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Credit Cycle Indicator Q2 2023: Peak In Early 2021 Highlights Credit Risks Now

Editor's note: This article is a compilation of the five Credit Cycle Indicator sidebars from our Q2 2023 Credit Conditions reports (see Related Research).

A credit correction is underway. That is the signal from our global and regional Credit Cycle Indicators (CCI), which are our proprietary, forward-looking measure of credit conditions. S&P Global Ratings' regional and global CCI have flagged the potential for increased credit stress since the indicator peaked in early 2021.

Peaks in our indicators tend to precede periods of negative credit developments by six to 10 quarters. The CCIs have since trended down, suggesting a credit correction, but the potential impact on nonperforming loans and defaults could linger beyond the current period.


Credit Cycle Indicator Points To Possibility Of Heightened Credit Stress

During the four quarters since the first quarter in 2020, the Global Credit Cycle Indicator (CCI) trended upwards and reached a peak of 2.8 standard deviations in the first quarter of 2021. This suggested a potential rise in credit stress in late 2022 or early 2023 (see chart 1). While the CCI is trending downward--indicating a credit correction is underway--the potential impact of the buildup of nonperforming loans and defaults could linger beyond the stress period in late 2022 and early 2023.

For more details about our proprietary CCI, see "White Paper: Introducing Our Credit Cycle Indicator," published on RatingsDirect on June 27, 2022.

Chart 1



Banking Turmoil To Intensify Credit-Correction Effects

When we introduced the Asia ex-China, ex-Japan CCI in June 2022, we signaled the risk of heightened credit stress occurring in late 2022 or early 2023. The Asia ex-China and Japan CCI has been trending downward since its peak in the first quarter of 2021, suggesting a credit correction is underway.

In particular, the slowdown in credit availability will further exacerbate already-tight funding conditions for borrowers. Likewise, the potential effect of the buildup of nonperforming loans (NPLs) and defaults could linger even further. Outside Asia, property prices are correcting across markets such as Australia and New Zealand. If combined with a pickup in unemployment, this could hit banks' asset quality and households' balance sheets.

Chart 2



Since reaching a peak of 1.5 standard deviations in the first quarter of 2021, the China CCI has been trending downward. This decline, driven by the household sub-indicator, reflects a slower pace of household borrowing. China's recent reopening could support the recovery for corporates, especially those dependent on mobility. That said, property sales remain weak--despite a slew of supportive policies--and household caution and subdued consumption may persist.

The recent downward trend in the corporate sub-indicator suggests a credit correction is underway. However, recent reports of late commercial bill payments and bank loan restructurings signal underlying distress (see "Corporate Top Trends Update: Asia-Pacific Credit Outlook 2023: Sand In The Gearbox," Feb. 21, 2023), and credit events may yet surface. Meanwhile, the Chinese Communist Party's emphasis on financial stability (see "Credit FAQ: What The "Two Sessions" Say About Chinese Government Finances," March 20, 2023), suggests a strong stimulus-led recovery may be less likely. That said, China's corporate sector leverage remains a pain point given the low productivity of state-owned enterprises (SOEs; see "Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap," Sept. 20, 2022). This is a point to watch given the current flattening of the corporate sub-indicator.

Chart 3



The Japan CCI continues to decline from its peak of three standard deviations in first quarter of 2021, reflecting the broad downward trend in both the corporate and household sub-indicators.

Japan's gross nonfinancial corporate debt is still rising as uncertainties over global economic conditions continue, but the pace has been modest compared with the sharp uptick in 2020, corresponding to the onset of COVID.

While a buildup of cash holdings has helped keep net debt stable or to even improve, this cash distribution could be uneven. We expect the Bank of Japan to begin hiking its policy rate this year (see "Economic Outlook Asia-Pacific Q2 2023: China Rebound Supports Growth," March 27, 2023). A sharp increase in interest rates would exacerbate interest rate burdens in the corporate sector, and squeeze businesses' profitability (see "Japan's Credit Risks Could Rise With Costlier Financing If Growth Falters," Feb. 23, 2023).

Heavily indebted small to midsize enterprises (SMEs) (mostly unrated) are particularly vulnerable. They have less capacity for additional borrowing and weaker cash build, and therefore face greater risks to creditworthiness.

Chart 4


Emerging Markets

Signs Of Heightened Credit Stress In Early 2023

Over four quarters since the first quarter of 2020, the emerging market (EM) ex-China CCI has trended upward. The indicator reached a peak of 2.4 standard deviations in the first quarter of 2021. This suggests potentially greater credit stress from late 2022 through 2023 (see chart 5).

