In a normally functioning economy debt has an important and beneficial role. It shifts purchasing power from savers to consumers of capital, allowing young people to anticipate consumption and governments and entrepreneurs to invest. This process is healthy and promotes growth.
However, debt accumulation loses its utility under several circumstances. First, it tends to be highly cyclical and prone to accentuate the volatility and swings of both the economic cycle and asset prices. Second, it exhausts itself when debt is directed to unproductive ends which do not generate the cash flows to service interest.
The debt cycle that the world has experienced over the past decades is characterized by these two circumstances. As debt levels have skyrocketed in both China and the United States, the marginal utility of the debt has diminished. Both countries face a reckoning of massive debt overhangs, which will impede future growth, made even worse by the worst demographics in a century. Moreover, as the credit data from the Bank for International Settlements (BIS) shows below, the debt problem is global in nature. Emerging Markets as a whole face the same quandary, facing a large overhang of debt, often with currency mismatched, much of which was used to finance non-productive activities.
However, the emerging market debt figures are highly influenced by the weight of China. A more granular view of emerging markets shows considerable differences within the asset class. We can see this in the table below. Several countries stand out for their relatively low total debt-to-GDP ratios, particularly Mexico and Indonesia which are both below 100% of GDP, while others are noteworthy for the very high levels of debt assumed in absolute terms and relative to their financial histories (China, Korea, Malaysia, Chile, Brazil).
It is also important to look at the composition of this debt for each country, between public and private debt, and the growth rate of the debt. Relative low public debt indicates the capacity to invest in the public goods (social and physical infrastructure) which are needed for countries to grow. High levels of public debt also cause a crowding out of the private sector and more productive investments. We can see that in this regard South Africa, Brazil, China and Argentina are in bad shape as they have very high and increasing debt levels, and these are countries that face enormous demands from their citizens for public goods (infrastructure, education, social safety nets, etc…) With the exception of China, these countries have managed to accumulate this debt without investing in public goods and continue to borrow to cover current spending. Not by coincidence, the countries that have the lowest levels of public debt are also those that have seen the slowest pace of debt accumulation: Russia, Chile, Thailand, Turkey, Indonesia, Mexico and Korea. These countries have maintained the capacity to invest in public goods.
With regards to private debt, several countries also stand out. China, Korea and Chile have high levels of private debt which has grown at a rapid pace. In the case of China and Korea, this points to vulnerability for sustained consumption and potential deflationary pressures. For Chile, much of the private debt has been assumed for foreign ventures, with dubious benefits for the domestic economy and uncertain returns. Colombia, Mexico and Indonesia have low levels of private debt and low growth of debt, and therefore have capacity for reflationary credit expansion.
Finally, we should look at these relatively unleveraged countries in the context of potential GDP growth. Countries with debt accumulation potential, growth in the working age population and GDP growth above 3% should offer relatively better opportunities for investors. I would put the Philippines, India, Mexico, Indonesia and Turkey at the top of my list of countries that retain healthy growth profiles. Unfortunately, both Turkey and Mexico currently face problematic political leadership which makes it difficult to attract investment capital.
