The unfolding crisis in Sri Lanka is causing millions of misery. While political blunders take some of the blame, the economic collapse is a symptom of a wider malaise.
Nearly a third of emerging countries are in debt, the IMF says. The same stock has pushed their interest rates up to at least 10 percent as rising interest rates in advanced economies drive capital outflows. Emerging market dollar-denominated government bonds, as measured by the JPMorgan EMBI Global Diversified index, are on track for their worst record ever, with total returns of minus 18.6 percent this year.
Excessive reliance on foreign money is a known risk. The sell-off during the ‘taper tantrum’ of 2013 illustrated the fragility of emerging economies. Turkey, then one of the ‘fragile five’ of the hard-hit economies, is in trouble again. Annual inflation is close to 80 percent after a succession of aggressive rate cuts. This year’s price increases are likely to be exceeded only by Venezuela, Sudan and Zimbabwe.
But Turkey is an outlier with its ultra-easy monetary policy. By contrast, aggressive central banks in countries like Brazil started raising interest rates last year, long before the US Federal Reserve. Brazil is also benefiting from the commodity boom that has provided windfalls for several emerging countries. Indonesia’s core inflation remains low at 2.6 percent, helped by energy subsidies. The central bank says the earliest rate hike will take place in the third quarter of this year.
Large developing countries have become more resilient in recent years, with less reliance on external financing and greater foreign exchange reserves. But even for the fittest, it will be difficult to get out of the turmoil if the dollar continues to rise. That would drive up the cost of commodity imports and make maintaining dollar-denominated debt more expensive.
A significant minority of debt-laden emerging countries are already on the brink of crisis. Without debt relief, a cascade of defaults ensues.
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