The aggregate indicator seems near to an inflection point, as some countries such as Chile and South Africa appear to have reached their CCI trough, while for others, credit conditions are expected to ease further in the next six to 10 quarters (Colombia, Malaysia, and Poland).


The corporate sub-indicator is trending down as corporate debt stalls, mirroring high funding costs in international and domestic markets, especially for companies at the lower end of the rated spectrum.

Equity prices keep on declining (particularly in Colombia, Mexico, Malaysia, Poland, and South Africa) as credit risk pressures mount, with persistent inflation leading to lower demand and margin compression. Slow economic activity and excess capacity in some cases keep corporate credit demand low, since investment needs are limited.


The decline in the household sub-indicator has moderated. Household borrowing is slowing, except in Brazil. This comes amid a weaker economic environment that is slowly eroding purchasing power. Property prices have not tracked any discernable pattern so far (with the exception of Turkiye), but may face a correction should interest rates continue at high levels.

Chart 5



Credit Cycle Signs Flagged The Potential For Heightened Credit Stress In Late 2022 Or Early 2023

Over the five quarters from the first quarter of 2020, as the pandemic took hold, the Eurozone CCI trended upward, reaching a peak of 3.1 standard deviations in the second quarter of 2021 (see chart 6). Based on statistical precedent, this points to potential heightened credit stress in late 2022 or early 2023. The most recent figures, for 2022, were characterized by the post COVID-19 recovery, which was reflected in the CCI trending downward. Yet, latent financial vulnerabilities often take time to surface, and the seeds may already be sown for the next credit downcycle, when NPLs and defaults could pick up in response to a trigger event.


Since peaking in the first quarter of 2021, the eurozone corporate sub-indicator has descended rapidly from a height of 3.1 standard deviations (in the first quarter of 2021) to -0.9 in the third quarter of 2022. The economic rebound from the pandemic has spurred growth across the eurozone, helping push down the corporate credit-to-GDP ratio, which fell to 109% in the third quarter of 2022, from 115.2% six quarters earlier.

And yet, debt in the corporate sector remains at historic highs in nominal terms. Though a declining CCI reading signals moderating stress down the road, higher rates, tougher financing conditions, and a stagnating economy may expose financial vulnerabilities within the corporate sector.

Given the widespread extension of debt maturities in recent years, we still see limited short-term refinancing risk, although weaker borrowers seeking additional financing for working capital or growth, especially unrated SMEs, may struggle.


The household sub-indicator follows a similar trend to that of corporates: a sharp peak followed by a large decline across 2021 and into early 2022. Over that period, total credit to households as a percentage of GDP decreased to 58.3% by the third quarter of 2022, down from 62.5% six quarters earlier.

This moderation must be viewed in the context of a cost-of-living squeeze across the eurozone. A key unknown for European households is how long they will have to shoulder high energy costs. Many governments continue to have subsidy programs in place to dampen consumers' pain.

This will likely keep retail energy prices higher for longer, even if wholesale prices fall back. Savings accumulated during the pandemic should help fund household budgets. However, an economic downturn involving higher unemployment would squeeze those with little savings, prompting some households to turn to expensive consumer credit markets.

Chart 6


North America

Credit Stress Heightens, Bank Turmoil Could Add More Pain

Since introducing the North America CCI in June 2022, we have signaled the risk of heightened credit stress unfolding in late 2022 or early 2023. The CCI is trending downward from the peak of 2.7 standard deviations above historical average as of first-quarter 2021, indicating a credit correction is underway.

The potential impact on NPLs and defaults from the buildup of debt leverage and asset prices could linger beyond the current stress period, especially considering the recent turbulence in the banking sector and potential further tightening of lending conditions(see chart 7).


The corporate sub-indicator has been declining steadily from the peak of 2.8 standard deviations above trend as of end-2020. This reflects moderating corporate leverage growth after a surge during COVID.

However, tighter financing conditions, more severe demand headwinds and persistently elevated input costs could exacerbate the debt overhang. Companies at the lower end of the credit spectrum are particularly vulnerable. They face more debt service difficulties and possible liquidity strains. SMEs could fare worse as banks tighten lending standards amid the recent failures of three U.S. regional banks.


The household sub-indicator is also trending downward. Though excess savings accumulated during the pandemic and a tight labor market have so far supported consumer health, households' financial buffers are running thin. Lower-income households that employed leverage with floating-rate debt could become more exposed to liquidity and rate shocks. In addition, any further correction of the U.S. and Canadian housing markets could dampen perceived household wealth and have spillover effects across sectors.

Chart 7


Related Research

Editor: Jasper Moiseiwitsch

This report does not constitute a rating action.

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