Observers’ outlook for public debts in the developing and emerging countries is worse than the 2013 debt crisis. While the 2013 crisis gave rise to what became to be known as the Fragile Five group of emerging economies, the COVID-19's economic fallout has already cast its shadow over most South American and African economies, whose public budgets are suffering from disturbing levels of debt. Moreover, major emerging economies such as Saudi Arabia, India and Turkey now appear to be more vulnerable to debt crises, due to lower levels of liquidity and dwindling global capital inflow.
In an interview with the Financial Times in March 2021, on the eve of the IMF spring meeting, António Guterres, secretary-general of the UN, warned that the world faces severe debt crisis in the wake of the coronavirus crisis that threatens to tip developing countries into a rising wave of hunger, poverty, social unrest and conflict. The world, he said, does not properly understand the full scale of the debt disaster.
Guterres said the fact that only six countries had defaulted on their foreign debts last year — Argentina, Belize, Ecuador, Lebanon, Suriname and Zambia — had created the “illusion” of stability and a “misperception of the seriousness of the situation”.
He added that the response to Covid-19 pandemic and to the financial aspects [of the crisis] has been fragmented, and geopolitical divides are not helping.
Signs of the worsening debt crisis
The global economy is being re-shaped in the post-Covid 19 recovery. According to the World Bank’s estimates, the Covid-19 pandemic has pushed about 120 million people into extreme poverty over the last year in mostly low- and middle-income countries, which now are facing several challenges posed by the pandemic.
The post-Covid economy is fragile, suffers violent volatility and generally is heading towards recession-driven monetary policies. Interest rates on most major currencies went up, while income from US debt instruments went up to record highs, pushing developing countries’ capitals to shift to these instruments.
According to the Institute of International Finance, the world’s outstanding debt stood at USD 296 trillion in late June last year. The rise in debt levels was the sharpest among emerging markets, with total debt rising USD 3.5 trillion in the second quarter from the preceding three months to reach almost USD 92 trillion.
According to the Institute, a slight decline in the first quarter, debt among developed economies -- especially the euro area -- rose again in the second quarter. In the US, however, debt accumulation of around USD 490 billion was the slowest since the start of the pandemic, although household debt increased at a record pace.
Globally, household debt rose by USD 1.5 trillion in the first six months of this year to reach USD 55 trillion. The Institute noted that almost a third of the countries in its study saw an increase in household debt in the first half.
Due to the gradual improvement of GDP growth during 2021, the amount of debt relative to the size of the global economy declined for the first time since the onset of the pandemic as growth rebounded. The total debt load stood at about 353% of the world’s annual economic output, compared with a record 362% during the first three months of 2021.
Of the 61 countries monitored by the Institute of International Finance, 51 recorded a decline in debt-to-GDP levels, mostly on the back of a strong rebound in economic activity after restrictions and lockdowns imposed during the pandemic. However, in many cases, recovery was not strong enough for economies to rebound to pre-pandemic levels.
Interest rates
The yield on the 10-year Treasury note rose by less than 1% to reach 1.7%, the fastest growth rate since the peaks that came in the wake of the 2013 global financial crisis. The rate, as of the date this analysis was written, the rate fell to below 1.5%, driven by fears about the omicron variant of the COVID-19 virus. But this decline does mean that an end to this crisis is in sight. Rather, it only adds to uncertainty and high volatility.
The significant rise in the yield on the US Treasury bond has always been a cause for deep changes in capital flow, which helped developing countries and emerging markets to remain resilient even after being hit by the Covid-19 pandemic, the hardest such crisis in decades. The pandemic left these economies fragile.
Higher interest rates are expected to strengthen the US dollar, which will negatively impact the developing countries' debts estimated at USD 4 trillion.
The US economy is now preparing to achieve the fastest growth rate in 40 years, driven by the government’s large financial coronavirus relief package, launched to mitigate the consequences of the pandemic and stimulate demand, the yield of the US Treasury bonds is likely to rise at higher rates than in 2013, driven by fears of a sharp rise in inflation which has already started to sweep markets, pushed by rising energy prices. This may be slightly slowed down by the omicron variant wave. The strong rebound of the US economy and higher interest rates are likely to push the US dollar to higher levels.
The 2022 scenarios
It should be noted that of the ten Big Emerging Markets, classified as emerging economies in 1981, only three became economies with high GDP, according to the World Bank.
Today, the International Monetary Fund classifies 23 countries as emerging markets, while Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging markets. S&P classifies 23 and Russell classifies 19 countries as emerging markets, while Dow Jones classifies 22 countries as emerging markets. The classification varies depending on classification criteria adopted by these organizations.
According to Alberto Ramos, an economist at Goldman Sachs Group Inc, emerging markets are likely to be hit by financial crises. Due to higher public debts, rising budget deficits, governments will adopt austerity policies that will reduce its resilience to economic slowdown caused by the Covid-19 pandemic. For example, in Brazil, fiscal deficits caused more pressure on the economy, forcing the central bank to increase interest rates to high levels although unemployment rates continue to rise.
