[Global Focus] Emerging Markets Face 'Domino Default' Crisis... Shaking Global Economic Stability

Sri Lanka Next is Pakistan?
Concerns Over Domino Defaults Triggered by Ukraine War Following COVID-19
IMF Judges 56% of Low-Income Countries’ Debt as Distressed

[Asia Economy Reporter Kim Hyun-jung] Concerns over a domino effect of debt defaults among developing and emerging countries are rising due to the aftermath of the COVID-19 pandemic, the Ukraine war, and inflation. If a chain of default declarations materializes following Sri Lanka, it could weaken the resilience of the global economy and shake global financial soundness.

On the 17th (local time), the Wall Street Journal (WSJ) reported that the debt repayment burden of emerging countries worldwide has increased since Russia’s invasion of Ukraine. Emerging countries have accumulated debt over the past decade in a low-interest, low-inflation environment, increased government spending due to COVID-19, and now face inflation triggered by the war.

The Journal forecasted that emerging countries, which already have weak economic fundamentals and industrial bases, lack the capacity to resolve the crisis on their own and are likely to follow Sri Lanka’s path toward default.

[Image source=Yonhap News]

◆IMF: "High Risk of Distress in Many Low-Income Countries"= The rapidly increasing external debt during the COVID-19 period is like a time bomb that could explode at any moment. Zeila Pazarbasioglu, Director of Strategy, Policy, and Review Department at the International Monetary Fund (IMF), expressed concern that debt has rapidly increased in many countries since the COVID-19 crisis. In 2020 alone, the total debt of governments, corporations, and households worldwide rose by 28 percentage points relative to global GDP, reaching 256%, a level unseen since World War I and II.

Moreover, among the 73 low-income countries designated for the international debt service suspension initiative during the pandemic, about 56% (41 countries) are already in debt distress or at high risk of distress, according to the IMF. This figure has more than doubled from 27% in 2015. Recently, the IMF has begun discussions with the World Bank (WB) on solutions to the debt problems of developing and emerging countries.

In fact, Sri Lanka announced on the 12th that it would temporarily suspend external debt repayments until negotiations with the IMF on bailout support are finalized and comprehensive debt restructuring is prepared, effectively entering a state of default. Sri Lanka’s external debt amounts to approximately $51 billion (about 62.79 trillion KRW), while its foreign exchange reserves stood at only $1.93 billion as of the end of March.

Notably, low-income countries have seen a significant increase in debt owed to China. According to the IMF, China’s share of external debt among the 73 low-income countries surged from 2% in 2006 to 18% in 2020. Private sector loans increased from 3% to 11%. Conversely, debt owed to traditional lenders such as multilateral institutions like the IMF and WB dropped sharply from 83% to 58%.

The Journal explained, "Efforts to assist indebted countries in distress have become more complicated in recent years with the entry of new creditors (China), who have less experience lending to developing countries." Regarding this, Sonya Gibbs, Senior Director at the Institute of International Finance, said, "If we do not clearly understand who owns the current debt, it is difficult to coordinate bringing everyone to the negotiating table."

Pakistan’s IMF Support Plan Suspended
Egypt Suffers from Loss of Tourism Revenue… National Currency Devalued by 14%
Basic Food Supplies Cut Off in Tunisia Including Sugar and Flour

◆Domino Default Concerns: "Who’s Next?"= Pakistan is currently considered the country in the most dangerous situation. After the ousted Prime Minister Imran Khan unilaterally announced a $1.5 billion fuel and electricity subsidy plan at the end of February, Pakistan’s IMF support plan was suspended. In March, Pakistan’s consumer prices rose by 12.7% year-on-year.

Egypt also suffered from the pandemic as tourism revenue dried up, and after the Ukraine war, it has faced severe inflation and foreign investment outflows. The Central Bank of Egypt devalued its currency by 14% to receive IMF support.

Since 2016, Egypt has borrowed about $20 billion from the IMF, spending over 40% of government revenues in 2020 and 2021 on debt repayments, with a similar situation expected this year. Experts predict that after receiving over $22 billion in support from Persian Gulf countries and the European Union (EU), Egypt will additionally request IMF assistance.

In Tunisia, supplies of basic food items such as sugar and flour have been cut off, and recently, public sector wage payments have been delayed. The government received $400 million in financial support from the WB last month and is also seeking IMF assistance.

[Image source=Yonhap News]

◆Small Economies but Global Soundness Concerns if Spread= Most low-income countries raising default concerns have small economies, so the immediate impact on the global economy may be minimal. Sri Lanka, for example, accounts for only 0.1% of the global economy (ranked 69th worldwide).

Looking specifically at trade with South Korea, trade volume with Sri Lanka is about $430 million annually, which is only 0.03% of total trade volume. Apart from the Export-Import Bank of Korea’s Colombo office, no financial firms have established a presence in Sri Lanka.

However, if the current situation leads to a Fed big rate hike and war-cession becoming reality, the domino defaults of these fundamentally weak countries are likely to become a “real situation” rather than just a “concern.” Goldman Sachs recently predicted that not only Sri Lanka but also El Salvador, Mozambique, Tunisia, Gabon, Ethiopia, and Angola in Latin America and Africa could face default within a year. For El Salvador and Mozambique, the probability exceeds 50%.

Roberto Sifon Arevalo, an analyst at international credit rating agency Standard & Poor’s (S&P), emphasized, "Almost all countries have more debt than in 2008," adding, "While the crisis does not seem imminent yet, some countries are indeed facing very difficult situations."