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Next Debt Crisis: Will Liquidity Hold?

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Next Debt Crisis: Will Liquidity Hold?

Highlights

Crisis. The next global downturn is unlikely to be as severe as 2008-2009 given that contagion risk from higher government and Chinese corporate leverage is limited (see section 1).

Transmission. We’re watching market movements on U.S. speculative-grade (e.g. “cov-lite”) and Chinese corporates (section 2). Global capital flows could amplify investor reaction in these segments.

Ratings. Notwithstanding a low interest rate environment, higher leverage has seen issuer ratings trend down globally over the past decade (see sections 3, 4 and 5).

Mar. 12 2019 — Will the next financial crisis be as bad as 2008-2009? Global debt is certainly higher and in many cases riskier than a decade ago. Nonetheless, the likelihood of a widespread investor exodus is contained, in S&P Global Ratings’ view. The increased debt is largely driven by advanced-economy sovereign borrowing and domestic-funded Chinese companies, thus mitigating contagion risk.

That’s not to say there is no vulnerability. A perfect storm of realized risks across geographies and asset classes could trigger a systemically damaging downturn. This downside scenario reflects an increased reliance on global capital flows and functioning secondary market liquidity.

It also reflects bottom-up risks, given that many speculative-grade corporate borrowers have obtained financing on reasonably good terms for much of the past decade. In looking at 11,947 corporates, we find the proportion of companies having aggressive or highly leveraged financial risk has risen slightly, to 61%. While defaults in recent years have been low, this could change.

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