Why corporate debt is a risk to the global economy

Global corporate debt is at record levels, representing a growing risk to the global economy, says the Organization for Economic Cooperation and Development (OECD).

In a new report, the global policy group says that corporate debt issued by non-financial companies finished 2018 at record levels, reaching $13 trillion (all figures in U.S. dollars), which is double the amount it reached before the global financial crisis in 2008.

Much of the growth in corporate bond issuance has come in emerging markets, led by companies in China, which now rank collectively as the second biggest source of corporate debt. Chinese companies were negligible issuers before the global financial crisis, it says.

This increase in corporate debt represents a potential vulnerability, the report suggests. “In the case of a downturn, highly leveraged companies would face difficulties in servicing their debt, which in turn, through lower investment and higher default rates, could amplify the effects of a downturn,” it warns.

Not only has the size of corporate borrowing grown sharply, but the OECD reports that the composition of bond issuance has also changed dramatically, with the lowest-quality investment grade bonds now accounting for more than half (54%) of outstanding corporate debt. This represents a historic high for these bonds, it notes, adding, “There has been a marked decrease in bondholder rights that could amplify negative effects in the event of market stress.”

The report estimates that a financial shock similar to the one experienced during the 2008 crisis would hit the fixed income market with $500 billion worth of corporate bonds being downgraded to non-investment grade status within a year, “forcing sales that are hard to absorb by non-investment grade investors.”

The OECD also reports that, while annual corporate bond issuance has averaged $1.7 trillion in the 10 years since the crisis—which is double the $864 billion in average annual issuance in the years leading up to the crisis—global net issuance declined by 41% in 2018 compared to 2017.

“Importantly, net issuance of non-investment grade bonds turned negative in 2018 indicating a reduced risk appetite among investors,” it says. “The only other year that this happened over the last two decades was in 2008.”

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.