Global corporates and households are in the midst of a major credit correction. This is according S&P Global Ratings' Credit Cycle Indicator (CCI), a forward-looking signal on credit stress. Following a period of very loose credit conditions and debt buildup, the cycle turned sharply in early 2021. Inflation, rising interest rates, and softening GDP growth in major economies have all had their effect. Our indicator suggests the current downcycle will be felt well into 2023.

CCI consolidates information about household and corporate indebtedness, equities, house prices, and regional financing conditions (see "Introducing Our Credit Cycle Indicator," June 27, 2022).

Comparisons with other indicators including credit spreads, net rating downgrades, and bond defaults show that peaks in the CCI tend to precede negative credit developments by six to 10 quarters. Moreover, when the CCI's upward trend is prolonged or is at a high threshold, the associated credit stress tends to be greater.

Global

During the four quarters since the first quarter of 2020, the global CCI trended upward. It reached a peak of 2.8 standard deviations in the first quarter of 2021. Similar patterns have been seen in regional CCIs, which all peaked in the first quarter of 2021. This suggests a potential rise in credit stress (see chart 1).

While the CCIs are trending downward across the board--indicating a credit correction is underway--the potential hit of the buildup of nonperforming loans and defaults could linger beyond the stress period in late 2022 and early 2023.

Chart 1

Asia

The Asia ex-China, ex-Japan CCI reached a peak of 2.2 standard deviations in the first quarter of 2021.

Chart 2

China 

Since reaching a peak of 1.4 standard deviations in the first quarter of 2021, the China CCI has been trending downward. This decline, driven by the household sub-indicator, reflects a slower pace of household borrowing. China's COVID-related lockdowns and the property sector's ongoing woes have exacerbated household caution and reduced consumption.

Meanwhile, the current flattening of the corporate sub-indicator hints at the possibility of rising corporate leverage, as corporates shore up borrowing to cope with COVID-related lockdowns. The mobility controls have hit earnings, particularly for consumer discretionary and mobility-dependent sectors.

Corporates, particularly state-owned enterprises, may also borrow more to help stabilize investment and economic growth amid loosening domestic funding conditions. This could imply deleveraging efforts in China's corporate sector are coming to a standstill. China's corporate leverage ratio is significantly higher than the global average (see "China's SOEs Are Stuck In A Debt Trap," Sept. 20, 2022).

Chart 3

Japan 

Since reaching a peak of almost three standard deviations in the first quarter of 2021, the Japan CCI has tipped downward. It remains at an elevated level. While the broad downward trend reflects declining household debt, a surge in Japanese house prices (mostly in prime areas) has led to an uptick in the household sub-indicator after a brief downtrend.

Japan's gross corporate debt has risen in recent quarters, supported by the country's efforts to keep interest rates flat--contrary to that of the Fed. While net debt has remained stable, thanks to a continuous buildup of cash, this cash distribution is uneven. If interest rates suddenly rise, heavily indebted small and midsize enterprises (SMEs; mostly unrated) could see their interest rate burdens intensify, posing a risk to creditworthiness.

To see how Japanese corporates would fare under higher interest rates and input costs, our stress scenario examined the hit of such shocks on a global (mostly unrated) pool of corporates. The scenario outcomes for the Japan sample reveal the corporate loss-making ratio could jump 19% by end-2023, from our base projection of 12% in 2022 (see "Global Debt Leverage: If Stagflation Strikes, China Corporates Are Most Vulnerable," July 12, 2022).

In a separate stress test on our Japan rated corporates, the railways and electric utilities and gas sectors would feel more pressure, under a stress trifecta of higher interest rates, recession, and yen depreciation (see "Japan's Corporations Are Equipped For The New Abnormal," Aug. 1, 2022).

Chart 4

Emerging Markets

Over four quarters since the first quarter of 2020, the emerging market (EM) ex-China CCI trended upward. It reached a peak of two standard deviations in the first quarter of 2021.

Chart 5

Corporates 

The corporates sub-indicator is trending downward in line with slowing GDP growth in many EMs. Bank lending is a viable alternative to capital markets, but this would come at a higher cost and at shorter maturities. The decline of this sub-indicator indicates that lending standards and financing access may become tighter for specific groups of borrowers (such as highly indebted SMEs).

