A quarter-trillion dollar pile of distressed debt is threatening to drag the developing world into a historic cascade of defaults.
Sri Lanka was the first nation to stop paying its foreign bondholders this year, burdened by unwieldy food and fuel costs that stoked protests and political chaos. Russia followed in June after getting caught in a web of sanctions.
Now, focus is turning to El Salvador, Ghana, Egypt, Tunisia and Pakistan — nations that Bloomberg Economics sees as vulnerable to default. As the cost to insure emerging-market debt from non-payment surges to the highest since Russia invaded Ukraine, concern is also coming from the likes of World Bank Chief Economist Carmen Reinhart and long-term emerging market debt specialists such as former Elliott Management portfolio manager Jay Newman.
“With the low-income countries, debt risks and debt crises are not hypothetical,” Reinhart said on Bloomberg Television. “We’re pretty much already there.”
The number of emerging markets with sovereign debt that trades at distressed levels — yields that indicate investors believe default is a real possibility — has more than doubled in the past six months, according to data compiled from a Bloomberg index. Collectively, those 19 nations are home to more than 900 million people, and some — such as Sri Lanka and Lebanon — are already in default.
At stake, then, is $237 billion due to foreign bondholders in notes that are trading in distress. That adds up to almost a fifth — or about 17% — of the $1.4 trillion emerging-market sovereigns have outstanding in external debt denominated in dollars, euros or yen, according to data compiled by Bloomberg.
And as crises have shown over and over again in recent decades, the financial collapse of one government can create a domino effect — known as contagion in market parlance — as skittish traders yank money out of countries with similar economic problems and, in so doing, accelerate their crash. The worst of those crises was the Latin American debt debacle of the 1980s. The current moment, emerging-market watchers say, bears a certain resemblance. Like then, the Federal Reserve is suddenly ratcheting up interest rates at a rapid-fire clip in a bid to curb inflation, sparking a surge in the value of the dollar that is making it difficult for developing nations to service their foreign bonds.
Those under the most stress tend to be smaller countries with a shorter track record in international capital markets. Bigger developing nations, such as China, India, Mexico and Brazil, can boast of fairly robust external balance sheets and stockpiles of foreign currency reserves.
But in more vulnerable countries, there's widespread concern about what's to come. Bouts of political turmoil are arising around the globe tied to soaring food and energy costs, casting a shadow over upcoming bond payments in highly-indebted nations such as Ghana and Egypt, which some say would be better off using the money to help their citizens. With the Russia-Ukraine war keeping pressure on commodity prices, global interest rates rising and the US dollar asserting its strength, the burden for some nations is likely to be intolerable.
For Anupam Damani, head of international and emerging-market debt at Nuveen, there’s deep concern about maintaining access to energy and food in developing economies.
“Those are things that are going to continue to resonate in the second half of the year,” she said. “There’s a lot of academic literature and historical precedence in terms of social instability that higher food prices can cause, and then that can lead to political change.”
A quarter of the nations tracked in the Bloomberg EM USD Aggregate Sovereign Index are trading in distress, generally defined as yields more than 10 percentage points above those on similar maturity Treasuries.
The gauge has tumbled almost 20% this year, already exceeding the full-year loss it notched during the global financial crisis in 2008. Some of that, of course stems from big losses in underlying rate markets, but credit deterioration has been a major driver for the most distressed nations2.
Samy Muaddi, a portfolio manager at T. Rowe Price who helps oversee about $6.2 billion in assets, calls it one of the worst sell-offs for emerging-market debt “arguably in history.”
He points out that many emerging markets rushed to sell overseas bonds during the Covid pandemic when spending needs were high and borrowing costs were low. Now that global developed-market central banks tighten financial conditions, driving capital flows away from emerging markets and leaving them with heavy costs, some of them will be at risk.