Frontier markets offer investors the promise of higher growth. Of late, that has come in the form of debt, not earnings.
Financial conditions for emerging economies have tightened dramatically over the past six months, according to the IMF’s latest Global Financial Stability Report, published on Tuesday. The soaring dollar and rising interest rates threaten to push dozens of countries to the brink of sovereign default.
The smallest emerging markets, so-called frontier markets, have the worst of it. Many are in Africa and, like Ghana and Zambia, have only sold their first foreign bonds in the past decade or so. But even larger economies, such as Brazil and India, which have been more resilient against the multiple crises of the past two years, are not immune.
The ratios of debt to GDP and of debt service to government revenues in frontier markets have doubled since 2010. Bond maturity amounts rise steeply from next year, but access to international markets is limited. Less than $4bn in foreign currency bonds comes due this year; that will rise to $10bn next year and about $16bn for the next two years. Without renewed access, the IMF warns, they will default.
Mercifully, the coming debt crises should not be systemic, unlike those that raged across the emerging world in the 1990s. Governments of larger economies from Asia to Latin America have built buffers of foreign reserves, developing deep local financial markets. Brazil and India, for example, borrow almost exclusively domestically.
But local market conditions are tightening too, partly to fight inflation, partly as foreign investors have taken flight. They have removed $70bn from emerging market bond funds this year, split roughly equally between local and foreign currency bond funds.
Even in their own currency, governments cannot borrow ad infinitum. Spending on debt service drains money from productive investment, stymying growth and stoking unrest.
Fixing that problem calls for tough and unpopular fiscal decisions that local politicians have dodged for decades. With financial conditions the tightest since the global financial crisis, this will not change soon.
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