Is it time to worry about an emerging market crisis?

The writer is head of emerging markets economics at Citi

The last two years have seen the risk of an impending debt crisis among low-income developing countries, but now it is worth taking those fears more seriously.

Even before the events in Ukraine introduced a new threat to risk appetite among global investors, a double whammy of tighter US monetary policy and a sharp drop in global trade growth was beginning to take hold. limit the ability of low-income countries to obtain dollars. The longer geopolitical tension remains high, the deeper the problem will become.

Fears of an immediate debt crisis arose as soon as the pandemic did in early 2020. The view was that many developing countries simply would not have the foreign exchange to service their debt. That kind of concern back then was misplaced for three reasons.

First, the US Federal Reserve’s drastic easing of monetary policy kept capital markets open for emerging market borrowers by supporting global risk appetite. Second, the huge fiscal stimulus from the US Treasury helped generate a surge in world trade. Third, the IMF supported the financial stability of developing countries through emergency disbursements and, most notably, through the issuance last year of $650 billion worth of special drawing rights, a multicurrency reserve asset. .

Now, however, the external environment facing low-income developing countries is rapidly deteriorating. US monetary tightening will certainly erode investors’ risk appetite towards emerging markets. The debt crises of the 1980s showed how the financial stability of developing countries is threatened when the US has an inflation problem of its own to deal with.

Meanwhile, global trade growth began to decline sharply in the latter part of 2021, terrible news for countries that rely on such growth to generate foreign exchange earnings.

All of this is taking place in a context in which some important metrics of the creditworthiness of developing countries have deteriorated to worrying levels. In developing countries rated B, for example, the average external debt-to-exports ratio is effectively above 200 percent, a level last seen in the late 1990s. The amount of export earnings from these countries that is consumed in servicing foreign debt payments also exceeds 25 percent again, an amount not seen for two decades.

The market had already begun to worry about single B-rated sovereigns, in that recent months had seen their risk premiums rise sharply relative to more creditworthy countries. But there is plenty of room for these concerns to deepen.

The current rise in commodity prices is, in principle, good news for low-income developing countries, many of which are commodity exporters. But it is not enough, in some cases, to offset the recent collapse in risk appetite.

Credit spreads for fragile commodity importers have obviously widened markedly since February 24, the start of the Ukraine invasion. However, there are also some exporters of fragile commodities that have been affected by risk aversion.

Another reason why default risk is rising among low-income developing countries has to do with the IMF itself. The last time developing countries suffered something like a systemic debt crisis, in the 1980s, the IMF’s view of its role was more or less to keep international payments flowing. Their behavior, in other words, was basically favorable to the creditors, placing the burden of adjustment on the countries themselves to control the growth of domestic spending by tightening their belts to pay the service of the external debt.

These days, however, it is much more sensible to describe the IMF as a debtor-friendly institution. The Fund has been making a big push to encourage the G20 to go further by offering debt relief to low-income countries under the umbrella of its Common Framework that was announced at the end of 2020. Currently only three countries, Chad , Ethiopia and Angola, have applied for debt relief under the framework and the IMF wants more involvement. Things being as they are, the Fund may get its wish.

And since the Common Framework requires private creditors to participate on terms comparable to the G20, it looks like private creditor defaults are set to rise. Maybe that’s not a bad thing: if a country can’t pay its debt, then debt relief is entirely appropriate. And it’s worth bearing in mind that private creditors tend to have short memories, allowing a defaulting country to return fairly quickly to international capital markets. But debt defaults are often messy, one more thing to worry about in a world full of worries.

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