Emerging economies set to struggle to meet debt obligations

As the coronavirus crisis deepens in emerging economies around the world, collapsing currencies, commodity prices, export earnings and tourism revenues threaten to shred the finances of many governments, leaving them scrambling to avoid default.

Zambia has already called in advisers to restructure its debt while Ecuador has asked for more time to make coupon payments on three dollar bonds. Few analysts believe they will be the last. Tunisia, Bahrain and Angola are among the other emerging and frontier countries that some economists fear will struggle to meet impending payments on their cross-border debt in the coming months.

The plunge in most emerging market currencies against the dollar has sharply increased the cost of servicing hard-currency debts, creating a serious threat to financially weaker states.

“The impact of global measures to contain the coronavirus will result in a steep fall in [emerging markets’] gross domestic product this year and the collapse in output, spike in capital outflows and plunge in commodity prices could trigger balance sheet problems that make the downturn much worse and the recovery slower,” said William Jackson, chief emerging markets economist at Capital Economics.

Reza Moghadam, chief economic adviser at Morgan Stanley, said that while emerging markets “largely escaped the 2008 global crisis and recovered quickly, they will not be so lucky this time” and their ability to access international finance is likely to come under “significant stress”.

Even before the pandemic, many developing countries were struggling to service their debts despite the world’s historically low interest rates. As global investors embarked on an ever more desperate search for yield in recent years, eurobond markets opened up to dozens of poorer countries that had historically been unable to access public debt markets, resulting in a borrowing binge.

Emerging economies’ debt servicing costs as a proportion of GDP have risen to their highest level since 2005, according to Oxford Economics. In October the IMF warned that 34 of 70 frontier economies were at “high risk” of falling into debt distress or were already distressed, up from zero as recently as 2014.

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Zambia is most exposed, according to Capital Economics; its gross external financing requirement — the dollars it needs to repay maturing external debt, make coupon payments on short-term debt and cover its current account deficit over the next 12 months — is 172 per cent of its foreign exchange reserves.

Tunisia, Bahrain and Argentina — which is already in restructuring talks with holders of $83bn of foreign debt — are not far behind, with figures of 158, 153 and 133 per cent respectively. African and Middle Eastern countries dominate the list of most exposed countries; Angola, Ghana, Oman and South Africa all have funding requirements of at least 90 per cent of GDP.

“It’s not altogether that surprising given that many of these countries have quite small domestic financial sectors so it’s much harder to raise debt domestically and many of these countries have had high current account deficits for some time,” Mr Jackson said.

Separate analysis by Moody’s suggested Fiji and Bahrain could come under pressure. Both have external bonds worth about 21 per cent of their foreign exchange reserves maturing in the coming year, without taking into account any coupon payments or their current account deficits. Montenegro, Sri Lanka, Croatia and Honduras are also at risk, Moody’s said.

“Typically they are frontier markets that have traditionally relied on concessional debt,” said Marie Diron, managing director for sovereign risk at Moody’s. “In a normal year these [refinancing requirements] would be perfectly fine but it is a particularly difficult environment.”

Some countries have managed to secure mitigating arrangements. Fiji is negotiating a loan from the Asian Development Bank, Sri Lanka secured $500m from the China Development Bank, Montenegro has a guarantee from the World Bank and Bahrain is widely expected to be bailed out by Saudi Arabia if it runs into trouble.

Despite such backstops, Morgan Stanley warned that “few [EM] countries look resilient”.

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Its stress testing — including assumptions such as tourism revenue crashing to zero, remittance payments falling by a quarter and a loss of a third of foreign portfolio investment — suggests that official foreign exchange reserves would cover just a tenth of external financing needs in Bahrain and Ecuador over the next year, and would be inadequate in a swath of other developing countries including Turkey, South Africa, Chile, Indonesia and Hungary.

Many countries are expected to turn to the World Bank or IMF for help; 85 countries have approached the latter for short-term emergency assistance so far, double the number seeking help after the 2008 financial crisis. The multilateral institutions are expected to announce bailout deals for some at their spring meetings later this month.

However, some countries may be reluctant to turn to the IMF.

“If Turkey or South Africa really ran into problems it would be very hard for them to go to the IMF” because of their domestic political dynamics, said Mr Jackson.

Even if governments do seek help from a multilateral lender, private creditors are still likely to be on the hook.

“The IMF can only lend to countries where it deems debt to be sustainable,” Mr Jackson said. “They are not going to tear up that rule, so for many countries an IMF role will have to come alongside a condition that debt restructuring is required.”