Debt sell-off heightens tensions for more than a dozen emerging markets

Sri Lanka’s debt default and political crisis have reignited fears that other emerging markets could face similar challenges as soaring inflation and rising US interest rates force investors to flee.

Sovereign bond yields have skyrocketed to levels that indicate heightened tensions in more than a dozen emerging markets, according to Financial Times analysis of Bloomberg data.

Emerging market investors are accustomed to volatility, but the asset class is now suffering from multiple crises at the same time. The unrest prompted investors withdraw $52 billion from emerging market bonds this year, according to JPMorgan.

“It’s amazing to see the collapse in bond prices on this scale,” said Charlie Robertson, chief economist at Renaissance Capital, adding that the sell-off is “one of the biggest I’ve seen in 25 years.”

The war in Ukraine has led to a sharp rise in food and fuel prices, with devastating social and financial consequences for many import-dependent developing countries. While some oil exporters, especially in the Gulf, have benefited from higher prices, others have seen some or all of the gains offset by pandemic-related disruptions.

Chart showing the change in the yield of 10-year foreign currency bonds since the beginning of the year

The Federal Reserve’s move to raise interest rates in an attempt to tame rising inflation has also led to a stronger US dollar. This has led to further pressure on emerging market economies that must service their dollar debt, while tightening financial conditions is hurting developing countries that are already starved of capital.

“Emerging markets don’t like Fed rate hikes and don’t like it when the dollar strengthens,” Robertson said, adding that “it’s just bad news for countries that need capital when it happens and we haven’t seen rate hikes like this.” nearly 30 years later.”

Yields on 10-year foreign-currency bonds from at least six emerging markets have jumped more than 10 percentage points since the start of the year, including Ukraine, Argentina and Pakistan, according to Bloomberg data.

While bonds in more than a dozen countries are trading at troubled levels that usually signal a high probability of default, analysts suggest that actual missed payments and restructurings are likely to be more isolated. Many large emerging market economies are in better financial and monetary shape today than in past crises, allowing them to better withstand today’s serial shocks.

“There is a lot of financial tension, especially in frontier markets,” said William Jackson, chief emerging markets economist at Capital Economics, referring to less developed emerging markets. “But [for the likelihood of default] countries must be considered on a case-by-case basis.

Esther Lowe, senior investment manager for emerging markets debt at Amundi, said the stress in bond markets was less of a signal of imminent defaults and more of worries about recession and inflation in the US, slow growth in China, and disruptions and deficits. caused by the war in the USA. Ukraine.

“This is more sentiment than fear that countries will default,” she said. “But if this continues, obviously it will increase the cost of financing for these countries and this will affect their ability to pay.”

Emerging markets under pressure

Ukraine

Russia’s invasion of Ukraine has sent Kyiv’s bond yields skyrocketing as investors flee the debts of the war-torn country. Regardless, the IMF said on Thursday that it expects Ukraine to continue servicing its debts and that the additional financing will help the country function without having to issue additional bonds.

El Salvador

El Salvador’s multi-million dollar bet on bitcoin has backfired as the value of the cryptocurrency has halved this year, hurting the Latin American country’s economic situation. El Salvador’s 10-year bond yields are up more than 18 percentage points this year as investors divest themselves of debt.

“The adoption of bitcoin as legal tender has added uncertainty about the potential for an IMF program that will open access to financing for 2022-2023,” Fitch analysts said.

The country has $800 million worth of bonds maturing in January, and analysts are also concerned about their ability to repay.

Sri Lanka

Sri Lanka was mired in political and economic chaos and defaulted on its debt in May. Its president fled the country this week, leaving behind millions vying for food and fuel and throwing the country’s debt restructuring talks with creditors into chaos.

Sri Lanka has $51 billion in debt, half of which is held by bilateral creditors including China and the rest by asset managers including Pimco.

The Asian country needs to form a new government to get funding from the IMF, which will allow it to move forward in negotiations on restructuring with creditors. “We are back to square one,” one bondholder said.

Argentina

Argentina is now unfamiliar with debt defaults. In 2020, the country went through a restructuring and agreed with the IMF earlier this year, which helped it avoid another collapse. Its 10-year bonds are currently trading below 20 cents on the dollar, which is extremely troubled territory.

Argentina’s new finance minister has vowed to clean up the mess as the country battles soaring inflation that is expected to top 75 percent this year.

Pakistan

Pakistan agreed a deal with the IMF on Thursday, paving the way for the release of $1.2 billion to help the country avoid default. Soaring import costs for oil and other commodities have widened Pakistan’s trade deficit and fueled fears that it could suffer the same fate as Sri Lanka.

His agreement with the IMF is expected to encourage other creditors to invest in the country and prevent a default.

The biggest pressure is on Ukraine, which since the Russian invasion in February has been asking foreign governments for cash to cover its growing budget deficit, which now stands at $9 billion a month, up from $5 billion in the early stages of the war. Its 10-year bond yield has risen more than 30 percentage points since the start of the year, reflecting investor concerns.

Last week, state-owned utility Naftogaz asked bondholders to accept deferred payments, raising fears that the government would default on $1.4 billion in bond payments due September 1, Bloomberg reported.

The IMF said on Thursday that it expects Ukraine to continue paying its sovereign debt. The foundation said it expects more donations in the coming days to an account it opened to support the country in April. He added that grant funding, not loans, should be a priority in the short term – the EU provided only $1bn of the $9bn pledged in April due to disagreements over whether to provide grants or loans.

Bond yields in Pakistan, Egypt and Ghana are also spiraling upwards. On Thursday, Pakistan reached an agreement with the IMF that paves the way for the country to access critical funds and avoid a potential default.

“The IMF has become the world’s firefighter,” Robertson said. “Even those who didn’t want them are now inviting them because they saw that Sri Lanka didn’t.”

Markets suggest that the risk of another Argentine default is also high. The yield on its 10-year bonds is up more than 10 percentage points this year, and the price has fallen below 20 cents on the dollar.

Kristalina Georgieva, the head of the IMF, sounded the alarm this week, saying: “The situation is getting worse for countries in or close to debt distress, including 30 percent of emerging market countries and 60 percent of low-income countries.”