David Worsfold
Last week, the International Monetary Fund held a briefing in Washington to update its World Economic Outlook. With UK Prime Minister Theresa May’s first major speech on Brexit and the fever pitch of speculation in the run-up to the US presidential inauguration, the IMF didn’t command the headlines it usual does.
Its generally optimistic forecasts, confirming its autumn predictions of a healthy 3.4% global growth this year with a further uplift to 3.6% in 2018, perhaps seemed rather too “steady-as-she-goes” to excite commentators unduly. The more bullish view of the UK economy, with this year’s growth forecast up from 1.1% to 1.5% was heralded in much of the UK media as an indication that Brexit is not going to harm the British economy as much as had been feared but much of the usual detailed analysis was absent.
The IMF update deserves closer scrutiny as it isn’t all sweet optimism, as Maurice Obstfeld, director of the IMF’s research department, commented at last week’s briefing: “Our earlier projection, that world growth will pick up from last year’s lacklustre pace in 2017 and 2018 looks increasingly likely to be realised. At the same time, we see a wider dispersion of risks to this short-term forecast, with those risks still tilted to the downside. Uncertainty has risen”.
Uncertainty was a recurring theme of the briefing with plenty of stress laid on the potential of geo-political events to destabilise local economies and impact on the wider global picture.
Of all the potential downside risks highlighted by the IMF, one that it seems to have an especially sharp focus on is emerging market corporate debt.
Its concern started to grow at the end of last year with the US Federal Reserve’s interest rate increase, accompanied by a clear indication that this was likely to be a feature of its policy throughout 2017. The IMF says much of what the Trump administration is now promising in terms of its fiscal policies is likely to accelerate this trend.
The aspect of this that makes emerging markets more vulnerable, says the IMF, is that their corporations are especially heavily burdened with debt in both local and foreign currency — to the tune of roughly US$18 trillion — fuelled in large part by low interest rates in the United States.
This debt now makes them vulnerable to the expected interest rate increases, leading the IMF to question whether firms will be able to roll over their debt. The debt of non-financial firms in emerging markets has quadrupled over the past decade, with bonds accounting for a growing share. The debt has climbed faster in more cyclical sectors with the steepest growth seen in construction, especially in China and Latin America. 
Obstfeld was very clear on how much of a threat this might present to the IMF’s fragile optimism: “There is a lot of debt out there. It does present an overhang to the world economy.
“The surest way to ease the burden is through structural reforms that increase growth, through smart fiscal policies that are growth friendly and equitable, and prudent fiscal frameworks might help also keep debts from rising further over time, unless justified by output growth.
“This will put the debt to GDP ratios on a declining path and … some countries, those where the immediate output gaps haven’t been reduced sufficiently really need to start worrying about demographics and how that will impact fiscal sustainability in the longer term.
“In terms of corporate debt, our main worries would be those cases in which we have, for example, emerging market corporates with significant foreign currency debts which might make them vulnerable to the financial tightening that could occur and is one of our downside risks.
“I think one important fact to keep in mind in this whole discussion is that in many countries, tax systems favour debt finance over equity finance and that’s hard to justify that in terms of the economics. Reform in that area would certainly help to mitigate the problem”.
Insurers searching for value among alternative assets will want to keep a close eye on the deeper sector-specific risks the IMF and other international bodies highlight. They are a reminder that where assets offer potential value to help them ease away from the constraints of the low return world, they also harbour risks.