As policymakers in the developing world battle the ongoing spread of the coronavirus, they also face the economic threat of inflation – and not just at home.
Escalating price growth in major economies, especially the US, is fueling investor expectations of interest rate hikes. That drives bond yields up, making it more expensive for other countries to sell debt as buyers demand higher yields.
What should have been good news — the start of a global recovery — has instead become a threat: that the cost of borrowing will reach dangerously high levels in countries like South Africa and Brazil, wreaking havoc on their already precarious public finances. touch.
Inflation: a new era?
Prices are rising in many major economies. The The Washington City Times is investigating whether inflation is back for good.
DAY 1: Advanced economies haven’t had to deal with soaring inflation in decades. Is that going to change?
DAY 2: The global consensus among central bankers on the best way to promote low and stable inflation has broken down.
DAY 3: The canary in the coal mine for US inflation: used cars.
DAY 4: How the virus disrupted official inflation statistics.
DAY 5: Why rising prices in advanced economies are a problem for indebted developing countries.
“Emerging economies should be more concerned about US inflation than their own,” said Tatiana Lysenko, chief emerging-markets economist at S&P Global Ratings.
It’s not just that inflation and rising interest rates in the US are driving up borrowing costs in the developing world, she said. The broader risk is that the US economy will outperform emerging economies, leading to outflows from their stocks and bonds and, ultimately, currency weakness.
While rich countries have been able to borrow at very low rates during the pandemic, many developing countries are already facing much higher borrowing costs.
S&P data shows that refinancing costs for 15 of the 18 largest developed economies have fallen more than one percentage point below their average borrowing costs. Most pay a fraction of 1 percent. A 1 percentage point increase in borrowing costs would be easy for most to bear.
The same cannot be said of developing countries. Egypt, which must refinance debt equal to 38 percent of gross domestic product this year, is paying an average rate of 12.1 percent, above the average cost of 11.8 percent, according to S&P. Ghana pays 15 percent, against an average of 11.5%.
The danger lies not only in very high rates. Brazil has refinanced an average of 4.7 percent this year, which is lower than the average cost of its existing debt. But it did this by selling bonds that have to be repaid faster than in the past.
This undermines the work of years in which Brazil sold long-term and fixed-rate debt to make its finances more sustainable. Last year, the average maturity of his new debt was two years, compared to five in 2019.
Brazil this year must refinance debt equivalent to 13 percent of GDP – a lower percentage than smaller countries, but a larger sum in total, and it could be plagued by rising interest rates or a slower-than-expected recovery.
The central bank has already raised interest rates twice this year in an attempt to quell price pressures after inflation passed its target range of 2.25 to 5.25 percent. Another rise is likely at its next meeting later this month, and it forecasts a base rate of 5.5 percent by the end of the year, up from a record low of 2 percent in March.
Brazil is a clear example of how inflation and rising yields threaten debt sustainability, said William Jackson of Capital Economics. “It has stretched public finances, increased inflation and a central bank raising interest rates, which is increasing the debt burden.”
South Africa falls in the same category, he said, along with Egypt and others with major refinancing needs.
There are mitigating factors. For example, Brazil, South Africa and India are all much more dependent on domestic lenders than on foreign ones. That makes them less vulnerable to capital outflows than during the debt crisis of the late 20th century.
India, in particular, has turned to its domestic banking system to issue 10-year benchmark bonds at a maximum rate of around 6 percent. It too has borrowed with shorter maturities during the pandemic, although low refinancing needs this year – equivalent to just 3.3 percent of GDP – make it less vulnerable to rising interest rates.
But William Foster, vice president in the sovereign risk group at Moody’s Investors Service, said India’s fiscal problems are making the country dependent on debt rather than government revenue to fund its pandemic response.
“India has large budget deficits and a very high debt burden,” he said. “The most important thing for debt sustainability is to achieve a higher growth rate in the medium term, through reforms and other measures to boost private investment that we have not seen in years.”
If, as many policymakers hope, this year’s rise in inflation proves to be temporary, emerging economies’ interest rates may not have to rise very far.
Roberto Campos Neto, governor of Brazil’s central bank, told a conference this week that the question was whether inflation was temporary and justified by growth, or whether central banks should raise interest rates further. “The first case is benign for the emerging world,” he said. “Not the second.”
Food and commodity prices are already rising at a pace that is fueling consumer inflation expectations, Lysenko said. If interest rates rise significantly, it will become much more difficult to reduce the debt of emerging economies to sustainable levels and achieve growth.
“In an interconnected world with a lot of capital flows, US returns have significant spillovers,” she said. “It is too early [for emerging markets] Tighten [monetary policy], as this could now undermine their recovery. But some countries may not have much room left to not tighten up.”