Is emerging market debt in crisis? That depends on who you talk to.
Absolutely, says Ulrich Volz, an economics professor and director of the Centre for Sustainable Finance at University of London. No fewer than 61 countries, from Suriname to Ghana and Pakistan, are threatened with default on their sovereign borrowings, his group calculates. They will need write-downs–or “haircuts,” in bond market parlance –of up to $520 billion. “This is not an Asian crisis or an African crisis. It’s a crisis across all regions,” Volz says.
To Carl Ross, sovereign credit analyst at asset manager GMO, not so much. He counts 15 nations whose bonds are trading below 70 cents on the dollar, a common parameter of distress. They account for just 8% of the emerging/frontier market debt asset class. Larger borrowers like Brazil, the Philippines or Indonesia are on solid footing. “It’s hard to view the problems systematically,” he says. “There may even be opportunities out there.”
The two men agree on some underlying facts. Developing nations started a debt binge around 2000, which ultralow interest rates accelerated after 2008. The Covid pandemic of 2020-2021 hit ability to repay, slashing export or tourist revenues for many countries and pushing emergency social expenditure. Russia’s 2022 invasion of Ukraine delivered a second shock, raising prices for energy and food imports. U.S. and euro zone interest rate hikes are a third blow: Debt coming due will be more expensive to refinance.
Not to mention a dollar that’s risen 30% over the past decade, and a significant new creditor, China, not eager to play by the historic restructuring rulebook.
A debt-plagued Global South needs more capital, not less, to mitigate climate change and shift to green energy sources, Volz argues. Last year’s floods in Pakistan, for instance, will cost the country more than $30 billion, or nearly 10% of annual gross domestic product, by World Bank estimates. “Not only is there a debt crisis, but a climate crisis in parallel,” Volz says.
Investors counter that markets have gotten better at anticipating debt difficulties, avoiding sudden implosions that spread panic. “Back in [Mexico’s] 1994 Tequila Crisis, countries reported reserves twice a year,” notes Jeff Grills, head of emerging markets debt at Aegon Asset Management. “Now we get data from central bank websites.”
The pool of bondholders has also widened, easing the exposure of any one group–like U.S. banks to Mexico in the 1990s, or European Union banks to Greece a decade ago.
Diversified bondholders, particularly China, can cause new difficulties. Beijing objects to what’s become standard rescue procedure over time: The International Monetary Fund steps in with an “adjustment program,” and in return is exempted from the haircuts forced on other creditors.
Zambia, which defaulted on $11 billion or so in 2020, has emerged as a test case, China co-chairing a creditors committee within a so-called Common Framework. The group met recently after a yearlong hiatus, with no public statement of progress. “Overcoming the deadlock between China and the Paris Club [of other bilateral creditors] is critical,” Volz says.
Carlos de Sousa, emerging market debt strategist at Vontobel Asset Management, is more focused on potential value in oversold emerging market bonds. The current price discounts offer wide options for double-digit yields in dollars. “Asset allocators who are too cautious risk missing out on some very nice carry,” he says.
Sovereign 10-year bonds from The Bahamas, for instance, are yielding 12% annually at a price of 82% of par. The repayment outlook is improving as tourism rebounds past prepandemic levels. Kenya offers similar yields with a “good chance that it will refinance” $2 billion due next year. A still higher risk-higher reward trade is Tunisia, with an IMF package pending and bonds trading at 68 cents thanks to political uncertainty.
Some credits already have rallied lucratively, combining macroeconomic luck with good domestic governance. West African oil producer Angola’s bonds have risen from the 40s to the 70s as export receipts rise and the government shows fiscal restraint, Grills says. He’s still a buyer. The Dominican Republic, which looked to be on the ropes during the pandemic tourist drought, raised $700 million from markets at 7% a few months ago.
Emerging market debt may gain political resonance over the coming year as larger and more strategically positioned countries, like Egypt, Nigeria and Pakistan, take center stage in place of Zambia or Sri Lanka, which last year defaulted on $50 billion in foreign borrowings. Turkey is a core credit with an out-of-control economy, but little medium-term risk of default, according to debt markets.
Investors are more nervous about Washington, D.C., as the game of political chicken around the U.S. debt ceiling heats up, Grills says. “There’s not really a big story in emerging markets right now,” he says. “Most of the talk at the IMF spring meeting focused on the debt ceiling debate.”
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