The US and China are particularly vulnerable, says the IMF © Bloomberg

High corporate debt is present across nearly three quarters of the global economy, threatening to amplify any economic downturn and put financial stability in peril, the IMF said on Wednesday.

The fund said that the world should be able to deal with a moderate economic slowdown without a financial crisis, but companies’ borrowing levels made it vulnerable to anything more serious.

Countries representing 70 per cent of global GDP have elevated levels of corporate debt, according to new research by the fund.

Tobias Adrian, financial counsellor of the IMF, said a “weak tail” of companies had poor prospects.

“There are growing signs that this credit cycle may be maturing and risks of an economic slowdown are rising. The most highly indebted companies could be vulnerable to such a shock,” he said.

Levels of borrowing are continuing to rise even as profitability is falling, the fund said, highlighting the US and China, the world’s two largest economies, as particularly vulnerable.

Chart showing that corporate debt levels have increased since the financial crisis

In Europe, the IMF said a potentially vicious circle of financial vulnerability between sovereigns with high debt and banks was a greater threat to financial stability.

Singling out Italy as the source of greatest risk, the fund said that “potential losses on non-performing loans and mark-to-market declines in the value of government bonds could result in a significant hit to capital for some banks”.

The warnings came in the IMF’s global financial stability report, which said that vulnerabilities in the world’s households and financial sectors were much lower than at the time of the financial crisis; however corporate debt would “amplify” any economic downturn as bankruptcies and default would increase any economic strains.

The IMF said the sharp falls in stock markets at the end of 2018 had tightened financial conditions and tested the resilience of the system but had not stopped debt levels growing.

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“The tightening in financial conditions in the fourth quarter of 2018 was too shortlived to meaningfully slow the build-up of vulnerabilities, leaving medium-term risks to global financial stability broadly unchanged,” it said.

With financial conditions much improved after central banks performed U-turns on policy tightening, the IMF said short-term economic risks stemming from the financial sector remained low. But with debt growing strongly, it said the danger to medium-term economic performance was still at “historically high risk levels”.

To address financial stability concerns, the IMF recommended countries should strike a balance between monetary stimulus and efforts to stop the further build-up of debt.

Chart showing that there have been continued downward revisions in corporate earnings forecasts

Advanced economies’ corporate debt vulnerabilities are primarily concentrated in nonbank lenders, especially in the US. Corporate debt is reaching historically high levels, while profit forecasts are over-optimistic, the IMF said.

While lending growth had slowed to a crawl at the end of 2018, it started to recover this year and, in the US, companies are increasingly borrowing just to pay out greater sums to holders of equity, leaving companies vulnerable to large economic and financial shocks.

“Although corporate balance sheets are strong enough to sustain a moderate economic slowdown or a gradual tightening of financial conditions, a significant deceleration in earnings growth or a sharp tightening of financial conditions could lead to a notable deterioration in corporate credit quality,” the IMF said.

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