The pain felt by a large number of EM sovereigns during a dreadful year for the asset class has sent yields spiking and put the sanctuary of market access well beyond the reach of many, calling into question whether stressed issuers can escape default.
In a sign of the trauma being inflicted on the asset class, JP Morgan's EMBI Global Diversified, which tracks US dollar bonds issued by sovereigns and quasi-sovereigns, is down more than 24% this year. While in spread terms the index has widened by almost 200bp, to 535bp, over the course of the year, the biggest reason for the terrible performance is because the yield has jumped by 500bp, to 9.4%.
"Volatility in rates is the story of the year. It's been almost uninterrupted pain, uninterrupted outflows, terrible liquidity," said Mikhail Galkin, CEEMEA strategist at Goldman Sachs, at an LSEG debt conference panel on Wednesday. "One could argue that, for EM credit, this period is possibly worse than the global financial crisis or Covid because of the longevity. We emerged from those crises relatively quickly."
Not every member of the asset class is struggling – the wealthier Gulf states, for example, are exporters of capital and, buoyed by relatively high oil prices, have demonstrated their financial power through loans to the likes of Egypt and Serbia. Brazil is another nation whose public finances are in good shape.
In turmoil
However, many others are in turmoil. Certain nations, such as Sri Lanka and Zambia, have already defaulted and taken their first steps towards debt restructurings. Another defaulter, Lebanon, has begun talks with its creditors, though the process appears to have stalled. Meanwhile Ethiopia, which though continuing to service its debt, has had talks with official creditors under the G20 common framework.
Russia's invasion of Ukraine has also had big consequences. Ukraine is deferring payments on its debts for two years, while Russia and Belarus are unable to make payments to their international creditors because of sanctions.
But beyond these sovereigns are a whole host of others that are on the edge: Argentina, Ghana, Pakistan and El Salvador among them.
Analysts put the number of EM sovereigns with at least one US dollar bond trading at a yield of 10% or higher at between 20 and 30, roughly equating to over a third of the EMBI GD. "Countries that are locked out of the market and have large external financing needs are the most vulnerable, including Egypt, El Salvador, Ethiopia, Ghana, Kenya, Pakistan and Tunisia, among others," said Patrick Curran, senior economist at Tellimer Insights, an investment research and data platform.
While debate will rage inside these countries about where the blame should lie for their plight, forces outside their control have exacerbated the problems.
"The points of stress this year have been the surge in food and fuel prices, as well as countries with large external financing needs," said James Wilson, EM sovereign debt strategist at ING. "Markets have been almost entirely shut for high-yield sovereigns this year, so wider current account deficits have been difficult to fund and refinancing risks have come to the fore."
Vulnerable
Two sovereigns most vulnerable to default are Ghana and Pakistan, said Carmen Altenkirch, emerging markets sovereign analyst at Aviva Investors. "Ghana doesn’t strictly need to default, but a well organised pre-emptive default may well be the best option, particularly if it includes a local debt restructure," said Altenkirch.
The government is said to be considering a plan to restructure its local currency debt, which prompted Fitch on September 23 to downgrade Ghana to CC from CCC.
As for Pakistan, the country is facing a balance of payment crisis, foreign reserves that cover barely a month's imports, historic lows in the rupee, inflation exceeding 27% and the aftermath of devastating floods. The country's finance minister, who has since been replaced, said on September 23 the country was seeking debt relief from bilateral Paris Club creditors, but not from commercial banks or Eurobond creditors.
Both Pakistan and Ghana are engaged with the IMF, but there will be policy conditions attached to any lending, which could include austerity and exchange rate devaluation. And while the IMF is a possible answer, Adam Wolfe, EM economist at Absolute Strategy Research, thinks funding from the institution could be made conditional on debt restructuring.
"I think increasingly defaulting is going to look like the least worst option for several EMs," said Wolfe. "Many don’t have market access to roll over their bonds, and China is unlikely to restructure its loans without forcing the same conditions on bondholders."
