A large amount of bad debt, worth a quarter of trillion dollars, threaten the world with a possible cascade of defaults.
Sri Lanka was the first country to halt payments to its foreign bondholders this year, hampered by sky-high food and fuel costs, social unrest and political chaos.
Now, attention is turning to El Salvador, Ghana, Egypt, Tunisia and Pakistan - countries that Bloomberg Economics believes are vulnerable to default. As the cost of insuring emerging-market (EM) debt from insolvency surges to its highest level, worries are also coming from the likes of World Bank Chief Economist Carmen Reinhart and long-term EM debt specialists such as the former Elliott Management portfolio manager Jay Newman.
"For low-income countries, debt risks and debt crises are not hypothetical," said Reinhart on Bloomberg Television. "We're pretty much already there."
Bloomberg also reported that the number of emerging markets with sovereign debt trading at troubled levels has more than doubled in the past six months. Together, these 19 countries are home to over 900 million people, and some, such as Sri Lanka and Lebanon, are already in default.
This means that at stake is a $237 billion owed to foreign bondholders, which adds up to almost a fifth, or about 17%, of the $1.4 trillion that emerging market nations have outstanding in external debt denominated in dollars, euros or yen.
Looking at the crises that occured in recent decades, it is likely that a financial collapse of one government can create a domino effect. The worst crisis was the debt crisis last 1980 in Latin America. According to observers of emerging markets, the current crisis has a certain similarity to it. Back then, the Federal Reserve also aggressively raised interest rates in an attempt to curb inflation. That caused dollar to soar in value, making it difficult for developing countries to service their foreign bonds.
Smaller countries with shorter experience in international capital markets tend to experience the greatest stress. Larger developing countries such as China, India, Mexico and Brazil boast fairly robust external balance sheets and foreign exchange reserves.
But in more vulnerable countries, there is widespread concern about what is about to happen. Political turmoil is brewing around the world as food and energy prices soar, casting a shadow over upcoming bond payments in highly indebted countries like Ghana and Egypt. And as the conflict in Ukraine continues to put pressure on commodity prices, global interest rates rise and US dollar strengthens. This makes the burden of some countries be unbearable.
Sami Muaddi, a portfolio manager at T. Rowe Price, calls this as one of the worst sell-offs in history.
He pointed out that many emerging markets rushed to sell overseas bonds during the Covid-19 pandemic, when spending needs were high and borrowing costs were low. Now, as global central banks tighten financial conditions, pushing capital flows out of emerging markets and leaving them at high cost, some of them will be at risk. "This is an acute period of problems for many developing countries," he said.
Risk aversion has also spread to active traders who buy default insurance in emerging markets. "The situation could get worse before it gets better," said Caesar Maasry, CEO of Goldman Sachs. And according to the Institute of International Finance, this forced foreign money managers to leave emerging economies. They pulled $4 billion out of emerging market bonds and equities in June, marking the fourth straight month of capital outflows.