The World Needs to Pay Attention As A Perfect “Debt” Storm is Brewing in the Emerging Economies!
The World Bank Group in its latest Global Economic Prospects’ report has underscored that global growth is slowing sharply in the face of multi-faceted challenges including price inflation, monetary policy shocks (from higher interest rates), reduced investment flows and ongoing geo political tensions. As a result, the World Bank expects the economic growth to slow to c1.7% in 2023 and c2.7% in 2024.
As shown in the graph below the recent monetary policy tightening by the Central Banks of the Group of Seven leading economies has been more similar in speed and quantum to those carried out in the 1970s and early 1980s. Although its true that the rates (this time) have started from a far lower level and increases have come on the back of years of quantitative easing however the key factor has been the strong appreciation of the US dollar.
With looming fears of a worldwide recession, the crisis facing the developing world is intensifying augmented by a multi-year period of slow growth driven mainly by heavy debt burdens and weak investment as global capital is being absorbed by advanced economies. This expected weakness in growth and business investment doesn’t bode well for emerging and developing world as it will likely compound the already-devastating recent reversals witnessed post covid-19 in education, health development, poverty eradication, and infrastructure in these countries. On the economic front, the below graph highlights the staggering impact of covid-19 pandemic on Emerging Economies Output.
The graph underscores the impact of the pandemic and the scale of development and progress that is being un-done since the onset of the covid-19 pandemic. Post the pandemic, geo political tensions ensuing from the war in Ukraine, the rapidly evolving commodity cycle leading to staggering inflation and the ensuing monetary policy tightening in developed world has led to significant appreciation in the value of the US Dollar against emerging market currencies. In the face of rising debt levels, effectively this has left certain Emerging and Developing economies vulnerable to economic and balance of payment shocks whereby the potential threat of waves of defaults in over-indebted developing countries appears likely. Taken together, these shocks will cause long-lasting effects, perhaps lost decades, in many vulnerable developing countries. For low income emerging and developing countries that have substantial external debt denominated in the US currency, this will also raise debt service costs sharply.
The initial signs of a brewing emerging market crisis were on display during the recent economic and social turmoil witnessed in Sri Lanka during 2022 whereby government mismanagement sent the country into a c$35Bn debt default amid severe food-and-fuel shortages sending shockwaves in markets as worries intensified among investors that other low- and middle-income countries soon would face challenges in meeting their debt obligations.
As noted earlier, highly indebted emerging economies have already absorbed the severe after effects of covid-19 pandemic leading to a sharp deterioration in their terms of trade given the supply chain shocks and as food and energy prices soared. However this double whammy of rising interest rates in developing world and a rampaging US Dollar will bring these economies more serious trouble. This should raise alarm bells as in many large number of low-income countries, the livelihoods of many are already on the margins of survival with the World Bank estimating that the the number of people suffering “food insecurity” (i.e. on the borders of starvation) in low-income countries jumped from c56M in 2019 to c105M in 2022.
If you look closely its a simple viscous cycle for Emerging economies , currencies of emerging markets have depreciated due to the rising rates in developed world, this leads to inflation and hurts their trade deficit. In order to reduce their respective budget and trade deficits, countries raise taxes, which hurt businesses and lead to lower job creation thus further impeding the economy. The graph below shows the deteriorating credit position of these countries as it underscores the impact the current crisis has had on emerging economies with relatively weak credit ratings whereby effectively, these countries have been shut out of credit markets. It is thus not surprising that there has been a huge decline in public and private bond issuance in emerging and developing countries since February 2022 compared with a year earlier.
So the events of 2022 have set the stage for a dangerous year ahead for emerging economies . Given some of these countries also suffer from political instability , such crisis may have unique and severe social consequences as well. Its time the developed world takes more responsibility and move for a coordinated joint economic action plan before the emerging markets enter a full blown debt spiral which may be difficult to reverse later on. Emerging markets for their part have always been characterized by one word… “Resilience” !
