'Chronic abuse' of cheap money leaves frontier markets vulnerable to rate hikes

Frontier markets that rushed to rack up cheap debt as funding costs hit historic lows are vulnerable to default if interest rates soar, raising the question whether they should have been allowed to borrow at all, leading experts tell GlobalMarkets

  • By Oliver West, Virginia Furness
  • 12 Oct 2017
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Frontier markets face the risk of major turbulence because of their “chronic abuse of cheap financing”, senior emerging market figures warned this week as they called on the IMF to provide greater support to debtor countries in the face of rising vulnerability to default risk. 
Benign global markets have spurred a sharp increase in the dollar denominated debt stock of frontier markets, but rising global interest rates will leave many unable to pay back increasingly expensive dollar debt, according to Anne Van Praagh, managing director and head of credit strategy and research at Moody’s Investor Services. 
Moody’s identified Mongolia, Mozambique, Egypt and Belize as most vulnerable to rising interest rates on account of high leverage and weak institutions.
Bryan Carter, head of emerging markets at BNP Paribas Asset Management, said the build-up of debt raised the question of whether some countries have been right to turn to the debt markets at all. “There is an over-reliance on foreign financing despite the pleas and warnings of watchdogs,” he told GlobalMarkets. “Some are becoming chronic abusers of cheap financing. And there is an inefficiency between access to capital, and oversight and transparency. Some should not be allowed to borrow, especially if they have IMF programmes.” 
Carter said there was a worrying complacency in the market because the debt build-up had not become a short-term liquidity crunch. “Nobody sees the risk but we have seen this before, when a catalyst increases in costs of financing because of rate hikes or a shock to growth like a hurricane or a terrorist attack suddenly stops capital. This is how most EM capital crises begin.”
A quarter of frontier markets issued new debt on commercial terms as of August this year, but elevated debt service costs and liquidity risks as rates rise is leaving many nations vulnerable. 
“Global liquidity conditions have reduced reliance on concessional debt, but in the medium term as liquidity becomes tighter, and interest rates rise it raises problems in the near term,” said Van Praagh. “Countries with higher leverage, upcoming refi risk and constrained ability on easing monetary policy are vulnerable.”

IMF urged to change course

The last 12 months have seen Mozambique, Republic of Congo and Belize default on Eurobond obligations. Guillaume Chabert, co-chair of the Paris Club, said an additional 12–13 countries were at risk of debt distress across the 36 countries that have reached completion under the Heavily Indebted Poor Countries Initiative.

While nations have several ways to reduce debt — fiscal reform, growth, inflation or restructuring —  both BNPP’s Carter and Chabert believe that it is the responsibility of IFIs to provide greater technical assistance to governments in managing both concessional and commercial debt. 
“This is a shared responsibility among primarily the borrower and creditors,” Chabert told GlobalMarkets. “The IMF can provide transparency on the debt ceiling which it fixes for each country and then it is up to the creditors to use all the tools that are available not to over-endebt the country.”
Carter said the IMF must change its attitude to market access and that the IMF was the “only organisation” which had the right level of access to track use of funds and demand regular due diligence. “No one else has that level of access,” he said. 
“The IMF sees the market as the ultimate graduation, if they can rehabilitate a country, and bring it back to the market, the IMF thinks its job is complete. They don’t see the market as a problem, they see it as a solution.”
Progress is being made however, with the OECD, World Bank, UN and IMF working together on the same platform to provide technical assistance which will help to remove the problem of competing institutions offering different advice, Chabert said. 
In addition, certain IMF programmes specifically prohibit external borrowing, according to Graham Stock, head of EM sovereign research at BlueBay.
“Mongolia [one of the country’s Moody’s highlights as most at risk] certainly exhibits these vulnerabilities but the risks are mitigated by the government’s commitment to an IMF programme that prohibits net new external market financing and entails significant multi/bilateral assistance on concessional terms,” he said.

  • By Oliver West, Virginia Furness
  • 12 Oct 2017

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