Surging inflation and sharply higher borrowing costs in the US and Europe threaten to push indebted emerging market and developing economies into further financial distress, a top IMF official has warned.
Almost a quarter of emerging market countries that have issued “hard currency” debt have bonds now trading in distressed territory, with spreads more than 1,000 basis points above US Treasuries, according to the multilateral lender.
Borrowers around the world have taken advantage of aggressive monetary easing by the Federal Reserve and the European Central Bank and issued dollar- and euro-denominated debt at ultra-low rates. But borrowing has become more expensive as central banks seek to tackle price pressures with tighter monetary policy.
Tobias Adrian, who heads the fund’s monetary and capital markets department, suggested levels of distress were at risk of rising further if central banks in advanced economies moved too abruptly or aggressively to unwind the monetary policy stimulus injected at the onset of the pandemic.
“There are certainly many countries that are either already in distress or will potentially be in distress in the near future,” he said in an interview with the Financial Times. The IMF on Tuesday cut its forecast for growth in emerging markets and developing economies to 3.8 per cent this year — down one percentage point from its January estimate.
“At some point, some major emerging market could also come into distress and the picture could change . . . That is not in our baseline right now, but it depends on how adverse the evolution of financial sector shocks is going to be,” Adrian added, noting that the amount of debt at risk is not “systemic in nature at this point”.
Countries that were particularly vulnerable included commodity and food importers such as Egypt and Bhutan, he said. Tunisia and Sri Lanka have also run into trouble, with the latter defaulting on its debts this month.
In its twice-yearly Global Financial Stability Report, published on Tuesday, the IMF said central banks in advanced economies were walking a narrow “tightrope” as they attempted to tame the highest inflation in roughly four decades against the backdrop of mounting geopolitical tensions, weakening global growth and whipsawing financial markets.
Traders now expect the federal funds rate to jump to 2.5 per cent by the end of the year from its current level of between 0.25 and 0.50 per cent. The ECB is also expected to lift rates for the first time in more than a decade later this year.
The Fed’s attempts to combat price pressures could hit emerging markets laden with foreign currency debt, the IMF warned on Tuesday.
The fund said: “A disorderly tightening of global financial conditions would be particularly challenging for countries with high financial vulnerabilities, unresolved pandemic-related challenges and significant external financing needs.”
Debt levels across emerging market economies have risen sharply in recent years, with the total amount outstanding jumping to nearly $100tn at the end of 2021 from less than $65tn roughly five years ago, according to the Institute of International Finance.
Global financial conditions have already tightened in recent months as inflationary pressures have become more acute following Russia’s invasion of Ukraine.
Adrian said the shift towards less accommodative monetary policy had been smooth, but warned the Fed and other central banks would have to proceed carefully and communicate clearly to ensure that remained the case.
“Right now, monetary policy in the vast majority of countries is being tightened and so this is exacerbating downward movements in sovereign debt.”
In addition to raising rates, the Fed will shrink its $9tn balance sheet by halting reinvestments of the proceeds from maturing Treasuries and agency mortgage-backed securities it holds. Should its actions roil markets and lead to a destabilising sell-off, Adrian said he expected the US central bank to moderate the pace at which it allowed its holdings of securities to shrink.
The shift in central bank policy — coupled with the fallout from the Ukraine war and sanctions imposed by the US and its allies on Russia — has also dented market liquidity, leading to larger price swings. The IMF on Tuesday warned that there were “some signs” that the uptick in volatility could be weighing on the ability of banks to lend and trade.
The fund pointed to the chaos in commodity markets that led to an eight-day suspension of trading in nickel on the London Metal Exchange this year. JPMorgan Chase disclosed a $120mn loss tied to the trade last week.
Huge swings in commodity prices have triggered big margin calls on short positions. Those margin calls were, the fund said, “testing the resilience of corners of global financial markets that were little known by the broader public only a few weeks ago”.
Source: Economy - ft.com
