Coming back from the IMF meetings in Washington, I was impressed to see how deep the consensus was on the necessity to find ways to counteract the largest risk: an emerging market financial crisis that will this time go beyond the low-income countries and reach emerging markets who had access to international capital markets.
Most of the borrowers, sovereign or corporate, chose to issue bonds or borrow in US dollars. All of them (except, in a bizarre way the Russian Ruble) have lost value in substantial proportions.
The increased risk associated to inflation, high interest rates and a strong US dollar combine to make the credit of the Emerging Markets more sensitive: it does translate in higher spreads over US Treasuries, who themselves have increased by 4 percentage points.
To add insult to injury, EM market borrowers, while relying less on foreign debt in relative terms, have quadrupled their foreign currency exposure to $ 5 trillion.
The BRIC countries offer a contrasting view. The most vulnerable is now, by a wide margin, the explosion of China’s debt, accentuated by the ideological policies that seem to put the economy in a stage of lethargy. India also increased its foreign debt that will impact the borrowers or issuers. It is, however, unlikely that they will be unscathed, and their size alone represents a potential financial tsunami much wider and bigger than the 2008 financial crisis.
The urgent need for consensus and collaboration
One message clearly came from the IMF meetings: the need for a consensus between the various private and public debtors. The main obstacle remains that China that is not disclosing the elements of its debts and did not allow the initiatives of the IMF and the World Bank to succeed, particularly in Africa. The current Emerging Market Framework is a failure, even if Zambia sings up by the end of the year. There is no shoe that fits all.
Facing the risk of 25 countries defaulting on their debt imminently, it is difficult to imagine how the sheer handling of restructurings will be manageable. With the cost of debt increasing budget deficits around the world, the service of the debt will become an increased part of government expenditures and increased costs for corporate borrowers.
The worst has yet to come. This galvanizes all the energies that can play a role in the solution of the worst emerging market debt crisis and will represent a huge burden on the IMF. The debt service is too high. The optimism prevailing at the end of the IMF meetings was not borne of utopia, but from a lucid view of what lies ahead and the need for converging efforts to tackle the complexity of the current situation.
There is limited fiscal and even policy space due to the debt used to fuel the economic growth. There will be a need to keep access to credit, and in the best cases, to capital markets. Emerging equity markets are tanking and have not yet reached the bottom. The recent crash of the Chinese market after the meeting of the Chinese Communist Party is due to the fact that the Xi Jin Ping message is for more ideology and less pragmatism. Around the world, corporate issuers who relied on debt financing rather than equity will need to take drastic restructuring measures at unfavorable market conditions.
Emergency measures are essential, but financial stability is a marathon.