Key Takeaways
- Our forward-looking global and regional Credit Cycle Indicators (CCIs), which tend to lead credit stress and recovery by six to 10 quarters, maintain their upward trajectory toward a credit recovery in 2025.
- However, headwinds in 2024 could mean a bumpy ride to recovery. Costlier debt, households' reduced propensity to spend, and lenders' risk aversion will strain corporate borrowers' profit margins and liquidity profiles, and exacerbate credit pressures.
- Risk of stickier than anticipated inflation could prompt central banks to keep rates high. A sharp economic slowdown and squeezed disposable income could lead households to pull back on consumption.
A credit recovery in 2025 is looking increasingly probable, according to S&P Global Ratings' CCI, a forward-looking measure of credit conditions. However, the effects from the ongoing credit correction could mean more pain before it gets better.
Global
A potential credit recovery in 2025, but risks remain in 2024
Our global CCI is signaling a potential credit recovery in 2025 (see chart 1). Globally, the decline in private sector debt-to-GDP, which started in early 2021, seems to be moderating. Market anticipation of a soft economic landing and interest rate cuts by central banks have boosted confidence. Equity prices are improving, benchmark bond yields coming down, and spreads tightening. There are green shoots of market access returning even for lower-quality borrowers early this year.
However, we continue to believe stronger-than-expected economic resilience in 2023 (see "Economic Research: The U.S. Economy Bucks The Global Trend," Feb. 28, 2024) and extended debt maturities may have pushed out some of the credit stress. Consequently, we anticipate the lagged effects of the credit correction to persist through 2024.
Furthermore, despite the recent improvements in financing conditions, interest rates remain high and lenders relatively selective. Meanwhile, we anticipate a slower economic growth outlook in 2024 compared with 2023. These combine to create the risk of further increases in nonperforming loans and defaults shaping credit conditions in 2024 (see "Highest January for Corporate Defaults Since 2010," Feb. 14, 2024).
We foresee the trailing-12-month speculative-grade corporate default rate will continue rising through the third quarter of 2024 before easing to 4.75% in the U.S. by year end, and stabilize at 3.5% in Europe, respectively (see "Default, Transition, and Recovery: U.S. Speculative-Grade Corporate Default Rate To Hit 4.75% By December 2024 After Third Quarter Peak," Feb. 15, 2024 and "Default, Transition, and Recovery: European Speculative-Grade Default Rate To Stabilize At 3.5% By December 2024," Feb. 16, 2024).
For more details about our proprietary CCI, see "White Paper: Introducing Our Credit Cycle Indicator," published on RatingsDirect, June 27, 2022.
Chart 1
Asia-Pacific
Asia-Pacific's credit recovery could take shape in 2025
The Asia ex-China, ex-Japan CCI continues to climb out of a trough since the first quarter of 2023 (see chart 2). Increasingly, we see a credit recovery taking shape in 2025 for Asia-Pacific. Outside China, the region's economies continue to grow, particularly for India and Southeast Asia. Rising credit appetite among lenders could spur credit availability as corporates seek to expand and households' propensity to spend returns.
Until then, the lagged impact of rate hikes could strain borrowers as maturing debt comes due for refinancing, while the risk of a sharper-than-expected economic slowdown could hit exports and consumer confidence throughout this year. Meanwhile, weaknesses in the property sector are spilling outside of China. A rapid intensifying of residential and commercial property strains may test banks (see "Asia-Pacific Financial Institutions Monitor 1Q 2024: Property Exposures Will Chart The Course," Feb. 7, 2024), narrowing credit availability. While onshore financing remains available across Asia-Pacific, lenders could turn selective in some sectors, hitting borrowers with impending financing needs.
Chart 2
China: The China CCI continues to climb from a trough, supported by the upward trend in the corporate sub-indicator (see chart 3). This rebound underlines a pick-up in corporate indebtedness, whereby lenders extend credit to nonfinancial corporates.
However, this upward momentum could be tested by cyclical, policy, and structural factors. The country's property sector troubles persist and are hitting household wealth. This is dragging consumption and in turn the economy's growth momentum.
Meanwhile, China's corporate leverage as measured by debt-to-GDP is the highest in the world at 167% as of end-2023, according to the Institute of International Finance. The indebtedness of the country's state-owned enterprises (SOEs) remains a key risk (see "Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap," Sept. 20, 2022 and "Global Debt Leverage: What If Chinese Corporate Earnings Further Decline?," Oct. 18, 2023). As authorities continue to tighten control over debt growth, credit and liquidity pressures could intensify for corporates and local government financing vehicles (LGFVs; see "China LGFVs Face Higher Liquidity Risks As Funding Channels Tighten," Jan. 11, 2024). These could hurt the capitalization of China's regional banks and reduce credit availability (see "LGFV Strains May Inflict A RMB2 Trillion Hit On China Regional Banks," Oct. 18, 2023).