Total fiscal deficit in Brazil and South Africa, the largest economy in South America, and South Africa, the largest economy in Africa, has ballooned to more than 10% of their GDP.
Argentina runs the highest risk of defaulting on debts this year, despite its success in restructuring its debts in 2020, and although it will not be hard for it to perform on debts in 2022, its loan from the International Monetary Fund (IMF) is another predicament. If Argentina is not given a loan with a longer term from the Fund, it will fall into arrears with the Fund as it will fail to amortize the repayments of around USD 18 billion in 2022.
On the other hand, the IMF will insist that Argentina increase electricity rates, curb lending from the central bank and adopt a more realistic exchange policy.
In a March 2021 global economy outlook, the Organization for Economic Co-operation and Development, increased its protection for the global economic performance, but warned that improvement will be in the advanced countries and will not benefit the developing world. The organization forecast that growth of emerging economies will be 3 to 4% lower than the pre-pandemic levels.
However, aside from the huge debts, the most significant crisis in 2021 was China’s Evergrande’s defaulting on more than USD 300 billion in financial obligations, the equivalent to the total debts of all but nine emerging economies. The world is now watching to see how China will solve this big crisis in 2022, which will serve as a significant indicator to global debt crisis management in the short term.
How is the current global debt crisis different from the early 1980s recession?
Forty years ago, the biggest debt crisis in history that changed the world’s rules and controls of risk management. The outcome was the Basel I set of international banking regulations. On August 12, 1982, Mexico's Finance Minister, Jesus Silva-Herzog, told the US Government that his country would no longer be able to service its debt and that it would run out of money in four days. Later, 26 developing countries restructured their debts. Fifteen of these were South American.
The 1980s debt crisis occurred one year after World Bank economist Antoine Van Agtmael coined the term “emerging markets” as an alternative to the term “third world.”
Forty years later, emerging markets are suffering record levels of debts. Emerging market government debt stands at about 63% of their combined GDP, according to the IMF, which is an increase of more than ten percentage points since 2018.
The early 1980s debt crisis is different from the one expected to hit in 2022. Forty years ago, debts were in foreign currencies, short-term and had variable rate of proceeds. Today, debts are restructured on the long-term and are offered on local markets to local buyers with fixed interest rates that are evaluated in local currencies. According to the International Monetary Fund and the World Bank, 29 poor countries were at high risk of debt distress. S&P downgraded the rating for an additional four countries to +CCC. In the past, half of countries rated CCC or CC file for insolvency within one year, but a majority of these indebted economies are too small to cause wide-scale high risk that would affect global markets.
Outlook for mitigating the crisis
The IMF urged member countries to alleviate financial pressure on medium and low-income countries and urged for issuing USD 650 billion in currency aid to countries hit hard by the coronavirus pandemic to increase their foreign currency reserves without adding to debt burdens. The Group of Seven supported the move.
International Monetary Fund Managing Director Kristalina Georgieva, at the conclusion of a virtual meeting with the G7 Leaders’ Summit, urged the world to brace for a debt crisis in emerging markets hard hit by the Covid-19 pandemic. She warned against higher interest rates, capital fleeing from fragile economies to countries at lower risk of insolvency and a repeat of the 2013 “taper tantrum”, when interest on US Treasury Bonds suddenly increased to high levels.
The IMF’s Managing Director expressed concern over the imminent debt crisis of emerging markets because they rely on income from sectors such as tourism, hard hit by the pandemic, as well as on increasing capital flow into debt instruments to pay old obligations and address new economic burdens that emerged in the wake of the pandemic.
António Guterres, secretary-general of the UN, said that, in addition to a new allocation of SDRs, wealthy countries should pool their existing SDRs through the IMF’s Poverty Reduction and Growth Trust for low-income countries and through a new facility to be created to channel funding to vulnerable middle-income countries. These include a debt service suspension initiative (DSSI) to provide temporary relief from debt repayments for 73 eligible poor countries, of which 46 have applied to take part. He further noted that large, middle-income developing countries had borrowed heavily from domestic lenders rather than from foreign investors, at interest rates much higher than those available to rich countries.
In general, the US President Joe Biden's USD 1.9 trillion stimulus package (which brings the total global financial pandemic aid to USD 16 billion), helped improve the outlook for global economy growth rates in 2021 to higher than IMF’s projected average rate of 5.5%.
In addition to this, trillion of dollars, pumped by the advanced countries into their economies in the first year of the pandemic, helped provide enough liquidity for credit facilities and keep interest rates relatively low.
In the advanced countries, debt service will not account for 3.3% of their public revenue this year - compared to 3.1% in 2019 - while in most emerging economies, interest rates remain, relatively, at high levels, with debt service accounting for an average of 10.4% of public revenue in 2020, up from 8% in 2019. Credit rating agency Fitch, estimates that public debt servicing in developing and poor countries will soar to USD 860 billion in 2022.
Accordingly, creditor advanced countries will have to keep interest rates at low levels during the imminent crisis while also pumping more aid to emerging countries to support spending on healthcare and to mitigate poverty, which became a highly increasing burden because of the Covid-19 pandemic.
