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OPINION: A silent wave of financial stress threatens crisis in emerging markets

Friday, 2 September 2022 14:48 GMT

FILE PHOTO: Shadows of protesters are seen as they shout slogans during a march to mark one month since a massive protest forced then Sri Lankan President Gotabaya Rajapaksa to flee the country and step down, amid the country's economic crisis, in Colombo, Sri Lanka, August 9, 2022. REUTERS/Kim Kyung-Hoon

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* Any views expressed in this opinion piece are those of the author and not of Thomson Reuters Foundation.

A confluence of climate disasters, COVID, conflict - and a strong US dollar - have pushed yields to unsustainable levels for many debt-laden poorer countries, but there are ways to ease the pain

A silent wave of financial stress is running through world markets and will soon crash onshore. The yield on long-term sovereign debt is a measure of pressure. It is no surprise that you can’t easily find prices for Sri Lankan, Ukrainian, El Salvadoran, Venezuelan and Argentinian debt.

Still, in Tunisia and Zambia, where you can, yields are over 25%, according to Thomson Reuters. Yields in Brazil, Colombia, Ethiopia, Ghana, Kenya, Nigeria, Pakistan and Turkey have climbed above 12%. Anything in double digits is likely unsustainable.

According to credit default swaps prices, many more countries are at risk. In the last five months, foreign investors have pulled out $38bn from emerging market stocks and bonds in the longest streak of withdrawals on record, according to J. P. Morgan data reported by the Financial Times. 

Part of the silence is because attention has been on the war in Ukraine and a scorching summer as the climate crisis deepens. But an emerging-market debt crisis is in the offing with widespread consequences. World leaders know what to do - they just need to do it.

The proximate cause of the crisis is the jump in the value of the US dollar. Since last May, the greenback has risen by an average of 20% in anticipation of higher U.S. interest rates. Following worrying inflation reports, US policy rates have increased by 1.75% in the most aggressive level of tightening in the Fed's history.

A stronger dollar causes three big problems for open emerging markets: it leads to a rise in the price of imports, increases the cost of servicing dollar-denominated debt and pushes away foreign investors. When central banks fight the dollar's appreciation against their currencies with higher interest rates, they invariably only succeed in pushing their economies into recession. 

They say when the U.S. sneezes, the rest of the world catches cold. Today’s susceptibility to catching cold is driven by COVID debt and the climate crisis. In 2020 and 2021, global debt rose by $43 trillion, its fastest jump on record, according to the Institute of International Finance.


For those on the frontline of climate change, this comes on top of balance sheets that were already stressed. In the most indebted region in the world - the Caribbean - over 50% of the increases in debt prior to COVID stemmed from mopping up after natural disasters. 

Away from this frontline, the central banks of Japan, the United Kingdom, the United States, and the euro area created the cash to purchase $10.2 trillion of existing debt during the COVID lockdowns, allowing new debt to be financed cheaply. These central banks could do this because they issue international reserve currencies that investors want to hold in a crisis and are often required to do so by regulations.

With the exceptions of China and India, developing countries cannot do that to scale. They face record refinancing needs as their economy slows, their currencies slump, and U.S. rates rise. A crisis is coming. 

During the 2008-2009 financial crisis, G7 leaders learned that even when a crisis begins with small players, like IKB, Northern Rock and Bear Sterns, if you don't stop the ball rolling early, it becomes almost unstoppable. They also learned to provide broad unconditional support so that those who need help do not refuse it to avoid the stigma of asking.

In October 2008, G7 finance ministers announced they would "use all available tools to support systemically important financial institutions and prevent their failure and take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding". The silence today is as dangerous as it is deafening. 


The equivalent action is fourfold. The International Monetary Fund should immediately increase access limits to its unconditional rapid credit and financing facilities to previous crisis levels, and it should suspend additional interest surcharges for heavy borrowers until the crisis ebbs.

Secondly, the IMF's shareholders, dominated by G7 countries, should agree to immediately re-channel at least $100bn of unused special drawing rights (SDRs) that give holders automatic access to liquidity to all countries without reserve currencies. They should agree to a new $650bn allocation of SDRs - a level that does not need U.S. Congressional approval - to provide further on-demand liquidity to all. 

Thirdly, G20 leaders should agree on a more ambitious Debt Service Suspension Initiative. It must include the temporary suspension of debt service of all official World Bank and regional development bank loans to the poorest countries as well as COVID-related loans to middle-income countries. Fourthly, these development banks should redouble efforts to utilize unused lending capacity.

None of these actions requires taxpayer sacrifice today, yet delay in acting decisively will spread social, financial and economic collapse. From the U.S. to developing countries through the dollar, and back to the U.S. through an international debt crisis, when will we act as if we all live on the same planet?