The IMF issued an ominous warning last week about the rapid slowdown in global growth and the growing threat of an emerging market debt crisis. The fear is that the global slowdown, combined with soaring inflation and rising interest rates, could hit the poorest and most indebted countries particularly hard, causing a drop in foreign investment and lowering their currencies.
Emerging markets already facing over-indebtedness would then be vulnerable to broader economic and social crises – compounded by emergency budget cuts – leading to the kind of food and electricity shortages, social unrest and political collapse that the currently observed in Sri Lanka.
Haven’t we heard this before?
Fears of an immediate debt crisis surfaced at the onset of the coronavirus pandemic in early 2020, David Lubin, head of emerging markets economics at Citi, told the Financial Times. But in the short term, those worries turned out to be overblown.
First, the dramatic easing of monetary policy by the US Federal Reserve and other major central banks has supported global risk appetite and kept capital markets open to emerging market borrowers. Second, massive fiscal stimulus from policymakers helped generate a surge in global trade. Third, says Lubin, the IMF has supported the financial stability of developing countries with emergency funds. Now, however, that relatively benign image has changed dramatically.
Even before the war in Ukraine introduced new threats to the global economy, the combination of tighter US monetary policy and a sharp decline in global trade growth was beginning to hamper the ability of low-income countries income to raise dollars. In 2013, the mere hint from the US Federal Reserve that it would reduce quantitative easing was enough to drive money out of emerging markets. What might happen now in the event of a significant unwinding of the Fed’s balance sheet remains to be seen – but the outlook is “gloomy”, says the FT.
The war in Europe has hit emerging markets with a “triple whammy”, according to The Economist. The first blow is the potential for a near-term drying up of liquidity – and a broader “flight to safety” that raises the cost of borrowing in emerging markets and increases debt burdens. The second is the broader macroeconomic picture of weaker growth and food and energy price shocks. The third is the likelihood of a long-term change in willingness to lend to high-risk sovereigns.
Russia’s war – and the West’s “shocking and terrifying financial and economic response” – are another jolt to a global economy that has recently weathered trade wars, a pandemic, chain disruptions supply chain and an increasingly unpredictable political environment. All of this could mean a permanent reassessment of how to price geopolitical risk, raising the cost of funding for emerging markets.
How much money is at risk?
According to the Washington DC-based Institute of International Finance, emerging market bonds and loans maturing by the end of next year total around $9 billion. Compared to the emerging market debt crises of the 1990s, far more debt is denominated in local currency and fewer exchange rates are pegged rigidly to the dollar, reducing risk. But even though about 85% of that debt is in local currency, more than $1 billion is directly exposed to rising U.S. rates, says Reuters’ Jamie McGeever. Total public debt in emerging markets stands at around 66% of GDP, according to the IMF, nearly doubling since 2008. “This debt explosion could only be paid off because global rates have crashed to virtually zero. after the 2008 crisis”. As they rise, it will not.
How bad are things already?
According to the IMF, the number of low-income countries near or close to the level of debt distress has doubled, from 30% in 2015 to 60% today. The war in Ukraine, which began in late February, has created “a crisis on top of a crisis”, says Kristalina Georgieva, managing director of the fund, with many issuers hit by capital outflows and bond yields well above levels before the pandemic.
What makes the situation “particularly worrying”, says Simon Nixon in The Times, is “the absence of any proven mechanism for restructuring sovereign debt”. This is bound to be necessary (and has already been requested by Chad, Ethiopia and Zambia) as conditions deteriorate and pressure on governments increases. The whole issue is complicated by big changes in who does the lending.
Today, the Paris Club of rich creditor countries represents about 11% of the external debt of emerging countries, against 28% in 2006. China’s share has increased from 2% to 18%, and the share sold to investors private increased from 3% to 11%. All of this makes debt restructuring “a much more complex matter.”
Why is it more complex?
Because the range of lenders is more fragmented and trust is rare. China, which has “made debt diplomacy a core feature of its global assertiveness, has made it clear that it has little interest in cooperating with other lenders.” And although the G20 agreed on a new framework for restructuring the debt of low-income countries in 2020, its impact has been marginal.
From March 2020 to December 2021, the G20’s “debt service suspension initiative” suspended a total of $10.3 billion, while in the first year of the pandemic alone, countries low-income people have accumulated a total debt of $860 billion, according to World Bank figures. The reason this is so important, says Nixon, is that an emerging-market debt crisis could easily widen – similarly to the eurozone crisis – into a banking, financial and economic crisis. wider.
The stakes are high – and the pressure is strong for the wealthiest countries to work together to solve the problem. “The alternative is hardly worth considering.”
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