Emerging Market Growth Heavily Debt-Fueled

While emerging market stocks boom on speculation that Asian economies will recover faster previously expected as governments in the region boost spending, there's a whole host of financial considerations that are being pushed to the bottom drawer.

At the top of the list is the rising amount of corporate debt on the balance sheets of emerging market companies. Last week, one analyst issued a research note pointing out that Korean multinationals have been using off-balance-sheet subsidiaries to borrow heavily on short-term loan agreements. The situation may account for some $30 billion in previously unidentified debt, according to Tim Rocks, head of research at Macquarie Bank in Hong Kong.

Meanwhile, Chinese debt deals have reached an unprecedented $28.5 billion so far in 2008, compared with $5.4 billion for the whole of 2008.

This week Hong Kong conglomerate Hutchison Whampoa said it would be raising $1.5 billion by selling corporate debt, after South Korean steelmaker Posco raised $700 million in a similar issue last month.

Government bond issuances are also on the rise, thanks to hefty Asian stimulus packages intended to stave off the worst effects of the recession. Monday, Japan's government announced that it would pour ¥10 trillion, or $100 billion, into its economy. The following day, China's healthcare minister said that its government would inject 850 billion yuan, or $124 billion, into healthcare reform over the next 3 years.

These kinds of plans cost money, as do corporate bond issuances, which are essentially just IOUs. Given recent turmoil in the west, it's reasonable to ask: where is the money coming from to pay back all the debt that is funding the intended growth? That's rather a hard question to answer.

While exports in Asia account for 60 percent of regional GDP, they've been on a hard decline lately. In January this year, Japanese exports dropped by a whopping 46 percent. China's exports, which account for around 80 percent of the country's GDP, plunged 17.5 percent in the same month. While exports may show signs soon of being on the rebound, western importers such as the U.S. and Europe will need to turn their economies around mighty fast in order for foreign exporters to just match last year's quotas.

Furthermore, foreign direct investment is all but disappearing. In 2008, foreign investment in emerging market countries accounted for some $466 billion; that figure is likely to be more like $165 billion this year. Those numbers are compared to emerging market FDI of $929 billion in 2007.

In the last year, the world has painfully witnessed the consequences -- both human and monetary -- of building growth on debt that can't be paid back. Asian governments and corporate leaders alike need to sit down and work out what, in a worst-case scenario, they will be able to honor before agreeing to huge debt issues.

In a nutshell, you want to create sustainable, rather than speculative growth. Just as it's no good selling someone a house who can't pay the mortgage, it's pointless building hospitals when you find that you can't afford to run them.