We estimate the Chinese government will increase its borrowings to US$1.7 trillion in 2024 from US$1.6 trillion in 2023—the biggest hike among the region's sovereigns. The increase underpins our view that the Chinese government will support the country's economic recovery with fiscal transfers to weaker local governments (see "Sovereign Debt 2024: Asia-Pacific Central Government Borrowing Stabilizes At Close To US$4 Trillion," Feb. 28, 2024).
In the coming decades, the country could face a gradual decline in trend growth. This is driven by factors including demographics, rebalancing, and decoupling efforts by the U.S. and other countries (see "Economic Research: China's Trend Growth To Slow Even As Catchup Continues," Nov. 10, 2022). These factors collectively underpin our view that the country's credit upturn, as currently signaled by our CCI, could face limited headroom.
Chart 3
Japan: The Japan CCI continues to buck the global trend. As the indicator follows a broad downward trend (see chart 4), the country's credit recovery may occur later than that of its Asian counterparts.
Japan's gross nonfinancial corporate debt build-up is still slowing. However, weakness in the yen is keeping foreign currency corporate debt elevated in local currency terms. Meanwhile, wage growth has not kept pace with rising inflation. Given the pinch to consumer pockets, households may hunker down to save instead of spend.
As the Bank of Japan (BOJ) looks to gradually and cautiously embark on an interest rate hike this year, the country's banking sector stands to see winners and losers (see "Japan Banking Outlook 2024: BOJ Hikes Will Widen Disparities", Jan. 24, 2024). If there is a significant rate increase hitting borrower creditworthiness, credit costs could mount for banks and keep lending appetite soft.
Funding and liquidity pressures could intensify for companies with relatively low creditworthiness. These are typically small to midsized (mostly unrated) companies, given their susceptibility to financial market conditions (see "Japan Corporate Credit Spotlight: Scant Room For Improvement," Oct. 18, 2023).
Chart 4
Emerging Markets
The CCI keeps on pointing to a credit recovery in 2025
Credit conditions have improved across most emerging markets (EMs). This stems from resilient economic growth, falling inflation, and market expectations of rate cuts, especially in advanced economies. These factors have led to increasing appetite for EMs debt and a moderate progress in credit demand.
The credit context still reflects high borrowing costs and corporate refinancing risks. This is especially so for the lower end of the rating spectrum. Our indicators have troughed at -1.5 standard deviations in fourth quarter 2022, suggesting a potential credit recovery could occur in 2025.
The upward trend comes after seven quarters of CCI easing from its 2.3 standard deviations peak in first quarter 2021. This pointed to credit stress through the entire 2023 (see chart 5). Several factors have cushioned this:
- Resilient domestic activity;
- Sustained fiscal stimulus and the economic rebound from the pandemic; and
- A manageable maturity wall.
With the latest data, the indicator has reached its inflection point for all EM countries. The correction is more pronounced for Chile, Mexico, and Turkiye.
Corporates: The corporate sub-indicator now displays its trough in third quarter 2023 at -1.6 standard deviations. Corporate debt increased also in third quarter 2023, while equity valuations stabilized. The increase in corporate debt reflects rising credit appetite by domestic lenders, especially in Latin America, as market sentiment turns positive amid the anticipation of a soft landing.
However, still-high interest rates, combined with a softening in external demand, will likely constrain EM corporate profits and capex in 2024. Meanwhile, equity valuations varied across regions. They dropped in Latin America and the EMs of Europe, Middle East, and Africa; and remained resilient in the EMs of Asia.
Households: The household sub-indicator increased to -0.8 standard deviations for the third consecutive month (-1.1 in fourth quarter 2022) rising less than its corporate counterpart. Indeed, household debt rose quarterly only in Brazil and Malaysia, whereas it was flat across EMs. Property prices showed mixed developments: they are still rising in Latin America, particularly in Mexico, where demand continues to exceed the tight supply of units. House prices fell elsewhere because of struggling retail markets, as prolonged high inflation limited purchasing power.
Chart 5
Eurozone
A credit upturn could be in sight, but headwinds abound
Our eurozone CCI is showing signs of a trough (see chart 6), signaling a possible turning of the credit cycle in 2025. Bank lending conditions are moderating and risk sentiment has improved somewhat (see "Default, Transition, and Recovery: European Speculative-Grade Default Rate To Stabilize At 3.5% By December 2024," Feb. 16, 2024). We expect eurozone growth to tick up to 1.5% in 2025, from 0.8% in 2024 (see "Economic Research: Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing," Nov. 27, 2023).
However, the lagged effects of the ongoing credit correction could persist throughout 2024. The investor environment remains selective, while the full effect of higher interest rates is still feeding through to businesses and households. The risk of a prolonged growth slowdown, amid escalating conflicts spilling over to Europe more broadly, could further knock confidence and economic recovery.
