The war in Ukraine is making it tougher for many emerging-market governments to make debt payments to foreign creditors, fueling concerns of potential crises that could shake markets and weaken the global economic recovery.
Many of these countries accumulated mountains of debt during the past decade while inflation and interest rates were low and in the past two years when Covid-19-related costs were climbing.
Then Russia’s invasion of its neighbor and the West’s sanctions sent food, energy and other prices soaring at a time when many major central banks are raising interest rates to tame inflation.
Now, from Islamabad to Cairo to Buenos Aires, government officials are struggling with rising import prices and debt bills on top of the continuing pandemic.
On Tuesday, Sri Lanka said it would suspend foreign debt payments and requested emergency financial assistance from the International Monetary Fund. Its finance ministry said the Ukraine war and the pandemic, which had hurt tourism revenue, left it unable to make the payments.
“There are going to be defaults. There are going to be crises. When we are hit by shocks like this, anything is possible,” Kenneth Rogoff, a Harvard University economist, said during a recent IMF panel discussion. “The thing which has been weighing against having any systemic problem at the moment has been the interest rates globally remaining low…but it’s less and less true for emerging markets and developing economies.”
While the IMF isn’t forecasting a global debt crisis at this point, “it is very much the risk that we are very concerned about,” said Ceyla Pazarbasioglu, IMF director of strategy, policy and review.
Figuring out how to expand and accelerate the framework for debt resolution for troubled developing nations will be a priority for the Group of 20 major economies, whose finance ministers and central bankers will be attending the IMF and the World Bank spring meetings starting Monday in Washington, Ms. Pazarbasioglu said.
Combined global borrowing by governments, corporations and households jumped by 28 percentage points to 256% of gross domestic product in 2020. That is a level not seen since the two world wars during the first half of the 20th century, she said.
While rich nations have a little problem coping with their growing debts thanks to still-low interest rates and solid economic growth, many developing economies are feeling more pressure. About 60% of low-income countries—defined as the roughly 70 nations that qualified for a global debt-payment suspension program during the pandemic—were at high risk of debt distress or already in distress in 2020, up from 30% in 2015, according to the IMF. Debt is considered distressed when a country is unable to fulfill its financial obligations and debt restructuring is required.
Efforts to help troubled debtor countries are complicated by the entry of new and less-experienced creditors in developing-world lending in recent years. Seeking to juice returns in a low-interest-rate market, investors including pension and private-equity funds and government-owned financial entities piled into high-yield government debt.
China’s share of external debts owed by the 73 highly indebted poor nations jumped to 18% in 2020 from 2% in 2006, while private-sector lending rose to 11% from 3%, according to the IMF. Meanwhile, the combined share of traditional lenders—multilateral institutions such as the IMF and the World Bank and the “Paris Club” lenders of mostly wealthy Western governments—fell to 58% from 83%.
“If you don’t have a good understanding of who owns the debt, then it’s very hard to do an efficient restructuring, to bring all of the people to the table,” said Sonja Gibbs, managing director for global policy initiatives at the Institute of International Finance, a group representing global banks.
Two of the starkest examples of the risks that weaker developing countries face are Sri Lanka and Pakistan. Both are mired in widening political crises following the invasion of Ukraine.
Both countries’ foreign exchange reserves have dwindled to the point where they can pay for only one or two months’ worth of imports, according to central bank data, analysts and the IMF.
Sri Lanka’s economic meltdown has sparked mass protests over record inflation, rolling blackouts and critical shortages in basic goods like medicines and cooking gas. According to data provider CEIC, the country’s annual inflation hit 17.5% in February. Public debts linked to infrastructure projects ballooned over the past decade. Debt payments coming due this year total $7 billion, with a $1 billion bond maturing in July. Yet the country’s foreign exchange reserves amount to just $2.3 billion.
Pakistan’s IMF assistance program is on hold after former Prime Minister Imran Khan in late February announced plans for a $1.5 billion fuel and electricity subsidy without the institution’s approval. Mr. Khan was ousted on April 9 as the rising cost of living emboldened his political opponents. Consumer prices in Pakistan rose 12.7% in March over the same month a year ago, according to CEIC.
Egypt’s economy also is struggling with the pandemic’s hit to its tourism sector and now higher inflation and fleeing foreign investment since Russia’s invasion. Egypt’s central bank devalued its currency by 14% in March to pave the way for potential IMF support. The government had previously been keeping a tight grip on the currency to make its debt more attractive to foreign investors.
“The war in Ukraine was the tipping point,” says James Swanston, an emerging-markets analyst at Capital Economics in London. “They really needed to devalue the currency to gain some external competitiveness and be able to export more.”
Egypt has faced long-running economic challenges including rising poverty and declining labor-force participation. The country has borrowed roughly $20 billion from the IMF since 2016, placing it second to Argentina in aid from the institution since the 1980s. In 2020 and 2021, Egypt’s government spent more than 40% of its revenue servicing its debt, and is forecast to do so in 2022.
Are we facing the risk of another global debt crisis? Why or why not? Join the conversation below.
Soon after Egypt’s currency devaluation, Persian Gulf states pledged to inject as much as $22 billion into the country, while the European Union extended 100 million euros in aid that it said was to combat surging food prices due to the war in Ukraine. Economists say Egypt is likely to seek more IMF support, too.
Tunisia is another economy seeking assistance, with grocery shelves recently emptying out of sugar, flour and other critical food supplies and the government delaying wage payments to civil servants. The government got $400 million in financing last month from the World Bank and hopes to secure a lifeline from the IMF.
“Pretty much every sovereign has more debt now than they did back in 2008,” during the financial crisis that year, said Roberto Sifon-Arevalo, chief analytical officer of sovereign ratings at S&P Global Ratings. “Do we have a debit crisis around the corner? I wouldn’t say that. But there are some sovereigns that really are in a very, very difficult position.”