Smaller emerging markets are struggling with high US interest rates, which have made it more expensive for them to borrow money.
This is putting a strain on their already fragile finances, according to the World Bank.
Last year, there was a sharp sell-off of emerging market debt after global interest rates rose rapidly and the US dollar strengthened.
Foreign investors are now betting that borrowing costs will remain high for longer, which has made it difficult for emerging markets to recover.
World Bank’s Concern
The World Bank estimates that 23% of emerging and developing countries now have borrowing costs that are more than 10 percentage points higher than those of the US.
This is a significant increase from the less than 5% of countries that were in this situation in 2019.
As a result, debt interest payments as a share of government revenues are at their highest level since at least 2010. This is putting a strain on government finances and making it difficult for countries to invest in essential services.
Ayhan Kose, deputy chief economist of the World Bank Group, described the situation as a “nightmare” for lower-income countries with high levels of debt.
He warned that these countries are facing “well-defined challenges” in rolling over their debt obligations.
Kose said that there is a “silent debt crisis” taking place in emerging markets. He called on world leaders to take action to help these countries, such as by providing financial assistance and debt relief.
According to the Financial Times report, the pain from higher borrowing costs is expected to be particularly acute for lower-income countries, given that many of them ran up large debt piles during the COVID-19 pandemic.
Higher yields mean larger interest payments on freshly issued debt, which can force up debt-to-gross domestic product ratios if governments borrow more to fund those payments. Bond yields move inversely to prices.
Emerging market and middle-income countries’ average gross government debt burden is heading above 78% of GDP by 2028, according to IMF forecasts, compared with just over 53% a decade earlier.
Whereas many of the biggest emerging economies have weathered higher borrowing costs relatively well, smaller economies with more fragile finances have struggled.
Financial Difficulties and Calls for Action
The rise in yields has also shut off many low-income countries from international financing, pushing the likes of Ghana and Sri Lanka into default and leaving many others on the brink.
- A subset of weaker emerging and developing countries “have been just priced out of the dollar bond market”, said Brad Setser, a senior fellow at the Council on Foreign Relations. “It’s an environment where only the stronger emerging markets can afford to borrow in dollars.”
If rates stay higher for an extended period, borrowing costs are likely to bear down on economic growth, say analysts, making it harder for economies to grow out of their debt stresses.
This is particularly worrying for countries such as Egypt and Kenya, which each have bonds maturing next year and face the difficult prospect of trying to refinance at higher yields.
- “Higher costs to finance will over time weaken fiscal deficits, so countries will need to tighten their belts to avoid having their debt ratios rise,” said Lucas Martin, fixed-income sovereign strategist at Bank of America, noting that this could be complicated in countries where there is fatigue over austerity measures.
Higher US interest rates also reduce the ability of emerging economies to cut their rates even when domestic inflation has fallen, as this could weaken their currencies, leading to inflation through higher import prices.
Impact on Emerging Economies
Several emerging economies were much faster to react than Western central banks to the threat of inflation in 2021 and have already started cutting rates, but countries including Hungary and Chile have slowed the pace at which they are cutting in recent months, partly to support their currencies in the face of higher US rates.
The volume of foreign currency debt issued in emerging markets has slumped dramatically over the past two years as the cost of borrowing has soared.
Emerging markets have issued about $360 billion of foreign currency debt this year, according to Dealogic, following a total issuance of $380 billion in 2022.
This follows the issuance of between $700 billion-$800 billion in each of the previous three years.
Issuance has been hit by a lack of demand, as investors favoured issuers with high credit ratings, and waning supply as many sovereigns with low credit ratings lost market access during the rapid increase in US rates of the past 18 months.
- “It’s a textbook environment for investors to hunker down and move capital toward the US and de-risk in EM and other asset classes,” said Paul Greer, emerging market debt fund manager at Fidelity.
- “Higher yields mean more expensive issuance, unless you need to borrow you can be a bit tactical and wait for lower yields to issue.”