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By David Rosenberg and Krishen Rangasamy
After reaping the benefits of decades of low borrowing costs, thanks to excess global savings, governments are now under pressure around the world. Some have been completely out of the money markets (Russia, Pakistan and Sri Lanka come to mind), while others face interest rates in decades.
The combination of high debt levels, emerging interest rates and low economic expansion increases the dangers of sovereign defaults, which can trickle down to an already weakened personal sector through government-banking ties.
As such, investors would do well to exercise smart judgment, focusing on economies that have manageable government debt, smart existing account positions, healthy foreign exchange reserves, and a weak sovereign-bank link. Countries like Thailand, Taiwan and Malaysia eliminate those measures well.
One of the legacies of the COVID-19 pandemic, the steep accumulation of public debt, now threatens to derail the global economy. Gross debt in complex economies rose to more than 112% of gross domestic product (GDP) in 2022, from around 104% of GDP in 2019, according to the International Monetary Fund’s most recent World Economic Outlook. Emerging markets grew even faster, up 10. 5% during this era to 64. 5% of GDP in 2022.
Among the complex economies, Japan and New Zealand led the rate in terms of debt accumulation (amid the fight against COVID-19), either with an accumulation of more than 20 percentage problems in their gross debt-to-GDP ratios. Others, including the United States, Canada and the major eurozone economies, have also posted double-digit increases over the past three years.
In emerging markets, Sri Lanka stood out with a cumulative of nearly 48 percentage emissions to 130% of GDP (not surprisingly now in default), while Bolivia, the Philippines and Thailand recorded increases of more than 20 percentage emissions. . China, Tunisia, Malaysia, Korea, South Africa and Indonesia also recorded double-digit increases this period.
This accumulation of debt, of course, has become imaginable through an environment of low interest rates, thanks to an excess of global savings and an accommodative central bank financial policy, especially in complex economies. But now it’s time to pay for the piper.
This year’s inflationary surprise triggered a shift in central bank policy, raising interest rates along the yield curve in peak countries, leading to higher borrowing prices for governments. 3. 5 percentage emissions (ppt) in Greece, Italy and the United Kingdom (although the latter two are partly due to the dubious political climate). In emerging markets, 10-year yields also soared: Mexico (2. 3 ppt), Korea (2. 1 ppts), South Africa (1. 5 ppts) and Brazil (1. 2 ppts).
High bond yields, coupled with past accumulation of debt, are resulting in a significant increase in debt service prices for many countries. The GIPS economies of euro dominance (Greece, Ireland, Portugal and Spain) are hit the hardest, given the relatively giant length of their public debt and the rise in bond yields, the US and UK are not far behind.
The debt-servicing surprise is less acute in emerging markets given their low, though still high, public debt rating of around 1 percent of GDP in countries such as Korea, Brazil, South Africa and India.
In other words, emerging markets are clear. The strength of the US dollar poses a major threat to this group, given that only about 16% of public debt is denominated in foreign currencies (compared to only 3% in complex economies). Either Disruption with public finances has the potential to spread to the personal sector given the deepening links between the sovereign and banking sectors.
Keep in mind that emerging market banks now hold more than 17% of their government’s sovereign debt, up from 14% before the pandemic. This stronger link between the state and the banks, as we saw in the sovereign debt crisis of the euro’s dominance, can threaten the stability of the economy and the monetary system.
Another complication for emerging markets is capital flight. Countries with a high percentage of non-residents in public debt are more vulnerable than others. Here we think of put options such as Indonesia (where foreigners hold up to 40% of public debt) and Turkey (where foreigners have about a third).
It is true that several complex economies have even larger reserves of foreign ownership (e. g. Ireland, Portugal, Spain and Germany). But they are also better at dealing with capital flight than emerging markets thanks, in part, to their simple access to money markets, and because they are subsidized by hard central banks that can help cushion the blow of EM bond yields: the European Union. The central bank’s new “transmission hedging instrument” and recent Bank of England interventions are one of them. Examples.
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The mix of higher government debt and EM loan prices suggests that fiscal policy, unlike the last two global recessions, will not cushion the blow of the looming economic slowdown. , the worst since the COVID-19 recession of 2020.
But things may be even worse than the IMF expects lately if the US dollar and bond yields continue their upward trend, capital flight is gaining momentum, and close links between the sovereign and banking sectors are spreading from the government to the personal sector. .
As such, investors would do well to exercise judgment and focus on countries like Thailand, Taiwan, and Malaysia that have manageable degrees of government debt, smart existing account positions, healthy foreign exchange reserves, and a weak sovereign-bank link.
David Rosenberg is the founder of the independent company Rosenberg Research