- Financial tightening in advanced economies and slowing trade growth have created less favorable conditions for emerging market sovereigns, which have been amplified by the effects of the war in Ukraine on commodity prices. While the capital accounts of emerging market sovereigns are often crucially influenced by the US monetary stance, their current accounts are very much dependent on demand from China due to their upstream integration in global supply chains.
- A repeat of sovereign debt crises similar to the ones in the 1980s and 1990s appears unlikely. However, several (large) emerging market (EM) economies have become highly vulnerable to tighter financing conditions, including those in Emerging Europe (Hungary, Romania and Turkey) and Africa (Egypt, Kenya and Tunisia), as well as in Latin America (Argentina and Chile), albeit to a lesser extent.
- Under baseline conditions, we expect a broad-based but contained EM sovereign spread widening. In local currency terms, divergences between countries are as heterogeneous as inflationary pressures. Local currency yields will remain elevated in 2022, with a gradual reversal in 2023 as headwinds start to abate. Should our adverse scenario materialize, we expect the escalation of the war in Ukraine to cause a global recession with significantly higher inflation. Deteriorating EM fundamentals and generalized capital outflows would lead to a significant widening of hard currency spreads and higher local currency yields.
Emerging market sovereigns: turbulent times ahead?
Pablo Espinosa Uriel