One Chart That Terrifies Emerging-Market Investors
If you’re wondering why investors seem so worried about China and other emerging markets, consider this: Companies there have piled on more risk than at any point in at least the past decade.
One measure of a company's riskiness is how much it borrows for each dollar of shareholders' equity. Such borrowing -- or leverage -- boosts profits in good times, but also increases the likelihood of financial distress if income declines, or if investors suddenly decide they don’t want to lend anymore.
So what's happening with leverage in emerging Asia, Eastern Europe and Latin America? To get a sense, I queried the Bloomberg terminal for financial data on more than 1,300 publicly traded non-financial companies in those regions (for ease of number-crunching, I limited the group to companies with more than $1 billion in assets). I then calculated their aggregate ratio of debt to common equity, and compared it to a similar group of companies in Western Europe and the U.S. The comparison isn’t perfect, because companies in different countries use different accounting standards, but it's good enough to get an idea. Here's what emerged:
The chart suggests that back in 2007, non-financial companies in emerging markets typically didn’t get as levered as their developed-nation counterparts. They had less than 60 cents in debt for each dollar in equity, compared with more than 80 cents in the developed world. This makes sense: Income for these companies should be more volatile and their access to capital more dependent on the changing whims of global investors, so they probably can’t afford to borrow as much.
As of the latest financial filings, though, corporate leverage in emerging markets had surpassed that in developed nations, exceeding 90 cents in debt for each dollar in equity. Among Chinese companies, the number was even higher: $1.06 per dollar in equity. In other words, companies in the developing world have been borrowing as if they were operating in much more mature and stable markets than they really are -- encouraged by a combination of extremely low interest rates and yield-hungry investors.
True, companies in both emerging and developed markets have boosted their borrowing in recent years, which explains increasing concern about creditworthiness everywhere. China and the emerging world, though, really do stand out.
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