A WORLD getting comfortable again with high debt but few defaults looks set for a rude awakening next year — and not just in the United States.

    As the U.S. Federal Reserve prepares to jack up interest rates next month and the U.S. dollar climbs again, anxiety over an alarming accumulation of corporate and household debt in emerging economies from China to Malaysia, Russia to Turkey, Mexico and Brazil has been building for the past five years.

    Characterized by Goldman Sachs as a possible third wave of the credit crash — the first being a sub-prime housing bust and serial banking collapse of 2007/08 and the second the euro sovereign debt crisis of 2011/12 — emerging market borrowing is now vulnerable to any reversal of the easy money policies the rich world adopted to cope with the first two waves.

    The reality of default and debt repayment stress will be a stark reminder of just how little deleveraging, or paying down of debt, has actually happened worldwide since 2007.

    According to Barclays research, default rates among sub-investment grade firms in emerging markets will almost double next year to as high as 7 percent from virtually zero just five years ago and well above 20-year averages of about 4 percent.

    High-yield emerging market default rates are already above U.S. corporate “junk” equivalents — also likely to double next year to more than 5 percent. And the gap is rising.

    Barclays points out this phenomenon is pretty rare without sovereign debt crises, notably absent in developing countries right now. But the unusual confluence of a China-led slowdown just as the West picks up is creating all sorts of currency and interest rates tremors that have sunk commodity prices and exaggerated local currency slumps alongside creeping dollar interest rates.

    That sort of default horizon is jarring given the scale of debt built up and the concern of an emerging credit crunch related to capital outflows over the past two quarters, estimated by JP Morgan to be unprecedented US$570 billion. Almost two thirds of that came from China.

    The debt build-up has been a growing source of angst for global watchdogs. In late September, the International Monetary Fund warned that a quadrupling of emerging market corporate debt over the past decade to a record US$18 trillion needed careful monitoring as the era of low interest rates came to an end.

    The Bank for International Settlements then estimated last month that up to US$3 trillion in non-financial emerging firms’ debt was dollar-denominated — a third of which were bonds — and said this would be stressed given the dollar had jumped about 30 percent against many local currencies over the past 12 months.

    And credit rating firm Standard and Poor’s reckons emerging market companies whose debt it monitors must repay or refinance roughly US$225 billion in dollar debt by the end of 2017 and US$500 billion by the end of 2020.

    More worryingly, the build-up of emerging market debt is not confined to the corporate sector. Ballooning household debt is also likely to raise questions for local banks, which have some US$700 billion outstanding in dollar-denominated bonds.

    The Washington-based Institute of International Finance (IIF), a banking industry group that specializes in emerging market investment flows, said this week that global household debt had risen by US$7.7 trillion since 2007 to more than US$44 trillion and that US$6.2 trillion of that rise was in emerging markets.

    Household debt per adult in emerging economies rose by 120 percent over that period to some US$3000, it added.

    Overall debt as a share of national output is also climbing, the IIF said. Total household, non-financial firms and public-sector debt was up almost 44 percentage points since 2007 to some 165 percent of gross domestic product.

    Against that backdrop, the prospect of a tougher credit environment and rising defaults is sobering — particularly in China, where the lion’s share of the debt has built up. (SD-Agencies)