Sovereign Debt Restructuring for Emerging Economies in Turbulent Times

In a new article, I discuss the impact of the currently turbulent global economic environment on the prospect for sovereign debt defaults and restructurings in emerging economies.  I also review three types of emerging markets sovereigns that may be at risk of such defaults and restructurings: countries adversely affected by the economic fallout from the war in Ukraine (e.g., Egypt), countries weighted down by debt incurred in connection with China’s Belt and Road Initiative (BRI) (e.g., Sri Lanka), and countries that have had ongoing sovereign debt problems (e.g., Argentina and Venezuela).

First, it is important to put recent global economic developments in context to understand why the current global economic environment poses such a formidable challenge to emerging market and developing country sovereigns.  In 2021, emerging economies and developing countries bounced back smartly from the adverse economic effects of the COVID-19 pandemic, with annual GDP growth at approximately 6.5 percent or higher in 2021.

At the outset of this year, even if not as robust as their performance in 2021, emerging economies and developing countries in 2022 were looking forward to a continued economic recovery from the pandemic-related slowdown that they experienced in 2020. Indeed, in projections released in January, the International Monetary Fund (IMF) and World Bank were projecting growth of 4.8 percent and 4.6 percent, respectively, for emerging and developing economies in 2022.

However, this positive outlook changed markedly with the start of the war in Ukraine in late February.  The economic fallout from the war has upended earlier projections, and now these economies are expected to grow less than 4 percent this year, nearly a 1 percent drop from projections in January.  In April, the IMF revised its projections for growth in 2022 downward to 3.8 percent, and, similarly, in June, the World Bank revised its projections for growth in 2022 downward to 3.4 percent.

Most obviously, with worldwide shortages of oil, the war in Ukraine has led to much higher prices for energy internationally, and this has been a major blow to the many emerging economies and developing countries that depend heavily on imports for their energy needs. Furthermore, the blockade on Ukraine’s Baltic Sea ports has led globally to acute shortages of grains and sharply increased prices for these commodities, and the war has also led to the disruption of supplies of fertilizer, an essential input for agriculture-based economies.

With price increases for fuel and food, many emerging and developing economies are experiencing much higher inflation than expected, and in fact inflation in the economies is much higher than it has been in a number of years.  Higher prices for fuel and food, together with  widespread shortages of these items, have already disrupted the everyday lives of ordinary citizens in many of those countries.  Analysts and national and international policymakers, including for example the secretary general of the United Nations, are  discussing the prospects for widespread “food insecurity” and even the possibility of famines in certain countries.

There are other significant headwinds facing emerging economies that pre-date the war in Ukraine.  Notably, interest rates globally are expected to continue to rise as the Federal Reserve tries to tamp down inflation in the U.S. economy and as other central banks follow suit.  But this rise in interest rates will make it more difficult for emerging economies and developing countries to service outstanding debt  with floating or variable interest rates.  Recently many emerging economies have also seen their currencies depreciate sharply vis-à-vis the U.S. dollar, and depreciating currencies will make it more difficult for emerging economies and developing countries to service their dollar-denominated debt.  d.

Furthermore, supply chain disruptions in the global economy, which came to the fore at the outset of the pandemic, continue to have a deleterious impact on these economies, and this situation was only exacerbated by the closure of factories in China in the spring due to the COVID-related lockdowns ordered by the Chinese authorities.

It is widely expected that a number of emerging and developing economies could face serious debt distress over the coming year or beyond.  For example, the World Bank has indicated that 60 percent of low-income countries are now either in debt distress or at high risk of debt distress, and others have called attention to the  dozen or more emerging market sovereigns whose bonds are now trading at distressed debt levels.

Some observers are even predicting that the global economy may see more sovereign debt defaults and sovereign debt restructurings than at any time since the sovereign debt crises of the 1980s ,when numerous countries around the world – particularly in Latin America but also in Africa, Asia, and Central and Eastern Europe – experienced severe sovereign distress.  Whether that will actually come to pass remains unclear.

In the meantime, there is already evidence that various sovereigns are showing signs of financial distress.  For example, Sri Lanka defaulted on its foreign bonds in May, the first default by an Asian government in over 20 years, and in recent months Sri Lanka has been facing political turmoil (resulting most recently in the forced resignation of its president), an economy in a tailspin, and widespread discontent among its citizens.   Countries such as Sri Lanka, Egypt, and Pakistan, which are facing serious balance of payments problems, dwindling foreign exchange reserves, and even critical shortages in basic necessities (e.g., food, fuel, medicines, etc.), have approached the IMF for new financing packages.

This post comes to us from Steven T. Kargman, founder and president of Kargman Associates, international restructuring advisers. It is based on his recent article “Sovereign Debt Restructuring for Emerging Economies in a Turbulent Global Economic Environment,” published in International Insolvency & Restructuring Review 2022/23 (IIRR).  The article is available here and is reprinted with the kind permission of the publisher of IIRR, Capital Markets Intelligence.