Smaller Firms in Emerging Markets Impacted by Macro Conditions, RBI Study Finds

Corporate leverage ratios in emerging market economies (EMEs) like India have been on the rise in recent years, and when considered against low global growth, reduced commodity prices and the risk of policy rates rising in advanced economies, they raise policy concerns in such nations.

Corporate leverage in EMEs climbed to about 55% of GDP during 2009 to 2014, from about 49% of GDP from 2003 to 2008, and was accompanied by lower earnings in a weak macroeconomic environment, according to a new study by the Reserve Bank of India (RBI) entitled “Corporate Leverage in EMEs: Has the Global Financial Crisis Changed the Determinants?”

The study essentially evaluated the drivers of corporate leverage in a broad swatch of sectors in Brazil, China, India, Indonesia, Malaysia, Mexico, the Philippines, Russia, South Africa and Thailand before and after the Great Recession.

“Firm-specific factors such as profitability, tangibility, market-to-book value ratio and firm size emerge as important determinants of corporate leverage,” the report’s authors concluded. “Our results imply that firms with more tangible assets found tapping the equity market more lucrative and were thus less leveraged in the pre-financial crisis period. In the post-crisis period, however, tangibility ceases to be a significant determinant of corporate leverage, possibly suggesting that debt-issuing conditions were lucrative for all firms, irrespective of whether they had high or low levels of tangible assets.”

Further, firm size was a significant factor with respect to debt buildup in the post-financial crisis period, implying that larger firms are more leveraged after the crisis. For smaller firms, “…leverage buildup was higher for firms with lower tangible assets but higher growth potential in the post-crisis period, while these factors were not influential in the pre-crisis period. More importantly, in the case of small firms, the coefficients of world GDP growth and the Fed shadow rate are statistically significant only in the post-financial crisis period, which indicates the influence of global developments on small firms in the post-crisis period,” the RBI said. This conclusion is at odds with a more “mainstream” view that firm-level factors are the key factors in determining corporate leverage after the crisis.

“In the face of interest rate and unhedged currency risks, issues relating to the servicing of debt can quickly snowball into a systemic financial stability concern,” the RBI said. “Against the backdrop of recent history, which showed that the deleveraging process is almost always lengthy, costly and painful, the challenges for policymakers include ring fencing their financial sector from possible effects of the deleveraging process.”

– Nicholas Stern, senior editor

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