Author 丨 Li Yinong
Editor 丨Li Yingliang
Figure Source 丨 Figure worm
Emerging markets are "highly indebted", and the debt crisis of developing countries may become another risk to global economic growth this year.
According to the Institute of International Finance, debt levels in emerging market economies have risen sharply in recent years. Total outstanding debt has jumped from less than $65 trillion some five years ago to nearly $100 trillion by the end of 2021.
On April 19, local time, the International Monetary Fund (IMF) lowered its growth forecast for emerging market and developing economies in 2022 to 3.8%, down one percentage point from its January forecast. The IMF warned that the Federal Reserve and the world's major central banks fighting inflation could further boggle emerging markets with high currency debt.
The IMF's Global Financial Stability Report, released in April, notes that the global financing environment is tightening and geopolitical tensions are intensifying. In this context, emerging markets face special challenges.
The report notes that growth prospects in emerging markets are generally weaker than those of advanced economies, with more limited fiscal space and rising refinancing risks compared to pre-pandemic trends. The macro-financial stability of many emerging markets will be more vulnerable to threats when there is a serious negative shock at which public debt is at historic high and the outlook for sovereign credit has deteriorated.
Yang Panpan, deputy director of the International Finance Research Office of the Institute of World Economics and Politics of the Chinese Academy of Social Sciences, pointed out in an interview with the 21st Century Business Herald that in the past year, the net increase in global debt has been mainly concentrated in emerging market countries. In contrast, advanced economies have recovered steadily, while emerging economies have been more affected and affected by the epidemic more permanently, and economic growth has not yet recovered. As the debt-servicing burden of developing economies increases, the situation will be even more dire this year.
Sri Lanka is in a debt crisis
Sri Lanka is in the midst of its worst economic crisis in history. The "Pearl of the Indian Ocean," which is highly dependent on imports, is facing an extreme shortage of other necessities such as energy, food and medicine, amid the onslaught of the COVID-19 pandemic, global inflation and the Russian-Ukrainian conflict. With the economic order thrown into chaos, the government may have been unable to repay the nearly $7 billion in foreign debt due during the year.
As of March 2022, Sri Lanka's foreign exchange reserves are less than US$2 billion. As foreign exchange is nearly depleted, Sri Lanka announced last week that it would temporarily halt all external debt servicing in order to keep its remaining foreign exchange reserves for imports of more much-needed necessities such as fuel and food.
The country's Ministry of Finance said in a statement issued on the 12th that Sri Lanka has maintained a good record of foreign debt repayment since independence in 1948. But recent developments, including the economic impact of the ongoing COVID-19 pandemic and the Russian-Ukrainian conflict, continue to erode Sri Lanka's fiscal position and make it "impossible" to repay its external debt.
Due to the Sri Lankan government's announcement of the suspension of the repayment of external public debt, credit rating agency Moody's downgraded Sri Lanka's long-term sovereign credit rating from Caa2 to CA on the 18th, that is, the debt is highly speculative and may or is likely to default.
Liu Xiaoxue, an associate researcher at the Asia-Pacific and Global Strategic Research Institute of the Chinese Academy of Social Sciences, said in an interview with the 21st Century Business Herald that the short-term factors that caused the economic crisis in Sri Lanka were the impact of the epidemic, and the Russian-Ukrainian conflict led to a surge in international commodity prices, including oil and agricultural products, resulting in a deficit in the balance of payments. The long-term factor is that the country's own industrial structure is single, resulting in a fragile economic structure. In addition, the severe shortage of foreign exchange reserves shows that the country's fiscal structure is unable to provide an effective buffer, and the government is able to adjust and take very limited response measures.
At present, the Sri Lankan government is actively seeking a "way out". For example, it has requested emergency financial assistance from international financial organizations such as the International Monetary Fund and negotiated with some countries to promote debt restructuring.
Liu Xiaoxue pointed out that once a developing economy with a fragile economic structure like Sri Lanka encounters external shocks, it is difficult to heal itself and can only wait for external relief. The continuous acceptance of loans for rescue has made the government unable to take effective countermeasures under the crisis, which is very passive and forms a vicious circle.
Be wary of emerging market "debt storms"
More worryingly, Sri Lanka's debt default may simply be a prelude to a "debt storm" sweeping through emerging markets.
