The focal point of our view remains that credit excesses throughout EM have, for the most part, not
been worked out: credit growth in the majority of EM countries remains above nominal GDP growth.
Our expectation is that after years of booming corporate and household credit, a period of indigestion
is inevitable. Hence, credit growth is set to drop at least to nominal GDP growth levels. Importantly, we are not saying that the EM/China credit-to-GDP ratio has peaked structurally, but rather that there will be a pause/retrenchment in their leveraging cycle for a period of time.
Remarkably, it only takes credit growth to decelerate – it does not require a credit contraction – for economic growth to suffer and corporate profits to deteriorate.
Credit Boom Forever?
Many investors have been asking us why developing nations in general and China in particular cannot sustain credit growth well above nominal GDP growth in perpetuity.
There are no historical precedents of uninterrupted credit booms. In terms of government borrowing, Japan has so far been the exception, with its public debt-to-GDP ratio skyrocketing. However, the focus of this report is not EM public debt, but EM corporate and household credit.
Overall, there appears to be no country where the private credit-to-GDP ratio has risen without interruption. Since this is true both for countries with high savings rates and those with sophisticated financial systems, we do not see why EM and China should be any different now.
Chart 1 categorizes EM countries into four categories by classifying them according to the credit-to-
GDP ratio (credit penetration) on the X-axis, and the speed of rise in the credit-to-GDP since the end of 2008 on the Y-axis: