According to General Re-New England Asset Management, a unit of Warren Buffett’s Berkshire Hathaway, bond yields in developing countries including Brazil, Turkey and Indonesia are poised to increase as “rapid” credit growth raises consumer default risk.
“Booms always appear sustainable at the time, but certain emerging countries show recognizable signs of unsustainability… The credit growth is merely a doubling up on an unsustainable burst of demand, and must in time meet expectations of repayment.”
Brazilian dollar-denominated bonds yielded 3.66 percent, or 1.79 percentage points over Treasuries, JPMorgan data show. A bond bubble?
According to Bloomberg, Brazil’s total bank lending has almost tripled to 2.2 trillion reais ($1.1 trillion) in July since the end of 2006, with the consumer default rate rising to 7.9 percent, the highest in almost three years, according to the central bank.
“The fearsome outcome is that growth slows as rising debt loads bite before deleveraging is complete in emerging countries. In that event there are few growth engines left.”
Here is an excerpt of what the asset manager wrote:
“The recent collapse in yields implies that such sovereign borrowers have demonstrated not only an improvement in their creditworthiness, but a permanent one. Booms always appear sustainable at the time, but certain emerging countries show recognizable signs of unsustainability. The principal one, now familiar in emerging countries, is rapid rates of growth in credit extension. An acceleration of growth in domestic demand is accompanied by rapid growth in borrowing. In the case of Brazil at the moment, for example, a massive positive shock in terms of trade – the huge rise in commodity prices for BRazil’s exports – caused Brazilians incomes to rise. If Brazilians save, the country’s current account surplus will rise and the country’s fiscal positions improve. But if, instead, Brazilians’ rising incomes stimulate domestic demand, the opposite occur. This is the choice they have made, and will be exaggerated if it is accompanied by rapid growth in credit.
This is not self sustaining. The credit growth is merely a doubling up on an unsustainable burst of demand, and must in time meet expectations of repayment. While Brazil is an important case because of its size, a similar patter is appearing elsewhere [Indonesia, Turkey]”.
Sources: Bloomberg, GR-NEAM