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Global Economy

Emerging markets are threatened with a new debt crisis

Concerns about a new debt crisis in the emerging countries are becoming more and more urgent: Ayhan Kose, chief economist and director of the World Bank's Prospects Group, recently warned in the Japanese business newspaper "Nikkei" that the rapid increase in key interest rates by many central banks would put heavily indebted emerging countries in a precarious state situation.

A few weeks ago, IMF head Kristalina Georgieva warned that if efforts to reduce debt do not pick up speed soon, there is a risk of a downward spiral. The experts at the US investment bank Goldman Sachs have long been talking about an impending debt crisis. "For emerging markets, dollar strength and reduced global risk appetite mean the future is more difficult," said Shoqat Bunlawala, head of multi-asset solutions at Goldman Sachs Asset Management.

Is a "Perfect Storm" looming?

"You could describe the current combination of various negative factors for the emerging countries as a 'perfect storm'," emphasizes Klaus-Jürgen Gern, an expert on the world economy and global imbalances at the Kiel Institute for the World Economy (IfW) to The level of debt is historically very high at the moment, he emphasizes. "This means that the countries also have a high refinancing requirement. And that is now affecting the interest rate turnaround in the USA."

A key reason for the fear of a renewed debt crisis in the emerging countries is the dollar, which has been rising for months. Not only the euro is under massive pressure against the US currency. It is also increasing strongly compared to other national currencies. This has to do with the aggressive interest rate policy of the US Federal Reserve (Fed), which has meanwhile raised the key interest rate to between 2.25 and 2.50 percent.

Higher risk, rising risk premiums

The tighter monetary policy is a serious problem for the emerging countries: "The consequence of the turnaround in interest rates is that investment capital, which has flowed into the emerging countries in the past two years because interest rates were so low in the USA, is now flowing back again," explains the IfW expert. This is also related to the fact that the risks for investment capital in the emerging countries are greater due to the level of debt and the risk of a global recession.

Many emerging market loans are denominated in dollars

"In addition, investors are concerned that the monetary policy of the central banks will become even more restrictive because of the risk of inflation," says Gern. Also, since emerging markets have to borrow and repay much of their debt in dollars, a strong dollar makes borrowing more expensive. The settlement is becoming more difficult, and the situation threatens to worsen further as a result of rising interest rates.

The players in the financial markets who provide the states with loans are aware of this. The risk premiums that they demand are also rising because the negative framework conditions increase the chances of the loans defaulting. Many emerging markets, which are already suffering from inflation, food shortages and the threat of recession, now have to deal with the debt issue in addition to the already difficult economic situation.

Commodity exporters have advantages

The number of countries affected is large: according to Georgieva, a third of the emerging countries and two-thirds of the developing countries are already facing a crisis. "Because of the global increase in energy and raw material prices, countries that do not have their own resources, i.e. that are raw material importers, are now coming under pressure. Raw material exporters among the emerging countries are more likely to be supported by the current price development," explains Gern.

For example, Turkey is one of the emerging countries that is particularly affected as a raw material importer, emphasizes the expert. "The country is heading for a serious crisis, also because the monetary policy there is fueling inflation with unreasonably low interest rates."

Kenya with debt problems

Kenya is also one of the countries that could slide into a crisis. Patrick Heinisch, country analyst at Helaba, sees Kenya's new President William Ruto facing a mountain of debt. According to Heinisch, Kenya's national debt amounted to around 70 percent of gross domestic product (GDP) in the 2021/22 fiscal year.

"The high proportion of foreign countries, which accounts for half of the total national debt, is particularly problematic. The rate of the Kenyan shilling, which is currently reaching new all-time lows every month, is increasing the problem of debt sustainability," Heinisch states in a current analysis. In recent weeks there have been protests about the high cost of living.

No risk of contagion for the global financial system

Gern considers the risk that a debt crisis in emerging markets could pose a threat to the global financial system to be low: "As far as I can see, there is no dangerous concentration of unprotected loans at important financial institutions and banks. That's why I think there is a contagion the global financial system unlikely."

In addition, the financial systems in the emerging countries are much more solid than they used to be. Even in Turkey the banking system seems to be stable. "It is unlikely that financial problems in individual countries will lead to a wave of financial crises throughout the entire cosmos of emerging countries, as in the debt crisis of 1997/98," explains Gern.

Important markets for the German economy

This does not mean, however, that this topic should be neglected for the German economy. In this country, a debt crisis and the associated recession in emerging countries would have consequences, because they now account for almost half of world production. And emerging markets are responsible for more than half of global growth.

Gern therefore warns: "For Germany as an export nation, the emerging countries have become important markets. Even if there is no pronounced debt crisis – the economic slowdown in the emerging countries that is to be expected due to the current deterioration in the general financial conditions will be clearly felt in this country."

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