As the United States steps back from the edge of an unprecedented debt default, experts are warning that credit bubbles in China and other economies in Asia could plunge the region into a severe debt crisis in the absence of urgent and effective measures.
The main threat appears to come from China, where local governments may have chalked up debt totaling U.S. $4 trillion or 42 percent of the country's annual output or gross domestic product (GDP)—much higher than U.S. state and local government debt of U.S. $3 trillion.
Red flags about excessive credit growth have also been raised in Cambodia and Laos while Vietnam, reeling from a prolonged banking crisis, is being cautioned over its high short-term overseas borrowings on the back of foreign reserves which can cover only two months of imports.
The Asian Development Bank (ADB), in its latest outlook for the region this month, warned that fiscal balances in Asia are deteriorating and governments are borrowing more to finance growth.
"Credit growth has accelerated, while, in some economies, banking sector leverage has reached record highs," the Manila-based bank said. "This renders banks vulnerable to financial shocks, given their high reliance on wholesale funding."
Credit booms in the past have been closely linked to financial crises, especially in emerging markets.
The ADB warned that in emerging Asian economies, rising exposure to short-term external debt is posing a threat to their development.
The region’s ratio of short-term debt to total external debt is almost 65 percent, much higher than other emerging regions, where the corresponding figure is generally below 50 percent, the bank noted.
Short term debt is typically pulled first when crisis hits—as it was in 2008—making it a major source of vulnerability.
China 'the most worrisome'
Standard Chartered said in a recent study on debt in Asia that "China's leverage is broadly the most worrisome in the region" as credit in the world's most populous nation has expanded at a rapid 22 percent a year in the past five years.
While Beijing has promised efforts to wrestle down credit bubbles and come to grips with a burgeoning "shadow banking" system, experts are not impressed.
They expect more effective measures to be announced at the top leadership meeting of the ruling Chinese Communist Party next month.
When International Monetary Fund (IMF) Managing Director Christine Lagarde was asked at a press conference in Washington earlier this month on what reforms she could expect at the Third Plenum of the Communist Party's Central Committee, she immediately forecast steps to rein in runaway credit growth.
"[W]e would certainly hope that it is very attentive to the development of its banking and non-banking credit sector, which has significantly fueled the development of credit lately, both for housing and for local governments," Lagarde said.
The IMF said in an annual report released this month that "slowing the growth of credit, especially in the shadow banking sector, is a priority" for China.
Shadow banking usually refers to activities such as deposit-taking and extending loans by institutions that are not regulated like banks.
Experts say China's rapid credit expansion poses a systemic risk to the financial sector, increasing the danger that some investments might be of poor quality and borrowers might default.
An unnamed Chinese audit officer last month was quoted as saying by Economic Information, a newspaper run by the official Xinhua news agency, that new studies may show local debt nearly doubling from 2010. But the report was later deleted from its website, Reuters reported.
The last Chinese audit showed local debt at 10.7 trillion yuan (U.S. $1.76 trillion) at end-2010, though it had used a narrower definition of local debt than that used by banks such as Standard Chartered, which see it as high as U.S. $4 trillion.
Amid the rising debt concerns in Asia, analysts say, insufficient government policy actions to counter credit problems may adversely impact sovereign ratings of countries.
"The positive trend of Asia-Pacific sovereign ratings we saw over much of the past decade looks likely to break in the next one or two years," Kim Eng Tan, a senior director for Standard and Poor's Ratings Services, told the Hong Kong-based FinanceAsia magazine.
"We do not see a high likelihood of a sovereign rating upgrade during that period," he said.
The Standard Chartered study also highlighted debt concerns in South Korea, which has highly indebted household and corporate sectors, and India, Malaysia, Singapore and Hong Kong, all of which it says face "moderate risk."
Japan was highlighted for its total debt-to-GDP ratio, which at 400 percent of GDP is far higher than any other country's but Standard Chartered said recent dynamics do not yet suggest that problems are building in the Japanese financial system.
Financial sector supervision
In debt-laden Laos, credit growth—partly driven by public spending—has raised concerns about the health of the banking system, the IMF said.
It has called on the Lao authorities to lower credit growth targets and beef up financial sector supervision to reduce leverage.
The authorities in Laos as well as in Cambodia "are very conscious that credit growth has been very rapid, and needs to be significantly reduced," IMF's Asia chief Anoop Singh said in a briefing last week.
In Vietnam, the IMF has called for strengthening credit risk analysis and governance by promoting greater transparency .
"[T]he authorities are also concerned about the fundamentals of the economy, in particular in the corporate sector and the financial sector, and they have announced their intentions to take whatever steps need to be taken in the coming years to improve these fundamentals, especially address the NPLs [non performing loans] of banks, and take the restructuring steps that are needed on the corporate side," Singh said.
"So there is high recognition of the need to strengthen these fundamentals over the medium term," he added.
Despite the debt problems in the region, the ADB dismissed fears of a financial crisis in Asia similar to that in 1997, when a currency meltdown plunged the region into its worst recession in decades.
"Developing Asia is now in a much stronger position to weather a crisis than it was then, in large part because it restructured and reformed in response to that crisis," it said.