The Pandemic Pushes Emerging Markets Into a Debt Crisis, Yet Again

Investors expect their coupon payments. Emerging markets, which owe more than $8.4 trillion in foreign currency debts, or about 30% of the developing world’s gross domestic product, need to fund health services as they deal with a global economic crash and still come out the other side afloat.

Investors were drawn into emerging markets in a hunt for higher yield, which always comes with risk—even if few would have predicted a crisis quite like the coronavirus. “For the private sector that has lent, it’s going to be very, very difficult,” says Bill Rhodes, a former Citigroup Inc. executive who worked on several emerging-market debt restructurings. Many investors are likely to take a hit.

Everyone agrees some relief is needed. The questions are how much and who pays. The Group of 20 leading economies backed a plan to suspend debt payments from some poor countries through the end of the year. The initiative, coordinated by the Institute of International Finance, a trade group that represents banks and financial institutions, is voluntary for lenders, and it excludes 10 countries that have dollar-denominated bonds that are trading in distressed territory—among them the Bahamas, Iraq, and Sri Lanka. One country, Ecuador, may become a prototype for future deals, having already won approval from bondholders to postpone debt payments.

One potential snag cited by the IIF is that the money managers who hold emerging-market debt have a fiduciary duty to look out for their clients’ interests. Negotiations will play out with a diffuse group of creditors ranging from New York hedge funds to Asian pension managers. “Private-sector debt relief, I think, is just a nonstarter,” said James Barrineau, head of emerging-market debt at Schroder Investment in New York, during a conference call with journalists. “It’s just a nightmare trying to get these guys together to agree to that. You have game theory problems, collective action problems galore.”

Some managers hope a hold on payments may not always be necessary. Virus-driven hardships could be temporary, and governments could find other ways to bridge funding gaps until growth resumes, says Mike Conelius, who manages emerging-market debt at T. Rowe Price Inc. in Baltimore. For countries that can’t do that, investors will want sweeteners, such as a promise of added fees later, to preserve the long-term of their holdings in spite of the missed payments. He warns against painting emerging-market countries with the same brush. “Every one of them has unique circumstances, unique challenges, self-inflicted wounds, and opportunities,” says Conelius.

Momentum is building in some quarters for broader action. Relief may need to reach beyond the list of poorest countries to include middle-income economies and provide a longer-term rescheduling or outright debt cancellation, Paris Club Chair Odile Renaud-Basso told Bloomberg News. The Paris Club is an informal group of creditor countries. “Some countries may need more than just a moratorium for six months or one year,” said Renaud-Basso. “We may need deeper debt alleviation.”

Bondholders say there will be consequences for debtors if payments are unilaterally halted. “Countries are going to box themselves into a situation where they’re unable to obtain market financing,” says Hans Humes, chief executive officer of distressed debt investor Greylock Capital Management. Private creditors representing more than $9 trillion of assets under management, including Greylock, have formed a group to negotiate debt relief for African nations, warning of the risks of a blanket standstill on payments.

Barry Eichengreen, an economist at the University of California at Berkeley and former adviser to the International Monetary Fund, thinks the hole that Covid-19 is putting in many economies will require that some debts be written down and converted into new assets, with individual and institutional investors bearing some of the pain. Policymakers may be sanguine about that. “Investment funds, unlike banks, are not highly leveraged, so they can absorb losses without being destabilized or destabilizing other parts of the financial system,” says Eichengreen. —With Alonso Soto

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