There are many things that seem like a good idea at the time, and being highly-leveraged is one of them. Corporates that gorged on cheap debt when rates were low continue to face an uncertain future as the macro environment, and higher interest rates, have turned against them. For some, with the benefit of hindsight, it now seems their pursuit of leverage was a risky strategy.
Concerns have persisted in Asia in recent months about the level of corporate indebtedness, and the impact that higher interest rates has had on companies’ ability to make their repayments. This in turn has led to fears of defaults among Asian corporates. While those issues remain, there is some hope on the horizon and there are several reasons for observers to have a more positive outlook about the months ahead.
A number of economists have pointed out how Asia’s corporates have been struggling to repay their debts in the face of rising interest rates. For example, companies, in the ASEAN+3 region [which comprises the Association of Southeast Asian Nations as well as China, Japan and South Korea], are more leveraged than their global counterparts.
In a briefing note on debt sustainability published in February 2023, the Organisation for Economic Cooperation and Development (OECD) noted that Asian corporate debt in 2022 comprised almost half of the outstanding debt on a global level. And Chinese corporates took up a large chunk of this, with 30% of global outstanding debt.
There are other measures that point to the concern around corporate indebtedness. The ASEAN+3 Macroeconomic Research Office (AMRO) points out that the ratio of corporate debt to GDP [global domestic product] for ASEAN was 80.7% while for China, Hong Kong, Japan and South Korea it was 171.6%. This is based on data from March 2023, and AMRO Group Head and Lead Economist, Dr. Kevin C. Cheng tells Treasury Today Asia that there has been no significant change in corporate debt size and maturity since. “The current data suggest ongoing concerns about corporate debt,” he says.
The risks are higher for the companies that have shifted away from bank loans towards bond issuance, which leaves them exposed to market risk. As the macro environment has become less favourable, they face the uncertainty about whether they will be able to refinance in the future. “It is noteworthy that over 40% of corporate bonds in the ASEAN+3 region are slated to mature within the next three years,” says Cheng.
Although there has been a recent let up in market conditions, there are still concerns that lie ahead. Cheng continues: “The financial market conditions have eased since Q323, but interest rates still remain elevated. As such, floating rate debt liabilities or maturing debts that need to roll over are expected to bear a higher interest burden.”
Interest coverage ratios
There has been particular concern about low interest coverage ratios, or the ability of a corporate to cover its debt obligations with its earnings. When earnings are divided by interest expenses, a ratio of less than 2 is generally deemed by many analysts as the minimum level that is sustainable.
In a blog, International Monetary Fund (IMF) economists Thomas Helbling, Shanaka Peiris and Monica Petrescu noted that in the middle of 2022, 17% of Asia’s corporate debt was held by companies with a level of below 1. Meanwhile, a third of corporates had interest coverage ratios of between 1 and 4.
A more favourable outlook
Now that corporates are already into 2024, the risk of default has diminished for the months ahead and ratings trends are becoming more positive. Christopher Lee, Managing Director in the Corporate Ratings group at S&P Global Ratings notes, for example, that the number of corporate defaults in Asia dropped from 12 in 2022 to two in 2023.
Regarding the outlook for the remainder of this year, Cheng at AMRO comments that the outlook for corporate indebtedness is influenced by a number of factors. “On the bright side, as private consumption remains resilient, domestic investment recovers and export rebounds, ASEAN+3 is expected to grow faster in 2024 than in 2023. The improving economic prospects will support corporate earnings growth in the region,” says Cheng.
There are other reasons for corporates to be encouraged. As global commodity prices come down, inflationary pressures in Southeast Asia and China, Japan and South Korea are expected to ease.
Buddhika Piyasena, Fitch Ratings’ Head of Asia-Pacific Corporates tells Treasury Today Asia that indebtedness per se is currently not a huge challenge. Although some sectors are facing headwinds, there are others that are bouncing back from the pandemic and have seen an improvement in their leverage.
“Compared to 2023, our expectations for 2024 and 2025 are very flattish,” says Piyasena. He notes there are particular challenges in China’s homebuilding sector, as well as the chemical sector. “All the other sectors generally have a stable leverage forecast,” he comments.
The commercial real estate sector remains challenging, says Piyasena, although this is a trend that extends to other regions. He adds that in Asia, the issues are not as acute as they are in the US and Europe, for example.
