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Signs of stress: Is Asia heading toward a debt crisis?

A crisis is by no means certain, but governments and businesses need to monitor potential triggers closely.

The Asian debt crisis of 1997 devastated the region, especially Southeast Asia, for many years and was felt in markets throughout the world. The last tremors of the 2008 global financial crisis are still resonating. And now, financial media and other observers question whether rising debt levels in Asia could trigger a new crisis. Unfortunately, the signs are ominous, and health in the real and financial sectors is deteriorating.

Three fundamental conditions of stress seem to be building throughout Asia:

  • In the real sector, corporations across the region are under significant stress to fulfill their debt-service obligations. Households in Australia and South Korea have accumulated unsustainably high levels of debt.
  • The Asian financial system shows vulnerability, with lower margins; higher risk costs, especially in emerging markets; continued dependence on banks and shadow-banking institutions for lending; and a capital buffer that could be challenged materially.
  • Overall, global cross-border capital inflows are down from their 2007 peaks. However, inflows into Asia have surpassed pre-crisis levels, resulting in a dramatically larger share of foreign inflows into the region.

Whether these conditions are cumulatively enough to trigger a new crisis remains to be seen, of course. Since 1997, financial regulators have become wary, and safeguards (such as a shift from a fixed exchange rate to a managed-float-exchange-rate regime in Thailand) have been put in place. Yet governments and businesses need to monitor potential triggers (such as debt-repayment defaults, liquidity mismatches, higher-interest-rates impacts, and large exchange-rate fluctuations) carefully and take adequate preventive action.

About the author(s)

Joydeep Sengupta is a senior partner and Archana Seshadrinathan is a senior expert in McKinsey’s Singapore office.