Emerging markets may soon sink as sovereign debt crisis lurks in the waters
Developing nations dream about one day holding the same political clout and economic power as their developed world counterparts. However, they have a long way to go.
With the absence of a “magic money tree”, according to rich world politicians, Mainstream economic theory suggests that governments in the global south ought to increase tax revenue to finance growth projects. If only it were that easy. The Coronavirus pandemic has ravaged emerging market economies, forcing governments to look to debt financing in an attempt to avoid widespread social implications and long-term economic damage.
Debt burdens among the 30 biggest emerging economies rose by 30 percentage points of GDP in the first two quarters of 2020. Therefore, unsurprisingly, piling debt and recovery calling for further public spending has raised concerns. Kristalina Georgieva, the IMF’s managing director, explained that “we know we must act quickly to restructure their debts… so there is no spillover to the rest of the world”.
Could the turmoil created by the Coronavirus pandemic, consequently, be the last straw in forcing some of these emerging economies to sink into insolvency?
Low per capita incomes, primary sector dependence and high birth rate, have thrown countless hurdles at the developing world for years. However, few have been subject to anything more catastrophic than the invisibly deadly Coronavirus pandemic. World Bank and International Monetary Fund (IMF) data show that at least 35 countries are currently in or at high risk of “debt distress.” Brazil, Indonesia, Mexico and South Africa are thought to be the least resilient according to bond strategists at HSBC, a bank.
What has made these economies so vulnerable? It is interesting to contrast Japans A-grade credit rating, according to Fitch, a credit rating agency, with South Africa’s BB-. The obvious answer to this stark difference centres around Japan having a significantly higher GDP compared to South Africa. However, Japan’s 264% national debt to GDP ratio must surely raise red flags. South Africa’s mere 83% debt to GDP ratio makes Japan’s economy seem like a house of cards. Yet, the strong and stable status of Japan’s economy remains. Is this due to Japan being able to bear the fruits of the “magic money tree” whilst South Africa has chopped it down, or are developed and developing worlds subject to two different narratives?
In short, Japan’s debt mountain continues to be somewhat sustainable due to its central bank’s ability to keep government bond yields ultra-low and investor confidence high. South Africa does not hold the same sovereignty over its currency. Therefore, lower commodity prices and low investor confidence has put this struggling nation on the verge of default.
However, data from S&P Global, a rating agency, suggests the IMF’s forecast of a sovereign debt crisis in emerging markets may be overly pessimistic. Recent projections put 53 of the 60 biggest emerging economies at risk of their interest rates falling short of their growth rate. Economic theory explains that high levels of debt only become unsustainable when interest rates rise above nominal growth rates. Therefore, perhaps the IMF’s warnings may never materialise or may not be as catastrophic as some believe.
Nonetheless, Georgieva should be prepared. The IMF’s advocacy for governments to spend all they can and worry about debts later could come back to haunt them. In this case, it will be of paramount importance that the correct preparations have been put in place to figure out how to restructure emerging market debt.
If the IMF fails, developed nations could be subject to spillover effects. Just like Japan, however, most have some ability to take fruits from the “magic money tree”. Emerging markets unfortunately do not have this luxury. It is unclear whether much of the developing world will ever catch up to the rich world giants. However, what is clear is that the emerging world may be sinking as a debt crisis could be lurking in the waters.