SINGAPORE (Mar 11): With a steady build-up of public debt becoming increasingly held by private creditors, frontier markets (FMs) are outpacing their emerging market (EMs) counterparts to become more and more vulnerable to global financial shocks.
This is according to Oxford Economics in its latest research briefing issued last Friday, where it noted that FMs are currently “drowning in debt”.
Based on Oxford Economics’ sovereign risk indicator, the risk profiles of 17 major FMs have deteriorated over the past decade with the influx of private capital, often with insufficient regard for their subpar credit metrics, in the firm’s view.
While three out of 17 FMs in Oxford Economics’ sample have commodity prices to blame for their fiscal deterioration, senior economist Evghenia Sleptsova notes that many others have facilitated a consumption-fuelled growth, which in turn widened their twin deficits to exacerbate their burdens.
She also observes a loose negative correlation between the level of debt and investment capacity: countries whose debt burden widened the most, have also seen investment as a share of gross domestic product (GDP) fall since 2011.
However, Sleptsova says an even more worrying aspect is FMs’ increasing financial dependence on China, with the build-up of official public debt seeing a surge of borrowing from China by lower-income economies.
One such example is Pakistan, which has already sought IMF support but encountered difficulties reaching an agreement owing to its large, non-transparent debt to China.
While the economist believes an agreement will ultimately be reached with additional support from Saudi Arabia, she sees Pakistan’s Emerging Bond Index (EMBI) spreads too low for the market’s fundamentals.
“The non-transparent nature of this debt [to China] and poor data availability mean that the external debt of the recipient economies is often significantly under-estimated,” says the economist.
“Using strategic public assets as collateral also bears obvious risks to the recipient countries, as in Sri Lanka where China took control of a key port, or Kenya where concerns of a similar outcome have risen regarding Mombasa port. Unsurprisingly, the opaque nature of these loans and the uncertainty surrounding potential future debt resolution is leaving the IMF and other international organisations alarmed,” she adds.
Based on Oxford Economist’s aggregate sovereign risk scores, Pakistan, Ukraine, Lebanon, Argentina and Ecuador top the list of the most debt crisis-prone markets.
This is followed by Kenya, Sri Lanka, Bangladesh, Ghana and Oman.
While Sleptsova notes that Ukraine, Argentina and Ecuador are already in International Monetary Fund (IMF) programmes and undergoing adjustment, she cautions that the former two FMs still face large twin deficits – and that the continuity of these reforms “cannot be taken for granted” in view of forthcoming elections.
Concerns are also high over Oman’s finances, particularly from 2021 onwards as its poor data quality indicates higher risks than Oxford Economics’ sovereign risk score implies.
Despite its relatively-good showing on political and institutional risk, Sleptsova notes this is largely dependent on policy continuity, which may not be a given as succession risk increases.
Conversely, the economist says she is moderately more optimistic on Egypt where external imbalances have corrected sharply, the government is progressing with fiscal reform and FDI is picking up – as well as on Ecuador, as she believes its bonds are set for a rally to reflect the impact that an IMF programme will likely have on macroeconomic stabilisation there.
