Breakneck inflation, rate hikes and a stronger dollar are reminiscent of the early 1980s, a decade that triggered a wave of sovereign debt crises in emerging markets. we take a look at how other emerging countries will fare and highlight an environment for frontier sovereigns in emerging markets.
While most countries are just beginning to recover from the Covid surprise, the war in Ukraine has caused another significant external surprise for emerging market (EM) hard currency (EM) sovereign bonds this year. An environment of increased geopolitical risk, financial tightening in evolving emerging markets, breakneck inflation, and commodity value volatility have created a kind of poisonous combination for emerging markets. This environment has prompted warnings from policymakers and the official sector about a new wave of emerging sovereign defaults and the dangers of more systemic embankment. crisis.
A transparent parallel was drawn with the 1980s, when a series of defaults and crises hit emerging countries as a result of competitive rate hikes through the Federal Reserve to persistent inflation in the United States. The graph on the left shows the magnitude of emerging economies’ sovereign market defaults (mainly on foreign currency bank loans) in the 1980s, which reached nearly one-third of the external public debt inventory in emerging markets. In particular, Latin American sovereigns felt the pressure, given the unsustainable accumulation of external debt relative to exports observed in the region (in light blue, reverse to the right).
1: sovereign bank loans in market currencies and non-performing bonds (% of countries’ external public debt).
2: Outstanding market external debt by region (% of exports of goods and services).
Source: BoC-BoE Sovereign Default Database, IMF, World Bank, Macrobonds, ING
This year, emerging U. S. Treasury yields are emerging. U. S. loan prices have begun to rise for emerging market issuers, many foreign bond markets, driving away portfolio flows from emerging market investors and strengthening the U. S. dollar. UU. de emerging markets since February this year, putting pressure on the account balance of weaker countries.
Sri Lanka defaulted after this external surprise pushed the country to the limit, although vulnerabilities had accumulated much earlier. Misguided tax cuts in late 2019 led to the premature termination of its IMF program and the loss of access to the foreign bond market. As a result, scarce foreign exchange reserves had to be used to pay for maturing Eurobonds and finance the existing account deficit, while budget deficits were increasingly financed through the central bank. The exchange rate and proceed to service the bonds in hard currency was almost impossible, as the degrees of foreign exchange reserve collapsed to almost zero. Russia, Belarus and Ukraine also failed to comply, although for many other reasons due to war and sanctions.
We believe that more breaches can be imagined between “border” countries, more or less explained as lower-rated, smaller (and therefore less systemically vital to the global economy). JP Morgan’s Next Generation Markets Index (NEXGEM) defines those countries as high-yielding ratings (BB or less) at a time in S
However, we are unlikely to see widespread contagion from past emerging market crises, given the gain of better basics and more decisive policy action through major emerging market central banks. while giant emerging countries have built up foreign exchange reserves and floated their exchange rates in reaction to harrowing past crisis reports.
Unsurprisingly, given the challenging macroeconomic backdrop, 2022 has been a bad year for emerging market hard currency sovereign bonds. ) and broadly in line with emerging stocks. Emerging market hard currency bond yields were affected by higher U. S. Treasury yields. The U. S. and widening credit spreads (reflecting higher country threat premiums and a greater investor aversion to emerging market threats).
Despite a slight rebound since mid-July (when yields since the beginning of the year were as low as -22%), yields at this level of the year are the lowest since 1998, the Russian currency crisis. Emerging market bond indices in local currencies held up better, thanks in part to the resilience of Latin American currencies, as did U. S. high-yield corporations (HY). Given the most solid macroeconomic scenario (minus 10% and minus 11%, respectively to date).
Source: ICE, Refinitiv, ING
And with fears that Sri Lanka’s default may simply be the canary in the coal mine for other more vulnerable emerging sovereigns, markets have begun to assess the dangers of new crises among some of the weaker loans. spreads averaging more than 1,000 core dollar bond issues relative to the UST) increased to 17, from 8 at the beginning of the year. as Egypt, Angola and Nigeria have fluctuated around this level. In addition to pointing out investors’ concerns, those spread grades also prevent issuers from entering foreign bond markets, which can be self-fulfilling in the event of a crisis, as sovereigns no longer have to be a key source of investment to renew bond maturities.
