A storm is brewing in emerging market debt. The Federal Reserve’s aggressive campaign against inflation has boosted the dollar. Add disruptions to the energy and food markets caused by the war in Ukraine, and you have the biggest set of challenges to developing economies for years.
The yield spread between the JPMorgan EMBI Global index — a benchmark index of dollar-denominated EM sovereign bonds — and safe US Treasuries has surged in recent days. Over the past year, the EMBI index has risen from about 300 to more than 400 basis points, according to Bloomberg data.
Sri Lanka offers a prime example of how external shocks can cripple a country. Its stock market has plummeted 64 per cent in dollar terms this year. Public anger over rising food and energy prices triggered the collapse of the government last month and pushed the south Asian nation to default on its debt.
It is unlikely to be the last. The World Bank reckons almost 60 per cent of the lowest-income countries were in debt distress or at high risk of it before Russia’s invasion of Ukraine this year. EMs face more than $5.5tn of bond and loan redemptions in 2022, according to the Institute of International Finance.
The most vulnerable countries have high debt and limited foreign exchange reserves. Egypt, Tunisia and Pakistan are among those in talks with the IMF for rescue packages. In sub-Saharan Africa, Ghana, Kenya, South Africa and Ethiopia stand out as being high risk.
In the past, EMs could count on cheap money created by loose monetary policies in the west to paper over problems. No longer. Rising interest rates in the developed world have curbed foreign investors’ risk appetite. At 18 per cent, foreign participation in local bond markets is at its lowest point since 2009, the IIF noted.
US retail investors are shunning EM debt. More than $38bn has flowed out of specialist mutual and exchange traded bond funds since the start of the year, according to EPFR data. The exodus will continue.
Source: Economy - ft.com
