The Looming Deleveraging Challenge

Several major economies are likely to face imminent deleveraging. If history is any guide, it will be a lengthy and painful process.

The specter of deleveraging has been haunting the global economy since the credit crunch reached crisis proportions in 2008. The fear: an unwinding of unsustainable debt burdens will drag down growth rates for years to come. So far, reality has been more benign, with economic growth recovering sooner than expected in some countries, even though the financial sector is still cleaning up its balance sheets and consumer demand remains weak.

New research from the McKinsey Global Institute (MGI), though, suggests that the deleveraging process may just be getting under way and is likely to exert a significant drag on GDP growth.1 Our study of debt and leverage2 in ten mature and four emerging economies3 indicates that some sectors of the economies of five countries—Canada, South Korea, Spain, the United Kingdom, and the United States—will very probably experience deleveraging.

What’s more, our analysis of deleveraging episodes since 1930 shows that virtually every major financial crisis after World War II was followed by a prolonged period in which the ratio of total debt to GDP declined significantly. The one exception was Japan, whose bursting asset bubbles in the early 1990s touched off a financial crisis followed by many years when rising government debt offset deleveraging by the private sector. The “lost decade” of sluggish GDP growth that followed is a cautionary tale for policy makers hoping to somehow avoid the painful process of deleveraging.

Business executives too will face challenges: they may have to adapt to an environment in which credit is tighter and costlier and consumer spending could be slower than trend over the medium term in countries where household debt has built up. Our findings underscore the likelihood that growth will be stronger in emerging markets, which are far less leveraged, than in mature ones. To cope, companies should build the potential impact of “pockets” of deleveraging into their market outlooks.
(Source: McKinsey Quarterly)