Others point to the continued woes in the property sector as a cause for concern. Lee at S&P Global Ratings notes that developers are prominent defaulters, but it is not just China where this is a problem. Lee highlights Vietnam, Indonesia and also South Korea where there is a greater risk of corporate defaults.
In China, most of the defaults have occurred in the property sector and it is property developers that take up the bulk of negative outlooks. These developers account for 40% of Standard and Poor’s corporate ratings that have a negative outlook.
Bright spots emerge
There are, however, some bright spots in the region and reasons to be cheerful. Several observers point to the positive outlook for India and Indonesia. Lee at S&P, for example, says that India has a solid outlook and expects a resilient performance for most of its rated companies. In India, Lee notes, most of the corporates that the ratings agency assesses have limited funding needs and refinancing risks, and also have relatively modest capital expenditure needs. “Balance sheet discipline and strong operating cash flows will likely keep the aggregate debt of rated companies broadly unchanged in 2024,” states Lee.
Indonesia has also emerged as a bright spot. The outlook for Indonesian corporates is favourable and Lee notes there is ample banking and capital market liquidity available for larger firms, although this is not the case for corporates with weaker ratings as they struggle to access the offshore bond market. In terms of bank loans, there is plenty of liquidity onshore in Indonesia although the lenders are focusing on less risky loans to larger more stable companies, even though are lower margin, to keep their non-performing loans in check. Lee also notes that the domestic capital markets have become a more attractive venue for corporates.
Preference for local currencies
Fitch Ratings’ Piyasena also notes the attractiveness of local markets. He comments that if dollar funding was the only avenue available for corporates, then the current environment would be a lot more challenging. “Thankfully what we have seen in markets like China, India and Indonesia is that the local currency liquidity has been very strong,” and many in those countries have been switching to local currency debt, he says. “When companies switch to the local currency they do not have to worry about the currency swap costs.”
Piyasena comments that the differential between dollar-denominated and local currency debt remains large. In India and Indonesia, however, he expects the differential to narrow. He also expects to see an improved level of activity in the dollar debt market in those countries – not just with high-grade corporates but also the high-yield segment.
Interest rate expectations
Many corporates were facing difficulties because of the monetary policies of central banks around the world to rein in inflation, and with rising rates, their ability to meet their debt repayments became more strained. Whether corporates can survive the current environment depends to some extent on what will happen to interest rates in the coming months.
Analysts have commented on what they expect to happen. Eunice Tan, Head of Credit Research Asia-Pacific at S&P Global Ratings, explains that the US Federal Reserve has made progress in tackling inflation. However, she does not expect the Fed to cut rates too quickly as consumer inflation is unlikely to fall sharply as economic momentum is strong and labour markets are still tight. She argues that the Federal Reserve will be cautious and other economies will follow this approach. “We expect central banks to take their time cutting rates. They will look at what the Fed is doing, with an eye on their currencies.”
Piyasena comments that Fitch Ratings expects the US Federal Reserve to cut its rate in the middle of 2024, which may be followed by three further rate cuts.
Even though a reduction in interest rates is good news for corporates who have been grappling with a rising cost of debt, it is not necessarily the end to their worries. Even if rates do fall, AMRO’s Cheng comments that the rates are unlikely to fall to the low levels that were seen in the past decade.
“Interest rates will likely remain higher for longer and though borrowing conditions may ease from current levels, they will stay tighter than those we have typically seen over the past decade,” continues Cheng.
Investor expectations
As corporates are hoping for a more favourable interest-rate environment, this will have an impact in other ways. “On the other side, with dollar rates coming down, investors will have to search for yield,” says Piyasena. As interest rates rose, there was more of a focus on money market funds, he comments, but as the rates outlook is changing – and rates are likely to fall – some of that activity may return to corporate fixed income.
That money will have to look for a home, and as rates come down investors may be willing to look at other kinds of corporates to invest in. They may not just invest in high-grade US corporates, for example, but may be willing to look at quality high-yield exposure. Corporates with a BB rating could be a sweet spot, adds Piyasena.
For fixed income investors, says Piyasena, there are certain markets that are attractive. China is a slow growth story with the main question being how quickly the government can stem the downside pressures on the economy. Meanwhile, the economies of India and Indonesia remain favourable. “India seems to be a darling for fixed income investors,” concludes Piyasena.
With bright spots such as these, the landscape for Asian corporates is not all doom and gloom. While concerns about the level of indebtedness remain, there are still many reasons to be optimistic about the months ahead.
