How Sovereign Debt in Three Developing Nations Just Became the Most Dangerous Trade on Earth

One figure that frequently comes up in discussions among investors in emerging markets is $400 billion, which is discreetly and almost reluctantly mentioned in risk meetings and research notes. That is about the amount of developing-nation sovereign debt that is currently trading at spreads of more than 1,000 basis points above U.S. Treasuries, or what analysts subtly refer to as the “danger zone.” To put it simply, that means investors are genuinely unsure that they will be reimbursed, so they are demanding extraordinary compensation simply to hold this paper.

Argentina is at the top of the list by a wide margin. Bonds trading at about 20 cents on the dollar, over $150 billion in outstanding debt, and a black market where the peso is exchanged at almost half the official rate. It’s a nation that has restructured its debt more times than most countries have had a change of government, and yet here it is once more, back in familiar territory.

Egypt and Ecuador come next, each with exposed debt of between $40 and $45 billion. These are not financial numbers that are abstract. Every basis point has a government employee who hasn’t been paid, a hospital that runs out of medication, or a school that doesn’t get built.

When you examine Egypt’s situation closely, it seems especially precarious. Nearly $11 billion in foreign capital left the nation in a single year, the debt-to-GDP ratio is close to 95%, and credit default swaps now factor in a 55% chance of a late payment. Cairo went to the IMF and devalued the pound by 15% earlier. These actions would have appeared drastic under normal circumstances, but considering the scope of the issue, they hardly registered as shocking.

Over the next five years, Egypt is expected to service about $100 billion in hard currency debt, according to fund managers at FIM Partners. There is some breathing room, but not much, because half of that is owed to the IMF or bilateral creditors, primarily in the Gulf.

Kenya’s crisis is more subdued and less prominent, but it may be more severe in some ways. Currently, interest payments account for about 30% of government revenue. The value of its bonds has dropped by almost half. Additionally, a $2 billion bond that matures in 2024 looms over Nairobi like an unanswered question because there is currently no real access to international capital markets.

Simply put, these nations are the most vulnerable due to the discrepancy between the amount of debt that is due and the reserves that are available to cover it, according to David Rogovic of Moody’s.

The banking aspect is what sets this time apart from earlier debt cycles, and it’s important to consider this. Domestic banks in emerging markets increased their exposure to the debt of their own governments by over 35 percent during the 12-year period between 2012 and 2023. That percentage rises above 50% in nations that are already experiencing debt distress. The sovereign-bank nexus is what economists refer to, and when it tightens excessively, the effects are rarely contained.

When a government is unable to pay its debts, it does more than simply default on bondholders in New York or London. The savings accounts and business loans of regular people who had nothing to do with any of this could be threatened if it drags down the domestic banks that piled up on its paper.

A 5% loss on government debt holdings, which is small by historical standards, would leave one in five banks undercapitalized in the most debt-distressed nations, according to a relatively conservative stress test conducted by the World Bank. That is not a situation of collapse. A baseline warning, that is.

With difficult-to-understand figures, UNCTAD’s 2024 debt report presented a more comprehensive picture. The world’s public debt reached $102 trillion. In interest alone, developing countries paid $921 billion, a 10% increase from the year before. Interest payments accounted for at least 10% of government revenue in a record 61 developing economies. Additionally, 3.4 billion people currently reside in nations where creditors receive more money than hospitals or educational institutions.

Because those numbers are so high, it’s possible to read them and feel nothing. However, try to picture what it might look like on the ground: a clinic in Accra that is running low on supplies while the Ghanaian government sends bondholders another payment. As the nation’s bond spreads rise above 2,800 basis points, a school in Tunis is understaffed and underfunded.

Many of these nations may still be able to avoid complete default, according to seasoned debt observers, especially if global interest rates decline and the IMF keeps up its involvement. However, that hope is contingent upon many moving components correctly aligning and remaining aligned. Since 2020, borrowing rates in the developing world have been two to four times higher than those in the US. There is no closing of that gap. As this develops, it’s difficult to avoid questioning whether the current structure of the international financial system was ever intended to support the burden that is currently being placed on it.