What happened?
Emerging market (developing) countries have racked up a total of $55 trillion of debt by the end of last year, according to research by the World Bank. This has been the fastest and the widest surge in emerging market debt in modern history. The debt to GDP ratio stood at 168 percent at the end last year. That is a 54 percentage point increase since 2010, according to a report published by the World Bank on Thursday.
Why is this important?
In general
High debt levels, whether for private or public entities always pose high risks. A low interest rate environment can encourage countries to borrow more. Borrowing can lead to increased public investment productivity, profitability, and increased taxes if done right. However, many countries overuse and abuse it, and do not spend it wisely. That is, whether due to corruption, bad decision making or other things. Debt levels rise, together with interest service payments. If those payments start making up a large part of the budget deficit, a country can become at risk of default. If debt needs to be serviced by more debt, and interest rates rise, the country’s debt can become unsustainable. Such crises have happened before in developing countries and have had lasting negative effects on the general population in terms of hurting their incomes significantly.
For investors
According to David Malpass, World Bank group president, “The size, speed and breadth of the latest debt wave should concern us all”. The bank warned that, on many measures, emerging economies were more vulnerable today than before the global financial crisis. 75% of emerging market countries have a budget deficit, hence need to borrow to cover their expenses. Since interest rates are low currently, in general, interest payments are bound to be lower. However, in general, the interest rates in emerging markets are higher than in the developed world. For a country such as Brazil, interest rates are at historic lows. However, a 4.5 percent interest rate is still considered moderate in nominal terms.
Brazil’s interest rate, historically. Source: Tradingeconomics
The bank’s “Global Waves of Debt” report compares the recent borrowing surge with three previous episodes of rapid emerging market debt accumulation, all of which ended in financial crises. China has accounted for the majority of the debt accumulation, however, it is by no means the main culprit. Nominal debt levels have doubled in the rest of the developing world since 2010.
For traders
Traders should be careful and on the lookout when it comes to trading emerging markets. For now, according to the report, low interest rates support growth and make borrowing smoother. However, half of the 521 national episodes of rapid debt growth since 1970 have resulted in crises.
