China's debt crisis will break out soon

Emerging countries on the "financial abyss" - why an impending debt crisis would also be felt in Switzerland

The corona crisis hit some emerging countries hard. There is a risk of payment defaults, which would also have consequences in this country. For example, many pension funds are invested in emerging markets.

The outbreak of the coronavirus is putting many emerging countries in great financial difficulties. Another financial and debt crisis could threaten. Some emerging markets are overwhelmed with debt servicing, said World Bank boss David Malpass recently in an interview with the German business newspaper “Handelsblatt”. Some emerging and developing countries are "financially on the brink".

The emerging markets seem far away. For retirement provision and for investors, however, the bad news is definitely relevant. Many are invested in emerging market funds as private investors. In addition, many pension funds rely on products that are invested in stocks and bonds from emerging markets.

Worry about the rise in debt

In a report published in early October, the Institute of International Finance (IIF) predicted a “slow and uneven recovery” from the coronavirus crisis for the emerging markets. According to the IIF, the world economy is likely to shrink by 4.1% this year - significantly more than in the financial crisis year 2009, when it fell by 0.4%. In addition to the lockdowns, China and India are primarily responsible for the particularly severe recession this year, the report says. China's infrastructure stimuli increased global economic growth and raw material prices in 2009, but this will largely not happen this year. Meanwhile, India's economy is likely to shrink by a high 11.3% in 2020, while it grew by 8.5% in the financial crisis year.

The analysts at Independent Credit View (I-CV), meanwhile, are concerned about the sharp rise in debt in emerging markets. This has continued uninterrupted since 2012 and is being accelerated by the outbreak of the coronavirus, according to a study by the Zurich research company. Even before the Corona crisis, various countries had little leeway.

Negative trend in China

The company sees the highest increases in debt in China, Peru, Romania, Brazil, Thailand, South Africa and Turkey. In China, national debt has almost doubled since 2013. For the year 2021, I-CV expects a national debt of 70% of the gross domestic product for the Middle Kingdom, state-related companies are not included here. China is not in immediate danger of default, but the debt trend is clearly negative, says René Hermann, who is responsible for research at I-CV.

For some emerging markets with even higher levels of debt, the situation is increasingly destabilizing, according to the research company's report. The emerging markets had a refinancing requirement in foreign currency of $ 730 billion this year. The sharp rise in foreign currency debt in Turkey, Chile and Colombia increases the risk of payment defaults. Weak emerging markets are likely to experience more refinancing problems in the future and defaults on government bonds will increase. In emerging countries, debt sustainability is often heavily dependent on economic growth. If this collapses and high foreign currency debts become due, debt servicing and the repayment of government bonds could become difficult in some cases.

Corona attacks economic base

Some so-called frontier markets have major problems in this regard. This means developing countries that are on the verge of becoming emerging economies, but are too small or too risky for this, for example. "In the past few years, many so-called frontier markets had the impression that they were now on the rise," says Hermann. Now the tables have been turned. He mentions Sri Lanka, Zambia and Angola as examples of frontier markets with major economic problems.

"The Corona crisis attacked the economic base of many developing and emerging countries from several sides," says Hermann. It is a kind of "perfect storm" for these states. These are highly indebted, they have weak institutions, and now the important source of income tourism has largely collapsed. Often these countries are heavily dependent on exports and manufacture inexpensive products with little added value. He cites textiles as an example. In the oil states, too, the situation is increasingly destabilizing due to the falling prices for the raw material. "In the past, countries with great oil wealth such as Saudi Arabia or Oman were able to calm their populations with transfers from the state treasury, now that is becoming more and more difficult."

Argentina and Lebanon have already defaulted on the capital market. I-CV counts Turkey, South Africa and Mexico among the potential downgrade candidates. During the assessment, the company's analysts looked at, among other things, the economic base, the importance of the shadow economy, debt, the health system and political stability. The countries mentioned here often appeared in the negative area. This is relevant for investors and savers, as these are larger emerging markets in which large institutions such as pension funds are definitely invested.

"Better to invest in companies than in states"

Meanwhile, the ultra-expansionary monetary policy of the US Federal Reserve continues to give the emerging countries tailwind, even if their financial situation is difficult, says Hermann. The Fed recently announced a new inflation target, which encourages investments in risky assets. Alejo Czerwonko, Investment Manager Emerging Markets Americas at the major bank UBS, also assumes that global liquidity will remain ample for a long time. According to him, bonds from emerging markets should therefore continue to attract yield-hungry investors.

At the moment, the central banks are driving investors into lower quality investments, says Hermann. "If something were to change in the monetary policy of the US Federal Reserve, the situation in the emerging markets would worsen very quickly," says Hermann. "In the medium to long term, however, we cannot avoid more defaults on bonds."

The I-CV specialist advises that when investing in emerging markets, it is better to invest in companies from these countries than in the countries themselves. The corporations are mostly more dynamic and have better governance. "A good bond issuer is usually also a good share," says Hermann. Even in these times, investors should not generally keep their hands off emerging market investments such as funds. After all, there are also emerging markets with potential such as Hungary or the Philippines. However, investors should be selective.

UBS representative Czerwonko assumes that emerging market bonds denominated in US dollars will remain attractive. Measured by the JP Morgan EMBI Global Diversified Index over the past few years, the asset class offers an average investment return of 5% per year. In his view, investments in Russia, India and Singapore are currently attractive.