Households 

Household credit to GDP is relatively low in most EMs in our sample. Exceptions include Thailand, where household leverage is a key risk, and Malaysia, where we assess credit risk as high but where household assets offset household debt to some extent. In our view, financing conditions are also tightening for households as high inflation squeezes their creditworthiness. Ultimately, this will dent banks' asset quality.

Eurozone

The eurozone CCI trended upward over the four quarters since the first quarter of 2020, reaching a peak of three standard deviations in the first quarter of 2021.

Chart 6

Corporates 

Since peaking in the first quarter of 2021, the eurozone corporate sub-indicator has descended rapidly from a height of two standard deviations to zero in early 2022. The economic rebound from the pandemic has spurred growth across the eurozone, helping push down corporate credit relative to GDP from 115.2% (first quarter 2021) to 110.0% (first quarter 2022).

Yet, even with this moderation, outstanding debt in the corporate sector remains at historical highs. Though the declining CCI reading signals moderating stress, deteriorating financing conditions and an economic recession would put added strain on corporates. Given the widespread restructuring of maturities over the past couple of years, we still see limited short-term refinancing risk. However, weaker borrowers are still vulnerable from a credit quality perspective. This is particularly true for highly indebted SMEs struggling to generate free operating cash flow.

Households 

The household sub-indicator follows a similar trend, a sharp peak followed by a large decline across 2021 and into early 2022. Over that period, total credit to households as a percentage of GDP has decreased from 62.5% (in the first quarter of 2021) to 59.4% (first quarter 2022). This moderation has to be viewed in the context of a looming cost-of-living strains across the eurozone; furthermore, an expected recession in some European economies could push up household debt to GDP.

The key unknown for European households is what portion of the hike in energy costs they will have to shoulder given government interventions. Accumulated financial savings from the pandemic should also help control the hit on household budgets. However, an economic downturn would put many more households at risk, especially the more vulnerable cohorts. With unit level energy costs rising at an exorbitant rate, the extent to which households resort to consumer credit markets will likely hinge on the generosity of government support.

North America

Over the five quarters since the fourth quarter of 2019, the North America CCI has trended upwards. The index reached a peak of 2.3 standard deviations in the first quarter of 2021.

Chart 7

Corporates 

The corporate sub-indicator is declining steadily from the peak of 2.5 standard deviations as of the fourth quarter of 2020, reflecting slowing credit growth. However, the unevenness in the recovery path, persistent cost pressures and supply-chain constraints, and tightening financing conditions could exacerbate the debt overhang. Corporates at the lower end of the credit spectrum are particularly vulnerable (see "Credit Strains Tighten," Sept. 27, 2022).

Households 

The household sub-indicator is also trending downwards. While on average household balance sheets have largely remained healthy thanks to COVID-related stimulus measures and a tight labor market, credit risks could prevail, especially for households in more vulnerable cohorts (lower income or with less liquidity) and as high prices continue to erode purchasing power. In addition, any large fluctuations in house prices could also affect household wealth.

For more details about our proprietary CCI, see "White Paper: Introducing Our Credit Cycle Indicator," June 27, 2022.

Editor: Jasper Moiseiwitsch

Related Research

• Global Credit Conditions Q4 2022: Darkening Horizons, Sept. 29, 2022
• Credit Conditions: Asia-Pacific Q4 2022: Brakes On Growth, Pain Down The Road, Sept. 27, 2022
• Credit Conditions Emerging Markets Q4 2022: Clouds Are Gathering, Sept. 27, 2022
• Credit Conditions Europe Q4 2022: Hunkering Down For Winter, Sept. 27, 2022
• Credit Conditions North America Q4 2022: Credit Strains Tighten, Sept. 27, 2022
• China's SOEs Are Stuck In A Debt Trap, Sept. 20, 2022
• Japan's Corporations Are Equipped For The New Abnormal, Aug. 1, 2022
• White Paper: Introducing Our Credit Cycle Indicator, June 27, 2022
• Global Debt Leverage: If Stagflation Strikes, China Corporates Are Most Vulnerable, July 12, 2022