In addition to the six countries that are already in default (Lebanon, Belarus, Zambia, Suriname, Sri Lanka, Ukraine), the chart below highlights other countries in difficulty, based on the sovereign sub-indices ICE EM USD. Ethiopia has also already signaled its goal to restructure its debt within the non-unusual framework of the G20. Argentina and Ecuador have recently restructured their debts and have low short-term bond maturities, without fully regaining market confidence. Ghana and Pakistan stand out as major issuers ($13 billion and $7. 5 billion in U. S. bonds, respectively) that have experienced significant volatility and appear to rely on the IMF and other bilateral lenders to meet their short-term financing needs. The IMF, however, plans to buy back some of its upcoming 2023 and 2025 bonds, what Finance Minister Alejandro Zelaya says shows its “ability to pay. “
Source: ICE, Refinitiv, ING
As discussed above, Sri Lanka has succumbed to a combination of high borrowing and debt service costs, as well as an immediate depletion of reserves in the face of massive external financing needs. In an environment of tighter global monetary conditions, a key vulnerability indicator is a country’s need for external financing (existing account deficit and external debt repayment). The chart below compares them to foreign exchange reserves, which can be used to finance external deficits in the absence of money inflows. It also tracks year-to-date foreign exchange reserves to see which countries have already been under pressure in this regard. Sri Lanka, as expected, is the largest excessive outlier on this scale, with the decreasing right quadrant representing the largest vulnerable area. Pakistan, Ghana, Egypt and Kenya stand out as giant emitters, all at or near problematic spread degrees. Soaring raw material costs this year have put pressure on existing account balances of food and primary fuel importers. In contrast, on this metric, Angola looks much safer despite existing spread degrees in line with many regional peers, with its existing account balance supported by higher oil costs.
Source: National sources, IMF, World Bank, Macrobonds, ING
On the fiscal side, higher levels of public debt are also a vulnerability, particularly when it comes to analyzing whether creditors will have to suffer cuts in a default or restructuring scenario. Here, we plot public debt relative to GDP relative to interest prices as a percentage of profits to see where debt service becomes prohibitive. Sri Lanka is again the outlier, while Ghana, Egypt and Pakistan also show greater vulnerability. Gulf Cooperation Council (GCC). By contrast, Nigeria’s public debt is quite low, but profit collection is low and, as a result, debt service prices are higher.
Source: IMF, Macrobonds, ING
Overall, public debt levels have risen due to the Covid crisis and now the current context of high food and fuel costs means that cuts in subsidy spending will be difficult to adopt politically. , the poorest countries remain particularly vulnerable to fuel and food costs.
Source: National sources, Eurostat, IMF, Macrobond, ING
Despite proactive policy by top central banks, inflationary pressures have shown little sign of easing, especially in CEEMEA and Latin America. Economic pressures can gently turn into political turmoil and become much less predictable, making unpopular reforms much more difficult.