Since 2020, the ongoing COVID-19 pandemic has expanded the total debt scale of emerging markets to its highest level in recent years. According to the IMF, nearly 60% of low-income countries are already in debt crisis or at high debt risk. The debt-servicing burden of middle-income developing countries is already at its highest level in 30 years.
Punam Chuhan-Pole, Chief Economist at the World Bank, noted that some low-income countries faced high debt levels and tough fiscal situations before the covid-19 pandemic hit. The pandemic has further contributed to a shrinking fiscal revenue and limited access to sustainable financing. However, both COVID-19 relief and economic recovery require more spending, which is exacerbating the economic pressures they face, putting the already fragile debt situation of low-income countries at greater risk.
Geopolitical risk events exacerbate pre-existing economic pressures. Marcello Estevao, a senior economist at the World Bank, notes that the conflict between Russia and Ukraine has dimmed the economic outlook for many developing countries, "which are either major importers of commodities or are highly dependent on tourism or remittances." ”
Nepal's foreign exchange reserves are being depleted at an accelerated rate as rising prices for commodities such as crude oil and agricultural products drive up import costs. A spokesman for Nepal's central bank said on April 15 local time that if the economic situation does not improve, Nepal's current foreign exchange reserves will be used up within 7 months. As of mid-March, Nepal's foreign exchange reserves were only $9.6 billion.
Egypt's economic situation is equally dire. As the world's largest wheat importer, Egypt has yet to pay a huge financial price for the spillover risks of the Russian-Ukrainian conflict at a time when it has not yet emerged from the huge impact of the epidemic on tourism. At present, the country has also sought loan assistance from the IMF.
Yang Panpan pointed out that for developing countries that are more dependent on imports of bulk commodities such as energy and food, the Russian-Ukrainian conflict has significantly worsened their current accounts. With the exit of monetary easing in the world's advanced economies, it can be said that the fundamentals of emerging economies remain solid compared with before, but have deteriorated.
Rising interest rates may exacerbate debt risk
Economists point out that the fiscal position of emerging economies is already deteriorating as monetary policy tightening in high-income countries has led to higher interest rates, pushing up the cost of debt servicing.
Tobias Adrian, head of the IMF's Monetary and Capital Markets Department, said on the 19th that at present, many central banks have to take farther and faster actions than the current market pricing to curb inflation. But it is likely to lead to tighter global financial conditions while exacerbating the downward trend in sovereign debt.
Adrian noted that emerging markets will face greater financial risks if central banks in advanced economies take overly aggressive monetary policy tightening actions. "There are definitely many countries that are either already in trouble or likely to be in the near future."
Yang Panpan pointed out that compared with the previous round of Fed tightening, the debt problem facing emerging economies will be more serious now. The last round was actually mainly economic overheating. In addition, the market's experience with balance sheet reduction is not very sufficient, but the balance sheet reduction mainly affects medium and long-term interest rates, and the bond market interest rate is more related, so what kind of impact the subsequent balance sheet reduction will have, especially how it will be transmitted to emerging economies, is worth further discussion.
According to Capital Economics, debt rates in African countries have risen relative to U.S. Treasury yields, with Ghana and Ethiopia having the largest spreads.
Against the backdrop of monetary policy normalization in advanced economies and heightened geopolitical tensions, a sharp tightening of global financing conditions that leads to higher interest rates and weaker exchange rates in emerging market countries will undermine investor confidence in the solvency of governments in emerging economies, the IMF noted. At the same time, the rate of return on capital in advanced economies is rising. This could make emerging-market debt less attractive and put upward pressure on their borrowing costs.
Yang Panpan told reporters that the good side is that in terms of sovereign debt, the proportion of local currency sovereign debt issued by emerging markets has risen, which has improved the concerns of currency depreciation and debt deterioration spiraling caused by foreign currency pricing to a certain extent. Historically, however, fluctuations in the value of foreign exchange have still been passed on to bond premiums in emerging markets. This is not a very good signal.
Estevao is concerned that the crisis could quickly worsen if it occurs. But he ruled out the possibility of a global crisis like the One in Latin America's debt crisis of the 1980s.
Yang Panpan also believes that at present, more risks are still concentrated in low- and middle-income heavily indebted countries, and these countries may have a certain degree of default. However, because these economies are relatively small and have relatively weak ties to the global financial system, local default events are more likely than to rise to systemic risks.
Editor of this issue Liu Xueying Intern Huang Jingshan