Emerging market debt threatens multiple defaults in global crisis

Sharp rises to interest rates and the value of the dollar put many emerging economies under strain, owing both to the higher cost of imports and the net increase in the cost of debt repayments. G7 countries may consider increasing their aid budgets as up to 60% of governments in emerging economies may defaultWe live in a world of global finance, combined with national-level policy making and budget-setting. This combination can create complex, inter-related problems, especially when several negative developments coincide, which we can observe today. The mood at the IMF annual meeting in Washington, DC earlier this month was gloomy. A Financial Times editorial comment observed on October 16: ‘It is rare for so many engines of the global economy to be stalling all at once,’ citing reduced growth in the major economies, high inflation and rising interest rates. We have stagflation. The pessimism is global, affecting wealthy nations also, with a recession probability of 100% recorded for the US by Bloomberg Economics.Policy-makers in western capitals have come under criticism for responding too late to inflationary pressures, and then having to move aggressively to raise interest rates. Inflation had been building for a while, beginning with the pandemic in 2020-2021 which caused supply chain disruption. Interest rates were kept low to minimise the risk of severe recessions, and then inflation increased faster than central banks expected after the end of most lock-downs, followed by the Russia-Ukraine conflict which led to sharply increasing prices of oil, gas and food, especially grain.Jay Powell, chairman of the Federal Reserve, observed that ‘without price stability, the economy does not work for anyone.’ As rates have risen, the dollar has appreciated significantly in value, with a direct effect on economies around the world. For emerging economies with dollar-denominated government debt, both imports and debt repayments have become more expensive, causing a brutal squeeze on public spending capability and living standards. Much of the inflationary pressure comes from increased prices in essential resources, namely energy and food.Of emerging economies, only Venezuela and Nigeria are oil exporters, so they do benefit from higher export earnings. Others have to import fuel. Bangladesh, one of the principal textile manufacturers in the world, has had to impose limited power cuts, as diesel for electricity generation is rationed. Given that the textile sector is a major user of electricity, this affects the strategically important export industry.Natural disasters have also had an impact. In 2022, both Pakistan and Florida in the US were affected by devastating floods. The cost of damage was estimated at $10bn for Pakistan and around three times that for Florida – but in the case of the latter, the federal government of the world’s largest economy will find it possible to afford the relief and recovery, and has near-limitless ability to borrow or ultimately print money, in the world’s principal reserve currency. The Pakistani government does not have such options and needs international assistance.This month’s IMF meeting heard an estimate that around 60% of emerging economies could default on their government debt before the current crisis is played out. And the IMF issued advice to governments to preserve dollar reserves as much as possible, and avail themselves of precautionary lines from the Fund in order to enhance liquidity. In today’s context, international aid budgets of the wealthiest nations represent a significant source of assistance and relief. An increase in aid would represent enlightened self-interest, as well as a humanitarian policy. The flow of refugees to such countries from regions badly affected by floods, or drought or economic crises is only likely to increase without more assistance.A reformed international system could feature more global funds, and global co-ordination, and potentially imaginative new ideas, for example to make borrowing less expensive for emerging economies, and less vulnerable to changes in currency valuations.* The author is a Qatari banker, with many years of experience in the banking sector in senior positions.