Chart 6
North America
Stresses will linger before a potential credit upturn in 2025
The North American CCI continued to increase from the trough reached in late 2022 and early 2023. This suggests a potential credit upturn in 2025, given the historical six to 10 quarters of lead time between CCI readings and credit developments (see chart 7). While market conditions and some asset prices have been somewhat improving, leverage in the system, such as corporate and household debt-to-GDP in the U.S., appears to be still undergoing a correction.
We could see continued credit deterioration among North American borrowers throughout 2024. This is because of higher borrowing costs, weakening demand from tighter monetary policy, and protracted higher prices from recent years of inflationary pressures. We expect the U.S. speculative-grade corporate default rate to hit 4.75% by December 2024 after peaking in the third quarter (see "U.S. Speculative-Grade Corporate Default Rate To Hit 4.75% By December 2024 After Third-Quarter Peak," Feb. 15, 2024).
Chart 7
Corporates: The region's corporate sub-indicator stayed relatively flat in the third quarter of 2023 at -0.9 standard deviations. The probability of a U.S. recession in the next 12 months has decreased thanks to the sturdy labor market. However, we expect borrowing costs will remain elevated in 2024 and weigh on the ability of corporates to service debt and refinance.
Meanwhile, supply chain constraints remain as do cost pressures, particularly related to labor. Companies at the lower end of the ratings scale may feel more severe liquidity strains if approaching maturities coincide with tough financing conditions (see "U.S. Corporate Credit Outlook 2024: A Bumpy Ride To A Soft Landing," Jan. 29, 2024).
Households: The household sub-indicator modestly increased to -1.5 standard deviations. Despite the resilient labor market, households' financial health has shown signs of weakness. In the U.S., new delinquencies of auto loans and credit cards have been surging, with transition rates now above pre-pandemic levels. In Canada, the mortgage component is driving the household debt service ratio to a historical high as borrowers renew variable-rate mortgages. A sharper-than-anticipated pullback in consumer spending could weigh more on the economy and lead to a jump in unemployment, causing more vulnerability in the household sector.
Related Research
- Economic Research: The U.S. Economy Bucks The Global Trend, Feb. 28, 2024
- Sovereign Debt 2024: Asia-Pacific Central Government Borrowing Stabilizes At Close To US$4 Trillion, Feb. 28, 2024
- Default, Transition, And Recovery: European Speculative-Grade Default Rate To Stabilize At 3.5% By December 2024, Feb. 16, 2024
- U.S. Speculative-Grade Corporate Default Rate To Hit 4.75% By December 2024 After Third-Quarter Peak, Feb. 15, 2024
- Highest January For Corporate Defaults Since 2010, Feb. 14, 2024
- Asia-Pacific Financial Institutions Monitor 1Q 2024: Property Exposures Will Chart The Course, Feb. 7, 2024
- U.S. Corporate Credit Outlook 2024: A Bumpy Ride To A Soft Landing, Jan. 29, 2024.
- Japan Banking Outlook 2024: BOJ Hikes Will Widen Disparities, Jan. 24, 2024
- China LGFVs Face Higher Liquidity Risks As Funding Channels Tighten, Jan. 11, 2024
- Global Credit Outlook 2024: New Risks, New Playbook, Dec. 4, 2023
- Economic Research: Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
- LGFV Strains May Inflict A RMB2 Trillion Hit On China Regional Banks, Oct. 18, 2023
- Japan Corporate Credit Spotlight: Scant Room For Improvement, Oct. 18, 2023
- Global Debt Leverage: What If Chinese Corporate Earnings Further Decline?, Oct. 18, 2023
- Global Debt Leverage: A 1% Financing Contraction Could Push Cashflow Negative Corporates To 13%, Oct. 16, 2023
- Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap, Sept. 20, 2022
- White Paper: Introducing Our Credit Cycle Indicator, June 27, 2022
This report does not constitute a rating action.
| Primary Credit Analysts: | Vincent R Conti, Singapore + 65 6216 1188; vincent.conti@spglobal.com |
| Yucheng Zheng, New York + 1 (212) 438 4436; yucheng.zheng@spglobal.com | |
| Christine Ip, Hong Kong + 852 2532-8097; christine.ip@spglobal.com | |
| Luca Rossi, Paris +33 6 2518 9258; luca.rossi@spglobal.com | |
| Secondary Contacts: | Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com |
| Eunice Tan, Singapore +65-6530-6418; eunice.tan@spglobal.com | |
| Jose M Perez-Gorozpe, Madrid +34 914233212; jose.perez-gorozpe@spglobal.com | |
| Paul Watters, CFA, London + 44 20 7176 3542; paul.watters@spglobal.com | |
| Osman Sattar, FCA, London + 44 20 7176 7198; osman.sattar@spglobal.com | |
| David C Tesher, New York + 212-438-2618; david.tesher@spglobal.com |
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