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Developing Countries at the Verge of Defaulting due to Current Crisis

In: Finance

Turmoil triggered by rising food and energy prices is already gripping countries like Sri Lanka, Egypt, Tunisia and Peru. It risks turning into a broader debt debacle and yet another threat to the world economy’s fragile recovery from the pandemic.

Compounding the danger is the most aggressive monetary tightening campaign the Federal Reserve has embarked on in two decades. Rising U.S. interest rates mean a jump in debt-servicing costs for developing nations, right after they borrowed billions to fight Covid-19, and tend to spur capital outflows.

On top of it all: The stark reality that war in Europe shows few signs of ending, which is driving the latest food and energy shock.

The cocktail of risks has already pushed Sri Lanka to the brink of default on its bonds. A handful of other emerging economies, from Pakistan and Tunisia to Ethiopia and Ghana, are in immediate danger of following suit.

The developing world’s commodity exporters stand to benefit from higher prices. Still, there are other troubles brewing, with a new Covid-19 outbreak locking down key cities in China, and growing angst that Europe and the U.S. will fall into recession.

The dominant themes at the spring meetings of the International Monetary Fund and World Bank in Washington this week are a slowing global economy and the rising risks facing developing nations.

The World Bank slashed its global growth forecast and announced the creation of a $170 billion rescue package for crisis-hit nations, bigger than its Covid-19 response.

The biggest default looming in emerging economies is in Russia, where Putin’s decision to invade Ukraine has brought sanctions, economic isolation, and a pledge to pay debts only in rubles which would likely be ruled a breach of commitments, triggering losses for investors.

Sri Lanka, for now, is at the vanguard of the potentially broader crisis. The country’s currency is down nearly 40% this year. Last week, it suspended foreign debt payments, deciding to use what’s left of its reserves to cover food and energy imports rather than pay investors.

Sri Lanka may be the first but it’s not alone. Some 13 emerging countries have bonds trading at least 1,000 basis points above U.S. Treasuries, up from six a year ago.

The building risks for Emerging Market countries, puts Turkey and Egypt top of the list of major emerging markets exposed to economic and financial spillovers from the Ukraine war.

The World Bank calculates 60% of low-income countries are in debt distress already, or at high risk of it. So far, the trouble is brewing in the sort of “off the radar screen” places investors don’t pay much attention to.

The increase in borrowing costs is likely to get steeper still as the Fed’s efforts to combat inflation at home lead to higher interest rates on U.S. Treasuries, the benchmark for many developing economies. Central banks across much of the emerging world are raising their own policy rates too, as prices surge.

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