[Lee Jong-woo's Economic Insights] Emerging Markets Facing Bond Maturities... Crisis with Snowballing Debt and Currency Depreciation

Debt Provision Ratios Between Advanced and Emerging Countries
8 to 2 Before the Financial Crisis, 5 to 5 After
Debt Increase Centered on Emerging Countries Over the Past 11 Years

The countries hit hardest by the spread of the novel coronavirus infection (COVID-19) are emerging markets. This can be seen in the exchange rates. The Brazilian real depreciated by 23%, from 4.3 reals per dollar to 5.3 reals per dollar. The Turkish lira fared even worse, with the exchange rate rising nearly 40%, from 6 lira per dollar to 8.5 lira per dollar.

As the damage caused by the disease worsens, concerns are growing that a collective crisis may soon occur in emerging markets. This is because $1.8 trillion worth of emerging market bonds and loans will mature over the next three years, and there is no certainty that these will be resolved smoothly. The easiest way to assess repayment capability is to compare each country's foreign exchange reserves with the amount of debt maturing. In the cases of Turkey, Indonesia, and South Africa, the amount of debt maturing within three years reaches 50% of their foreign exchange reserves. Unless these three countries maintain high credit ratings to extend maturities or borrow from elsewhere, they are likely to face a crisis due to foreign exchange shortages.

Currently, the proportion of debt in the global economy is higher than at any other time. This is because debt has increased significantly since the financial crisis; over 11 years since 2009, the global debt-to-GDP ratio has risen by 23.9 percentage points. This is 1.5 times faster than the 27.6 percentage point increase over the 20 years from 1989 to 2008. The only other time the global debt ratio increased by more than 20 percentage points in a decade was during the 1980s.

Since the debt increase over the past 11 years has been centered on emerging markets rather than advanced economies, emerging markets are particularly problematic. Because the financial crisis began in the US real estate sector, lenders were more attracted to emerging markets, which are growing in importance in the global economy, than to advanced economies that caused the crisis. As a result, the debt provision ratio between advanced economies and emerging markets shifted from 80:20 before the financial crisis to 50:50 afterward. The entities increasing debt were also problematic. In advanced economies, government debt increased due to active fiscal stimulus measures, while private debt decreased. In emerging markets, both government and private debt increased. Considering that governments generally have higher creditworthiness than the private sector, emerging markets have taken on greater risk.

Among emerging market debts, corporate debt has been particularly problematic. After the financial crisis, emerging market companies borrowed money overseas to develop oil fields or mine precious metals such as gold. Investing in manufacturing would mean competing with advanced economy companies, which they were unlikely to beat, but commodities were highly profitable because oil prices approached $100 per barrel immediately after the financial crisis. Problems arose after these investments were made. Due to global economic slowdown and increased development, commodity prices fell, making it difficult to break even. Large-scale commodity investments became non-performing loans and a headache, but governments could not decide to shut them down. Because the companies are large and have serious impacts on the national economy, solutions have yet to be found.

If emerging market economies were strong, problems from debt to non-performing companies could be easily resolved, but circumstances are unfavorable. While the real economy, damaged by COVID-19, has entered a recovery phase mainly in advanced economies, emerging markets remain stuck in recession. The International Monetary Fund (IMF) forecasts emerging market economic growth at -3.3% this year, a 0.2 percentage point decline from June. In June, the downward revisions for advanced and emerging economies were similar, but by October, while advanced economy forecasts improved, emerging market forecasts declined due to reduced demand from the disease and concerns over credit tightening. Considering China's significant upward revision of its growth rate, the slowdown in other emerging markets is even more severe.

There are few viable options to revive emerging market economies. At the beginning of the COVID-19 outbreak, both advanced and emerging market central banks implemented aggressive monetary easing and interest rate cuts. Now, monetary policies in both are weakening, especially in emerging markets. Advanced economies have currencies like the dollar or euro that are internationally accepted, but emerging markets cannot conduct external settlements in their own currencies. If the value of their currencies deteriorates significantly or inflation rises sharply, capital outflows are inevitable. This situation makes additional interest rate cuts or liquidity provision difficult.

Emerging markets need to use fiscal policy to stimulate the real economy through job creation and boosting domestic demand, but currently have almost no capacity to do so. Over the past four to five years, advanced economies have taken measures to reduce government debt, while emerging markets have taken none. As a result, emerging market government debt had already reached worrisome levels before the pandemic. The COVID-19 emergency response programs have further increased government debt. To address the economic contraction caused by COVID-19, appropriate fiscal support is needed at each stage of lockdown expansion, economic activity resumption, and recovery. Many advanced economies have progressed to the second stage, but most emerging markets remain stuck at the lockdown expansion stage, limited to one-time income support such as disaster relief payments, tax deferrals, and liquidity support.

In the past, emerging markets excluding China and Southeast Asian countries were not our focus. They were geographically distant and had limited trade volume. Since the mid-2000s, the situation has changed. Securities firms have actively sold emerging market bonds, including Brazilian government bonds, increasing the number of stakeholders in financial markets. Interest in emerging markets, previously limited to a few companies selling products, has expanded to the entire financial market.

Although emerging markets are indeed facing difficulties, investment requires a more nuanced approach. China has shown the fastest recovery among major countries since the COVID-19 outbreak. Exports are solid, and recent global demand for Chinese bonds has increased capital inflows. Reflecting this, the yuan has strengthened from 7.3 yuan per dollar to 6.7 yuan per dollar. Increasing investment there poses no problem. Brazil, India, and Malaysia have government debt levels exceeding the emerging market average, so debt expansion could translate into fiscal burdens. It is advisable to postpone investments there. Turkey and South Africa have high debt ratios and severe currency depreciation, so it is better to avoid investing there for the time being.