.7% a year.

Even after the global danger had passed, credit in China continued growing faster than GDP. With exports no longer driving the economy as much, credit expansion has become a key ingredient to growth.

When China tried to slow credit growth in early 2010, the economic growth rate fell as well. Quarterly GDP growth dropped nearly without interruption for 10 consecutive quarters through the third quarter of 2012. Six months after lending started to increase again in April 2012, quarterly GDP growth—on a year-over-year basis—picked up again.

“Last year showed you can’t slow credit growth in the economy or economic growth will slow more rapidly,” says Charlene Chu, senior director of Fitch Ratings Inc. in Beijing. China’s GDP growth slipped in the first quarter to 7.7%, from 7.9% in the final quarter of 2012.

In central Hunan Province, home of fiery food and Mao Zedong, a government-owned highway company called Hunan Expressway went on a road-building spree. By the end of 2015, Hunan, roughly the size of Minnesota, expects to have more than 4,000 miles of highways.

To pay for it, Hunan Expressway amassed 174 billion yuan in debt as of last September, mostly bank loans, doubling its 2009 debt level. Despite an increase in drivers, toll revenues haven’t covered loan payments. The company recently issued one-year bonds to cover the gap. In a February report, China Lianhe Credit Rating Co. highlighted cash-flow problems.

In a written statement, Hunan Expressway said it hasn’t had any overdue loans and has enjoyed good credit ratings. “The overall repayment risks are controllable,” it said.

In the mid-2000s, state-owned shipping giant China Cosco Holdings Co.601919.SH +0.29% grew rapidly by buying and chartering ships. When the financial crisis hit, shipping rates collapsed, a glut of shipping capacity developed, and revenue fell sharply. The company borrowed from state-owned banks and sold corporate bonds, which allowed it to avoid layoffs. Total debt rose to 123.5 billion yuan in 2012, from 85.2 billion yuan in 2009.

Cosco is “controlled by the Chinese central government,” says BarclaysBARC.LN -3.71% analyst Jon Windham. “The hand of the market that would normally force a company to get smaller is just not there.”

Some economists contend that China’s debt problems are isolated and won’t infect the general economy. They say the central government has a relatively low government-debt-to-GDP ratio of about 20%, giving it plenty of firepower to bail out ailing enterprises.

In Malaysia, growth has hovered around 5% for the past two years, despite weak exports. Households have been gorging on credit-card debt and mortgages, and developers have been snapping up bank loans.

Malaysia’s debt-to-GDP ratio rose to 242% in mid-2012, from 192% in 2008, according to McKinsey. The run-up includes a steady increase in government debt and debt to government-linked companies.

Mr. Idris, the government minister charged with economic transformation, says: “We don’t want investment for the sake of throwing around money. We want to direct investment in places where we have an advantage.” Among the industries where more investment will make Malaysia more competitive, he says, are oil, gas, financial services and high-tech manufacturing. Such spending will result in faster growth and higher incomes, which will enable the country to pay off its accumulating debt, he says.

Kuala Lumpur last boomed in the 1980s and 1990s. Blistering growth back then in Southeast Asia’s so-called tiger economies ended in a debt-fueled crisis. Malaysia was hard hit. Its currency plunged and businesses failed. The economy shrank 7% in 1998. Construction projects such as Plaza Rakyat were abandoned.

Malaysia rebounded in the 2000s thanks to export growth. Now, with exports slumping, the government is pouring money into big capital projects.

The Mass Rapid Transit Corp., a subsidiary of the Ministry of Finance, is building the first half of a planned 60-mile subway system in Kuala Lumpur, to be financed with $10 billion of bonds. Although many residents and economists think a bigger system will benefit the city’s economy, critics worry that taxpayers might eventually get saddled with the debt. A monorail project built in the 1990s under a similar structure required a public bailout in 2001.

The Malaysian government is pushing for the construction of new office buildings across Kuala Lumpur and using government resources to fund them. Yet office vacancy rates in the city already exceed 20%, the highest level since 2003, according to government statistics reported by CEIC Data.

State-run Permodalan Nasional Berhad, a government investment manager, is the developer of the Warisan skyscraper, which is projected to have as much space as the Empire State Building. The PNB plans to use the tower to house companies it owns, which would empty space elsewhere.

A few miles away, construction has started on Tun Razak Exchange, with more than a dozen towers planned. 1Malaysia Development Berhad, a government investment entity spearheading the project, says it has investors from Abu Dhabi. It recently issued nearly $4 billion in bonds.

There is even talk about reviving the abandoned Plaza Rakyat project.

The city’s mayor, Mr. Ahmad, says the goal is to attract 100 new multinationals, stealing business from nearby Singapore.

He dismisses concerns about the high vacancy rate. “It’s decided by the government,” he says. “We need to provide these types of very premier office space.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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