The Fed's Interest Rate Increase Makes a Number of Developing Countries Threat of Defaulting on Debt

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The Fed's Interest Rate Increase Makes a Number of Developing Countries Threat of Defaulting on Debt


A series of ongoing crises have further drowned the economies of a number of developing countries. After the Covid-19 pandemic, rising food and energy prices have increasingly gripped these countries.

These crises have turned into broader debt disasters for developing countries such as Sri Lanka, Egypt, Tunisia and Peru. As well as being a threat to economic recovery after the pandemic.

Aggressive tightening of monetary policy in the United States (US) with the Fed's interest rate hike will further threaten developing countries amid a pile of debt in handling the pandemic. The cost of debt they have to bear will swell. This condition will tend to spur capital outflows.

Meanwhile, the wars between Russia and Ukraine, which have triggered recent food and energy shocks, are showing little sign of ending.


These risks have pushed Sri Lanka to the verge of default or default on its bonds. Other developing countries such as Pakistan, Tunisia, Ethiopia and Ghana are also in similar danger, according to Bloomberg Economic data.

The increase in commodity prices does provide benefits for developing countries that are commodity exporters. The problem is, China as one of the importers is currently implementing a lockdown in a number of main cities due to the recent increase in Covid-19 cases. Meanwhile in Europe and the US there is increasing concern that their economies are falling into recession.

The world's top economic policymakers have sounded the alarm. At the IMF and World Bank meetings in Washington this week, the themes raised were the global economic slowdown and increasing risks in developing countries, both visible and invisible.

The IMF in its latest world economic outlook equates the impact of war in Europe with seismic waves that will roll up the global economy. In fact, the IMF warned that there was the potential for emerging markets to become a kind of catastrophic loop that caused Russia to default in 1998 and brought hedge fund Long Term Capital to the brink of collapse.


The World Bank has cut its forecast for global economic growth and announced the creation of a $170 billion rescue package for crisis-hit countries.

"We can see this train wreck coming our way. The combination of the real economic shock and tightening financial markets will push a number of low-income countries into debt restructuring," said John Lipsky, IMF managing director as quoted by Bloomberg, Thursday (21/4).

The biggest failure looming in developing countries is in Russia. Russian President Vladimir Putin's decision to attack Ukraine has brought sanctions, economic isolation and promises to pay debts in rubles only — which would likely be seen as a breach of commitments, triggering losses for investors.

However, Russia's role as a sanctioned aggressor makes it a unique case.

While Sri Lanka, for now, is at the forefront of a wider potential crisis. The country's currency is down nearly 40% this year.

The uncertainty has prompted protests calling for President Gotabaya Rajapaksa to step down even as his government tries to negotiate aid with the IMF and Asian powers such as China and India.

Sri Lanka was probably the first. But it's not alone. About 13 developing countries have bonds trading at least 1,000 basis points above the US Treasury, up from six years ago.

Defaults on developing-country debt spiked in the first weeks of the Ukraine war, reflecting growing fears of default. Although it has dropped since then it is still around 90 basis points above last year's average.

Bloomberg Economics, which notes the risks for developing countries, places Turkey and Egypt at the top of the list of major emerging markets exposed to the effects of the Ukraine war. And ratings of Tunisia, Ethiopia, Pakistan, Ghana, and El Salvador — with large debt stocks and borrowing costs that have increased more than 700 basis points since 2019.


Meanwhile, the World Bank calculates, 60% of low-income countries are already in debt trouble or at high risk. "So far, the problem is taking place off the radar screen" that investors are not paying much attention to," said World Bank Chief Economist Carmen Reinhart.

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