Rising financing costs, rapidly growing debt piles and erratic growth threaten to become a toxic combination for emerging economies this year as they struggle to recover from the economic impact of the coronavirus pandemic.
The OECD this week raised its forecast for the global economy, but most of that improvement would benefit the developed world. It warned that emerging economies would remain 3 to 4 per cent below their pre-pandemic growth path by the end of next year.
The forecast dealt a blow to hopes that fiscally fragile nations would be able to grow their way out of the massive expansion in public spending many have undertaken in the past year in a bid to assuage the damage to their healthcare systems and economies caused by the pandemic and related lockdown measures.
Governments worldwide have been urged by the IMF and other bodies to spend all they can during the pandemic and to worry only later about debt.
Many have done so: Brazil’s public debt hit 102 per cent of gross domestic product at the end of last year according to the Institute of International Finance, India has reached 89 per cent and South Africa at 82 per cent.
Meanwhile, the trillions of dollars pumped into global financial markets by the US and other rich countries as part of their pandemic response have pushed borrowing costs down: public debt service for advanced economies will average 3.3 per cent of government revenues this year according to rating agency Fitch, up only slightly from 3.1 per cent in 2019 despite the huge increase in debt and a sharp decline in tax revenues.
But most emerging economies still have considerably higher interest rates. On average they will spend 10.4 per cent of revenues on interest payments this year, up from 8 per cent in 2019.
As a result, according to Fitch, the amount governments in emerging economies spend on interest payments will next year equal the spending of advanced economies — about $860bn for each group — even though advanced economies have borrowed roughly three times as much as emerging economies.
“All the dialogue we hear is that governments should take advantage of low interest rates [to borrow and spend] but if you don’t have them, the burden on public accounts continues to grow,” said James McCormack, global head of sovereign ratings at Fitch.
The most vulnerable countries are those whose average rate of interest on their debt is higher than their growth rate, according to analysts.
“The long-term real interest rate in South Africa remains close to 4 per cent, which is absurdly high when the potential growth rate in the economy is about 1.5 per cent,” said David Lubin, head of emerging market economics at Citi. “The debt people should worry about is that of countries that don’t have a reliable growth model.”
IIF figures suggest Brazil and Mexico face a similar problem, while countries such as Indonesia, Turkey and India are less vulnerable.
Although India’s debt service costs last year ate up more than a quarter of its government revenues, investors believe its economy will grow fast enough to keep the rupee firm and even rising against the dollar. It sells bonds at long-dated maturities, which reduces refinancing risk, and foreign investors hold less than 2 per cent of its domestic debt, according to the IIF, which means its markets are not vulnerable to sudden outflows of volatile foreign capital.
“What India has is growth credibility,” said Lubin, an appeal it shares with others such as Indonesia, Hungary and Poland. “If you lack growth credibility — and Brazil, South Africa and Mexico lack it — then the market is not prepared to give you the benefit of the doubt.”
That leaves these countries grappling to keep a lid on their financing costs, analysts warn.
For example, Brazil has been selling bonds on its domestic market at shorter maturities — the average maturity of new government debt fell to two years in 2020, down from more than five years in 2019, according to its central bank. Shorter-dated bonds are cheaper to issue but must be paid back more quickly — a tough call in a crisis.
Many economists regard South Africa’s debt problem as the hardest to solve because of the scale of the fiscal adjustment needed. Peter Attard Montalto of Intellidex, a research firm, warned that the South African government’s position was “politically unsustainable and not efficient . . . South Africa will have to go to the IMF [for support] within two years”.
Pretoria’s debt has long maturities — an average of more than 13 years, according to the central bank — and its local capital markets are deeper than those in other large emerging economies.
But the willingness of foreign investors to buy its bonds is coming under strain. They owned about 30 per cent of its local currency debt at the end of last year, down from about 40 per cent between 2017 and 2019, according to the IIF.
Emerging economies’ ability to sell debt in their own currency helps mitigate against the classic form of emerging market debt crisis, in which a shortage of dollars inhibits the ability to repay foreign debts.
But the resilience of these local debt markets has yet to be tested, Lubin warned — so they may not prove to be much protection against the growing fiscal burdens.
“We don’t have any experience of a domestic debt crisis in a large emerging market . . . the kinds of things that act as triggers for external financing problems may also act as triggers for domestic financing problems,” he said.
Source: Economy - ft.com
