Rising debt worldwide will likely be the biggest problem in the aftermath of the Covid-19 pandemic, said Mr Ravi Menon, managing director of the Monetary Authority of Singapore (MAS).
While fiscal and monetary measures across the world have, for now, lowered the risk of credit defaults and funding shortfalls, the debt build-up is going to have multiple effects, including the risk of corporate distress once banks start calling loans in, he said in a May 28 podcast interview with Mr Tim Adams, president and chief executive of the Institute of International Finance.
The transcript of the interview was released by MAS yesterday.
"The accumulation of debt is probably going to be the No. 1 aftermath of the Covid-19 pandemic. And we're going to have to deal with it, you know, from 2021 onwards," Mr Menon said.
Singapore's fiscal response to the crisis - four support packages in as many months totalling about 20 per cent of gross domestic product (GDP) - was helped by its healthy stock of reserves.
But governments elsewhere have racked up huge amounts of debt to support their economies.
Mr Adams cited data from the Organisation for Economic Cooperation and Development showing that the budget deficit in the United States has risen to 6 per cent of GDP, with debt increasing by US$17 trillion (S$24 trillion).
He also noted "a big increase in corporate debt among emerging markets and state-owned enterprises".
Mr Menon said that corporate debt, already high before the outbreak, is now building up in many parts of the world.
While banks - including those in the US, Britain and Asia - generally have very strong capital and liquidity buffers, corporate distress is on the cards, he said.
If the Covid-19 situation is not contained, that debt is going to continue to grow, credit quality will deteriorate and credit risks will start to mount, he added.
Once all these loan deferments and forbearance are over - because the authorities can do only so much - then there will be more corporate distress, Mr Menon said.
Another risk is increased deterioration in credit quality, leading to ratings downgrades, he said.
"I think once the rating agencies start to downgrade bonds and corporate loans, you're going to see an exacerbation of existing stresses."
He noted that many corporate bonds in the US and Europe are at the borderline between investment grade and below. If these BBB-rated bonds cross that threshold, "fire sales, large outflows and sell-offs" may start, Mr Menon said.
This could exacerbate some liquidity risks. "It's important that emergency measures that all governments and central banks have taken cannot be carried on for too long. We need an exit strategy before this debt accumulates to a point where we have to deal with it for years after," he said.
A key concern is the risk of renewed capital outflows from emerging market economies, as they remain vulnerable if there is a round of secondary waves of infection, Mr Menon added.
"I think the market expectation that there's going to be a recovery in the second half of this year and then we'll all gradually get out of this over the course of 2021 is going to be severely tested," he said, given the likelihood of renewed outbreaks and secondary waves of infection. "How we deal with these secondary waves is going to matter a great deal. Different countries will respond differently and they have different capacities."
He said there is a mismatch between market expectations and how economies are likely to come out of the pandemic, because there are going to be setbacks.
"It's going to be a fits-and-starts kind of recovery," he said. "That could trigger renewed capital outflows from emerging economies because of a renewed rush into liquid and safe assets. That's never a good scenario for emerging markets - tighter financial conditions and corporate refinancing risks."