Despite central banks keeping interest rates at the lowest levels in history and buying debt like there’s no tomorrow, the mountain of debt is not getting any smaller. Emerging markets are, as usual, the place where people are looking for the first signs of trouble.
Over the past six years, nine countries – Argentina, Barbados, Belize, Chad, Ecuador, Grenada, Mongolia, Mozambique and Ukraine – have restructured sovereign debt that was held by private investors, according to a recent paper on the issue published by the International Monetary Fund.
Debt restructuring in other emerging markets – the Republic of Congo, Lebanon, Venezuela and Zambia – is either forthcoming or under way.
The problem will not stop here, unfortunately. While interest rates in developed countries are low, emerging markets can perhaps afford to either take on more debt to try to stimulate growth that would help them pay it off, or at least keep servicing their existing debt.
But the developed world’s profligacy will probably not last that long. The Germans (the ultimate paymasters in the eurozone and, by the looks of it, even beyond) have never ceased worrying about the effects of the European Central Bank’s lax monetary policy.
And they are becoming more vocal about their concerns again, as illustrated by the following quotes from a recent speech by Dr Sabine Mauderer, Member of the Executive Board of the Deutsche Bundesbank at the virtual conference of CFA Institute and CFA Society Germany:
“Clearly, bond purchases are a legitimate and effective monetary policy instrument. But large-scale government bond purchases come with risks and potential side-effects, especially the risk of blurring the lines between monetary and fiscal policy. This is particularly problematic in the context of a monetary union. Therefore, government bond purchases under the special terms of the monetary union should be an emergency tool.
Moreover, crisis-related monetary policy measures must be limited, both in duration and volume. Let’s not forget that the letter ‘E’ in PEPP stands for ‘emergency’: the PEPP must be scaled back when the emergency is over. Similarly, crisis support for enterprises from fiscal policy must also be temporary.”
This is a reminder, to borrowers and the buyers of their debt alike, that the current lax monetary policy environment is by no means guaranteed to last.
As if investors had heeded the warning in Dr Mauderer’s speech, last week global emerging market debt funds posted a small outflow, which ended their longest streak of inflows since 2017, of 12 weeks, according to data from Bank of America analysis.
For now, this is not a problem. Investors will come back to buy emerging markets debt, as they can hardly find better yields elsewhere. But a sobering chart from the IMF shows how much this debt has growth since the global financial crisis:
The IMF acknowledges that the initiatives taken so far to try to deal with the problem are temporary and that measures that have focused on liquidity – making sure that countries have access to finance – will fall short in the case solvency problems (inability to repay debts) crop up.
Investors should think of a plan to deal with this problem when, and sadly not if, it will occur.