To take advantage of this analysis, the key to the near-term default threat is to take a look at upcoming Eurobond maturities and how they can be refinanced or redeemed. The chart below shows maturing bond refinancing wishes across the HY country and the year to the end of 2024, scaled across foreign exchange reserves. A silver lining for weaker sub-Saharan African credits, such as Angola and Nigeria, is that near-term refinancing threats are low. Ghana, Pakistan and Egypt are still below a moderate threat threshold of 20%. Kenya has significant maturity, but not before 2024. Bahrain is the outlier, as it has been in recent years, but the strength of peers like Saudi Arabia mitigates some of this threat. Turkey’s refinancing wishes are great, so the country hopes to regain access to the market in the short term. Threats to Oman and Azerbaijan are offset by hefty existing account surpluses and more foreign assets held in SWFs. Overall, Eurobond refinancing desires are not at critical levels for top HY sovereigns in the next year or two, however a longer era of no market access would still be a fear for many. Array
National sources, ICE, Refinitiv, IMF, Macrobond, ING; Note: Excludes countries with combined foreign exchange reserves, foreign assets of the central bank are used when knowledge of reserves is available, knowledge of Ethiopia’s reserves is an estimate
To compensate for some of the negative news and dangers highlighted, it is worth reviewing our view that we are not hunting in the barrel of a closed and closed emerging global crisis, with symptoms of widespread contagion. On the one hand, many “big” emerging markets have advanced their basics compared to old periods of tension. Countries such as Mexico, Brazil, Indonesia, the Philippines and South Africa have accumulated foreign exchange reserves, increasingly issuing in local currency, and many are reaping benefits from the step-by-step. Future industry terms attempt given the high costs of raw materials. Central banks have been active and orthodox enough to try to get ahead of the curve, and the Federal Reserve, with some notable exceptions. Foreign holdings of local assets in emerging markets are also relatively low and investor positioning in emerging markets is light, reducing some other facets of vulnerability.
Furthermore, the IMF remains an essential safety net for many weaker “border” countries. Many of the troubled sovereigns discussed are trading or already participating in IMF systems (Kenya, Pakistan, Egypt, Ghana) and positive news or investment outlays can generate a virtuous cycle of investor confidence and market access. However, this does not mean that the IMF acts as a guarantee of security for all. The interaction of reform demands with domestic politics can be complicated: Sri Lanka waited too long to compromise, having in the past ended its IMF program early and enacted tax cuts contrary to recommendations, while countries such as Turkey have preemptively ruled out any cooperation. with the IMF And a country can still find itself in a crisis and default when it is in an IMF program (Argentina is the most recent example). Given this dynamic, the resources of choice for public investment, such as China, India and the oil-rich Gulf countries, have become increasingly important, along with the geopolitical points that influence those decisions.
When put into context, valuations of emerging market sovereign loans look poorly globally (i. e. , index spreads are wide relative to overall grades), however, as we dig deeper, it is clear that HY sovereigns are the main driver. IG spreads, even at the BBB level, appear tight compared to old securities, while single sovereign B spreads remain high.
Source: ICE, Refinitiv, ING
There has been a lot of regional differentiation in this dynamic. High energy costs have led to significant overperformance and a basic improvement for primary oil exporters, such as the GCC in the Middle East and Azerbaijan. GCC countries now have a combined weighting of around 20-25% in primary emerging market sovereign hard currency indices, after experiencing a significant expansion in issuance to almost nothing a decade ago, in part due to the fall in commodity costs in 2014.
On the other hand, one of the main areas of fear has been the outlook for Europe, given the existing energy crisis that presages a more serious slowdown in growth. In turn, this fed weaker functionality for the sovereign states of Central and Eastern Europe, such as Hungary, Romania, and Serbia. Prior to this year, the Central and Eastern Europe region was perceived as relatively strong within the hard currency space, with many sovereigns trading with narrow deviations from their ratings and low volatility.
Looking ahead, we expect volatility to continue as we rise in value amid a challenging era for emerging sovereigns. Uncertainty is growing again about the possible intensity and duration of global financial tightening, as well as about the extent of the most likely economic slowdown ahead. EM high yield dollar bond spread levels have tightened since mid-July, recovering somewhat from their sharp summer sell-off, but appreciation increased relative to the average of the past decade. While we do not expect spreads to retest the highs seen in mid-July, we do expect a higher-than-general threat premium to rally as investor considerations of the option of further sovereign defaults persist. Most likely, the main differentiator for low-rated sovereigns is the IMF. Nations with a strong record of cooperation with the IMF and the political leeway to enact less popular reforms deserve to be better able to weather the storm. Recent evidence of increased IMF activity (deals and distributions to countries like Zambia, Sri Lanka, Pakistan and Chile) is very likely to be a continuing trend.
Read the original review: Back to the 80s? What dizzying inflation, rate increases in the U. S. A stronger medium for emerging market sovereign debt
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