Bloomberg warns … emerging markets are on the verge of a historic series of debt default

Bloomberg warned that a pile of bad debts of about a quarter of a trillion dollars threatens to plunge the developing world into a historic series of defaults.

Sri Lanka was the first country to suspend payments to its foreign bondholders this year, burdened with excessive food and fuel costs that caused protests and political chaos.

Russia follows suit

Shortly afterwards, Russia followed suit last June after falling into a web of sanctions.

A report published by Bloomberg Network said the focus is currently shifting to El Salvador, Ghana, Egypt, Tunisia and Pakistan, which are countries that Bloomberg Economics believes are vulnerable to default.

The report conveyed warnings from several economists about the faltering of those markets in light of the high cost of insuring emerging market debt from the risk of default, to the highest levels since the Russian war in Ukraine.

Carmen Reinhart, a long-term emerging market debt specialist, says: “Debt risks and debt crises are not hypothetical with low-income countries. We are already suffering a lot from it.”

The number of sovereignty markets in emerging markets – yields that suggest investors believe default is a real possibility – has more than doubled in the past six months, according to data compiled by Bloomberg.

Together, these 19 countries are home to more than 900 million people, some of whom – such as Sri Lanka and Lebanon – are already in default.

$ 237 billion

In effect, $ 237 billion in debt is at stake for foreign bondholders, bonds that are now in default, and it adds about a fifth – or about 17% – of the $ 1.4 trillion in sovereign money in emerging markets that are outstanding foreign debt has denominated. In dollars, euros or yen, according to data compiled by Bloomberg.

“domino effect”

Crises in recent decades have always shown that a single government’s financial collapse can create a domino effect, known as market language contagion, as volatile traders withdraw money from countries with similar economic problems, accelerating the collapse of their economies. .

The worst of those crises was the Latin American debt disaster of the 1980s, and emerging market observers say the current moment has some resemblance to that crisis. As it happened, the US Federal Reserve suddenly resorted to raising interest rates rapidly in an effort to curb inflation, which led to the appreciation of the dollar and thus the difficulty of developing countries in their foreign bonds. to repay.

Countries under greater stress tend to be smaller countries with a record in international capital markets, while large developing countries such as China, India, Mexico and Brazil can boast fairly strong external balance sheets and shares of foreign exchange reserves.

But in the most vulnerable countries, there is widespread concern about what is going to happen as attacks of political unrest emerge around the world linked to rising food and energy costs, casting a shadow over prospective mortgage payments in countries with heavy debt, such as Ghana and Egypt, which some say would be better off using Funds to help citizens.

With the war between Russia and Ukraine still putting pressure on commodity prices, rising global interest rates and the US dollar confirming its strength, the burden on some countries is likely to be unbearable.

On the edge of the abyss

The data show that a quarter of the countries tracked by the Bloomberg Composite Index of Emerging Market Debt in US Dollars are treated as distressed, usually defined as returns of more than 10% on treasuries with similar expiration dates.

Sami Maadi, portfolio manager at T. Rowe Price, which helps oversee some $ 6.2 billion in assets, described the situation as one of the worst emerging markets’ debt sales and “probably the worst in history”.

He points out that many emerging markets scrambled to sell foreign bonds during the pandemic when spending needs were high and borrowing costs were low. After central banks in global developed markets tightened their fiscal policies, it pushed capital inflows away from emerging markets and left them with huge costs.

“This is a challenging period for many developing countries,” Maadi added.

It has driven foreign money managers out of developing economies. They withdrew $ 4 billion worth of bonds and shares in emerging markets in June, according to the Institute of International Finance, which was the fourth consecutive month of outflows as the Russian war in Ukraine and inflation hit investors. sentiment.

Meanwhile, Jane Podkaminer, head of research at Franklin Templeton Investment Solutions, said: “It could have a very long-term impact that will change the way we think about emerging markets, especially emerging markets in strategy.”

Sri Lanka’s political turmoil has been fueled by persistent power outages and rising inflation that have deepened inequality. This is something Barclays analysts led by Christian Keeler have warned about could be repeated elsewhere in the second half of this year. “Populations suffering from high food prices and insufficient supplies may serve as a powder keg for political instability,” his team wrote in their mid-year report.

Here is what is currently happening in some of the world’s struggling emerging markets:

El Salvador

Credit rating agencies downgraded the Central American country as its dollar effects tumbled, driven by the sometimes unpredictable policies of President Nayib Bukele. The acceptance of Bitcoin as a legal tender, as well as the Bukele government’s moves to consolidate power, have also raised concerns about El Salvador’s ability and willingness to keep abreast of foreign obligations, especially given its large fiscal deficit. and $ 800 million worth of bonds payable in January. .

Ghana, Tunisia and Egypt

These countries are among the less frequent and less rated low-reserve lenders that serve as a safety margin, and Moody’s Investors Service warns that they will be vulnerable to higher borrowing costs.

African governments have relatively low amounts of foreign reserves to cover bond payments due by 2026. This can become a problem if they are unable to roll over their maturing bonds due to the increasing cost of borrowing from external debt markets. Ghana is seeking up to $ 1.5 billion from the International Monetary Fund, while Egypt has about $ 4 billion in foreign debt owed in November 2022, and another $ 3 billion owed in February 2023, according to data compiled by Bloomberg.

Pakistan

Pakistan has just resumed talks with the International Monetary Fund and has run out of dollars as it needs at least $ 41 billion over the next 12 months to repay its debt and finance imports. Similar to the events in Sri Lanka, the protesters took to the streets to protest against the authorities’ imposition of a power outage of up to 14 hours to save fuel.

Argentina

The South American country is in distress after the latest of nine defaults, which occurred in 2020 during the recession caused by the outbreak.

Inflation is expected to reach 70% by the end of the year, increasing pressure on the authorities to curb the flight of dollars out of the economy to control the exchange rate.

Ukraine

The war has led to Ukrainian officials investigating debt restructuring, especially as financing options in the war-torn country are in danger of running out, according to sources familiar with the matter. The country also indicated that it needs between $ 60 billion and $ 65 billion this year to meet funding requirements, billions more than its allies have promised so far.

Policymakers in Kiev are struggling to maintain the budget as the military struggles with a Russian war that devastated Ukraine’s economy, halted the country’s major grain exports and displaced more than 10 million people.

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