Global debt nears record high as rate hikes trigger ‘adjustment crisis’ says top trade body

The global debt pile grew by $8.3 trillion in the first quarter to a near record high of $305 trillion as the global economy faced a “crisis of adjustment” to the rapid tightening of monetary policy by the of central banks, according to a closely monitored report from the Institute of International Finance.

The financial sector body said the combination of such high debt levels and rising interest rates drove up the cost of servicing that debt, triggering concerns about leverage in the financial system.

Central banks around the world have been raising interest rates for more than a year in a bid to curb skyrocketing inflation. The US Federal Reserve earlier this month raised the federal funds rate to a target range of 5%-5.25%, the highest since August 2007.

“With financial conditions at their tightest levels since the 2008-2009 financial crisis, a credit crunch would lead to higher default rates and result in more ‘zombie companies’ already approaching around 14% of listed companies in the United States,” the IIF said in its quarterly Global Debt Monitor report late Wednesday.

The sharp increase in the global debt burden in the three months to the end of March marked a second consecutive quarterly increase following two quarters of sharp reductions during last year’s series of aggressive monetary policy tightening. Non-financial corporations and the government sector led much of the rebound.

“At nearly $305 trillion, global debt is now $45 trillion above its pre-pandemic level and is expected to continue to rise rapidly: despite concerns about a potential credit crunch following the recent turmoil in the banking sectors of United States and Switzerland, government lending needs remain high,” the IIF said.

The Washington, D.C.-based organization said an aging population, rising health care costs and substantial climate finance gaps were putting pressure on government budgets. National defense spending is expected to increase over the medium term due to heightened geopolitical tensions, which could potentially affect the credit profile of both governments and corporate borrowers, according to IIF projections.

“If this trend continues, it will have significant implications for international debt markets, particularly if interest rates stay higher for longer,” the report noted.

Total debt in emerging markets hit a new all-time high of more than $100 trillion, about 250% of GDP, up from $75 trillion in 2019. China, Mexico, Brazil, India and Turkey were the largest contributors to the rise.

In developed markets, Japan, the US, France and the UK posted the sharpest increases over the quarter.

Banking turmoil and the “crisis of adjustment”

The rapid tightening of monetary policy has exposed fragile liquidity positions in a number of small and medium-sized banks in the US and led to a series of meltdowns and bailouts in recent months. The resulting market panic eventually spread to Europe and forced the emergency sale of Swiss giant Credit Suisse to UBS.

The IIF suggested the companies suffered a “crisis of adjustment” to what it called a “new monetary regime”.

“Although recent bank failures appear more idiosyncratic than systemic and US financial institutions have much less debt (78% of GDP) than they did before the 2007/8 crisis (110% in 2006), fear of contagion has prompted significant withdrawals of deposits from US regional banks,” the IIF said.

“Given the central role of regional banks in credit intermediation in the United States, concerns about their liquidity positions could translate into a sharp contraction in lending to some segments, including households and subbank businesses.”

This tightening in credit conditions could hit small businesses in particular, the IIF said, as well as cause higher default rates and more “zombie companies across the board.”

Zombie companies are businesses with sufficient earnings to allow them to continue operating and pay interest on their debt, but not to pay off the debt, meaning any cash generated is immediately spent on debt. The company is therefore “neither dead nor alive”.

“We estimate that about 14% of US companies could be considered zombies, with a substantial portion of these in the healthcare and information technology sectors.”