Risks of the Rapid Accumulation of Private Debt: the Overall Impact on the Economy and Scenario Analysis for Individual Countries

Credit to the private sector has been growing dramatically in both developed and developing world for more than six consecutive decades, which has been bothering both fiscal and monetary authorities along with corporate players as big banks and insurance companies. Many scholars outlined the drastic effects of fast debt build-ups and credit booms on economic growth, overall economic stability, and long-term economic performance. At the same time, however, ideas that these effects are country-specific and ambiguous are also quite persistent in the existing academic research: while some authors claim that developing countries and emerging market economies can suffer severely from the limitations in credit provision, others point to the fact that excessive capital flows and increased availability of new financial instruments created not only credit booms but also shadow-banking and unsustainable internal and external imbalances. It is clear that the developing world differs in the effects of private debt accumulation and requires particular policies adjusted to the level of local financial depth and development. Moreover, benefits from credit expansion are more evident for countries with low levels of financial development. It is also quite intuitive that booms of private credit themselves differ in quality. This paper is aimed at analysing the way booms of private credit affect the economy and at developing a framework of distinguishing between «bad» and «good» booms so policymakers can treat them differently. First, by analyzing an unbalanced panel dataset for 89 developing countries and emerging market economies for almost 30 years starting in 1990, it captures the episodes of rapid private credit accumulation, defines their quality and spot the characteristics of the “unhealthy” booms, that can be later used for its classification, early prediction and subsequent policy response by the authorities. By analyzing the coinciding macroeconomic processes and intrinsic characteristics of the booms, this paper finds that the size of the boom, its duration to peak, and indicators as current account balance, loans-to-deposit ratio and the volatility of the stock market can serve as powerful predictors for the quality of the boom. Besides, this research demonstrates that knowing the predictors and the way they are synchronised with the booms of private credit allows policy-makers to spot the «bad» ones in real time, which is especially valuable since the last decade is marked with the highest amount of booms over the studied 30 years.