The U.S. dollar strengthened to a 20-year high against a collection of foreign currencies this week, spelling more trouble for heavily indebted smaller nations around the world. The stronger dollar makes payments on loans owed in U.S. currency more expensive. This comes as some lower-income countries face mounting economic problems and others — including Sri Lanka, Lebanon and Zambia — have already defaulted on their international debts.
Last week, Argentina slapped sweeping new restrictions on imports of everything from whiskey to software to consulting services to try to contain inflation that's running at over 70%. The South American nation has been hemorrhaging foreign currency and the strengthening U.S. dollar threatens to make that worse. In July, the value of the Argentine peso fell to a record low against the dollar on the black market.
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Francesc Balcells, who manages emerging market debt at the Dubai-based Frontier Investment Management Partners, says U.S. interest rate hikes like we are seeing often spawn disaster for lower-income countries.
"If you look at the history of emerging markets from the Latin American debt crisis in the 1980s, the Mexican peso crisis in 1994, to the different Argentine defaults, to the Brazilian crisis in the early 2000," Balcells ticks through a list of the most recent emerging market meltdowns, including the Asian financial crisis in the late '90s. "All of those periods always coincide with periods of interest rate hikes in the U.S."
Not only do poorer countries have larger debts in U.S. currency, now they are having to pay even more for imports bought in dollars as the currency strengthens. And this time around, global prices for fuel and food were already surging, due to currency fluctuations and significant supply shortfalls caused by the Russian invasion of Ukraine.
"Not to overuse the term, but it's been pretty much a perfect storm for emerging markets," Balcells says of the current situation.
According to the business news service Bloomberg, the number of emerging market borrowers that have debt trading at distressed levels has doubled over the last six months. The pandemic played a hand in that, as many governments took on additional debt to subsidize idled workers and keep social services functioning.
An investment analysis by Barclays Corporate and Investment Bank called the second quarter of 2022 an "unmitigated disaster" for the global economy and warned that the third quarter is "shaping up to be the summer of discontent."
Balcells says many of the larger middle-income countries can weather that storm. But others are getting battered. For instance, in May, Sri Lanka had a political and economic meltdown and was unable to pay its foreign debts. The default makes it nearly impossible for Sri Lanka to buy food and fuel on international markets.
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Other nations facing financial distress are spread around the world, including El Salvador, Pakistan and Ghana. In Nigeria, the largest economy in Africa, inflation has hit a 20-year high driven almost entirely by skyrocketing food prices.
"Right now, the world is experiencing the worst food security crisis any of us have ever seen," says U.S. Ambassador to the United Nations Linda Thomas-Greenfield. Speaking at the Chicago Council on Global Affairs in late August, Thomas-Greenfield said much of the current global food crisis is driven by the Russian invasion of Ukraine.
She notes that before the war, Russia and Ukraine accounted for almost a quarter of global grain exports. The disruption to those grain supplies, she says, is doing more than just leaving people hungry.
"Food security is directly linked to economic growth," she said. "And it matters because food insecurity leads us to political and social instability. And that endangers us all."
The big question is how much instability the current global economic downturn will produce.
Increases in food prices hit poorer nations and households harder than wealthier ones, because spending on food consumes a larger portion of their budgets. For instance, the International Monetary Fund estimates that food makes up 40% of the consumer price index in sub-Saharan Africa while accounting for less than 20% of the index in advanced economies.
Balcells, with Frontier Investment Management Partners, thinks the worst economic pain from the current economic downturn will be in smaller, highly indebted emerging market economies. He includes Ecuador, Ghana, Zambia and El Salvador on that list. Two larger nations — Pakistan and Turkey — are also at risk, he says. The IMF this week approved a billion dollar bailout to support Pakistan's floundering economy.
Another thing making 2022 different from global economic crises of the past is the role of China as a major lender. A significant portion of the debt now owed by low and middle-income countries is owed to Beijing.
"In terms of foreign debt, China is the elephant in the room," says Vasuki Shastry, an associate fellow with the global think tank Chatham House.
Unlike global debt crises of the 1980s, the lending side of the equation is now significantly different. There are now billions of dollars owed to China. Much of that debt has come as part of China's ambitious Belt and Road infrastructure program. The issue, Shastry says, is a lack of transparency around much of the lending by China. Some of it is labeled as commercial debt rather than sovereign debt even though it's owed to state-owned Chinese companies.
And negotiating debt relief with Beijing is novel territory not just for individual countries but for the broader international community. Traditionally, the IMF and the so-called Paris Club of wealthy nations play a significant role in restructuring distressed debt. But so far Beijing has preferred to deal with its borrowers on its own.
"China is essentially signaling that there are two tracks in terms of global debt negotiations," Shastry says. "One track is led by the OECD [the Organization for Economic Cooperation and Development], which includes the U.S. and Europe, the traditional Paris Club. And China wants to be part of a separate track, where it alone wants to determine how it wants to deal with countries facing debt distress."
Another forum for emerging markets to hash out debt relief has been the Group of 20. But given that Russia is a member of the G-20, it's been nearly impossible since the February invasion of Ukraine to get the group's finance ministers to agree on a unified response to the growing global economic troubles.
Particularly if the war in Ukraine drags on, Shastry says the current global economic conditions are going to lead to "a lot of pain" in low and middle-income countries. He predicts that that pain is going to be even worse and could drag out even longer this time because of a lack of global cooperation to address it.
