- A record number of sovereign dollar bonds are now trading at distressed levels, although these are mostly those of smaller EM governments. Among the most highly distressed sovereigns, Zambia and Ecuador are most likely to default in the very near term. But more generally, the huge fiscal costs and humanitarian consequences of coronavirus could incentivise a slew of distressed governments to default on their debts.
- Excluding Venezuela, Argentina and Lebanon (where governments are already in the midst of sovereign defaults) 17 EM governments now have bond spreads exceeding 1,000bp – a threshold that has historically preceded defaults. This includes the likes of Ecuador, Zambia, Angola, Nigeria and Ghana. (See Chart 1.)
- Unsurprisingly, all these countries fare badly on the standard sovereign debt metrics. Most of these governments have large budget deficits, unsustainable public debt ratios and high FX debts. (The latter have been at the heart of almost all sovereign debt crises, with the exception of Russia in 1998.)
- When gauging default risks in the current climate, there are three general points to make. First, market routs like the current one can be self-fulfilling. High bond yields, triggered by investors’ concerns about default, make it more difficult (and expensive) for governments to refinance their existing obligations. Few sovereigns issue debt at double-digit yields. (See Chart 2.) High yields make investors even more concerned about debt sustainability, exacerbating the sell-off.
- Second, the current period of market dislocation could continue for some time. We don’t expect a sustained rebound in global markets until there is evidence that the coronavirus is being brought under control. With little sign of this happening yet, EM bond spreads and currencies are likely to come under further pressure in the coming weeks, weakening public debt positions.
- Third, the large fiscal costs and social consequences of coronavirus could incentivise governments to push losses onto bondholders. After all, default is often a political decision as much as an economic one. Indeed, Ecuador’s Congress has in recent days asked the government to suspend debt repayments to free up funds to deal with the coronavirus. Other distressed governments will be under political pressure to do the same.
- In terms of which sovereigns are most likely to default, Angola and Zambia, as well as Ecuador, stand out. One important point, though, is that defaults and restructurings would probably be more orderly in Ecuador and Angola. Both countries already have deals with the IMF, which would provide technical expertise. And governments have shown appetite for policy tightening in recent years, suggesting that they would be willing and able to follow a credible fiscal programme to stabilise public debt and incentivise bondholders to participate in restructurings. In contrast, Zambia has no IMF deal and a dire track record on policy tightening, suggesting that a messy default and restructuring would be more likely.
- Over a 2-3 year time horizon, we think that default risks may be underappreciated in Nigeria and Ghana. Both countries’ gross external financing needs as a share of FX reserves are not alarmingly high, making imminent defaults unlikely. But weak revenue-raising abilities and a lack of commitment to policy tightening mean that outright fiscal crises are likely to crystallise over the coming years.
Chart 1: EMBI Bond Spreads Over Treasuries
Chart 2: EM International Sovereign Dollar Bond Issuance Since 2010
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Edward Glossop, Emerging Markets Economist, +44 20 7808 4053, email@example.com