Credit boom stokes risks in emerging markets, BIS warns

Credit boom stokes risks in emerging markets, BIS warns

London: Loose global monetary conditions are stoking credit and asset price booms in some emerging markets that could lead to a new financial crisis, the Bank for International Settlements (BIS) warned on Sunday.

Such a boom-and-bust cycle might have severe global repercussions, not least due to the increased weight of emerging markets in the world economy and in investment portfolios, BIS said in its annual report.

It urged central banks to pay more attention to the global spillovers from their domestic policies, an echo of complaints from Brazil and others that the ultra-loose monetary stance in older economies has touched off large, destabilizing flows of capital into emerging markets in search of higher yields.

Credit growth that is well above its long-term trend in relation to economic growth opens up a gap that has often presaged serious financial distress when it has exceeded 6% in the past, the report said.

Thailand and Turkey have credit gaps of 15% or more, while Brazil and Indonesia are also in the danger zone above 6%, according to BIS.

Real credit growth in Argentina and China has also far outpaced gross domestic product (GDP) growth, but their credit gaps are well below the 6% threshold.

Asset prices also look increasingly frothy in many emerging economies, BIS said. In some local Brazilian markets, real estate prices have almost doubled since the subprime crisis. The prices in some Chinese cities have risen even faster.

High debt loads could be a problem, too.

The fraction of GDP that households and firms in Brazil, China, India and Turkey are allocating to debt service stands at its highest level since the late 1990s, or close to it, even though the interest rates are low.

BIS acknowledged that emerging market central banks are nursing a policy headache: raising interest rates may attract even more capital inflows and, thus, fuel domestic credit growth.

As a result, it said, monetary policy in emerging markets may be systematically too loose.

“One way out is to accompany higher interest rates with macroprudential measures such as higher capital ratios or tighter loan-to-value ratios. And, even if these tools fail to slow credit growth significantly, they should at least reinforce the financial system against the consequences of a credit bust."

BIS also urged emerging markets to wean themselves off exports because prospects for the world economy are poor: only two out of 28 representative economies can expect their trading partners to grow faster in 2011-2015 than in 2003-2007.

For example, around one fifth of Thai exports goes to countries where growth is projected to drop by no less than 2 percentage points in 2011-15.

Russia and India are also vulnerable to the slower growth expected in their trading partners—Ukraine and Turkey for Russia, and the Middle East for India, BIS said.

BIS was formed in 1930 and acts as a central bank for the world’s monetary authorities. It said extraordinary measures have reduced incentives for politicians and other borrowers to repair balance sheets, and created the illusion that central banks can do much more to stoke growth and redress imbalances.

Central bank policy buys time in the short term for banks and governments to tackle debt overhangs, BIS said. European finance ministers meeting in Luxembourg last week battled over strategies to contain the debt crisis. Leaders are due to hold a summit on 28-29 June, which will be their 19th since the turmoil erupted.

Bloomberg contributed to this story.