General overview

Whereas the post-pandemic recovery remains fragile, emerging countries are now facing the consequences of the conflict in Ukraine on foreign trade, capital flows and inflation. This is the main issue of our latest Eco Emerging publication. For the time being, the conflict has not generated a financial shock, strictly speaking, neither on interest rates, risk premia nor on exchange rates. The direct effect of the expected sharp contraction of Russian and Ukrainian imports (demand effect) should not be very severe, except of course in the CIS countries and, to a lesser extent, the Central European countries, the Balkans and Turkey.

On the other hand, the indirect effect of rising commodity prices on inflation or on agricultural and industrial productions, will affect all areas and could be particularly severe for the purchasing power of population in low-income countries, especially from Africa. The rise in the price of raw materials is massive and concerns both energy and industrial, agricultural and non-agricultural raw materials. The effect on inflation and activity is general as companies are faced with both rising prices and, if the supplier is Russia or Ukraine, supply constraints.

Despite a gloomier external environment, we do not anticipate, for emerging countries, a general deterioration of external solvency nor even of States’ solvency. Regarding external solvency, most of them have a comfortable mattress of foreign exchange reserves and solvency ratios have not deteriorated compared to the end of 2019 (the only exceptions are Argentina, Egypt, Tunisia and Turkey). As regards States’ solvency, debt ratios have risen sharply in virtually all countries. But the other major solvency ratio of debt interests as a percentage of States’ revenue has generally increased moderately since late 2019. On the other hand, with regard to States’ external liquidity, a big dozen of countries have repayments of international bonds and loans that represent at least 20% of foreign exchange reserves or net financial assets of the state. For the most fragile of them, such as Egypt, Tunisia and Argentina, the possibility of a default will depend on the willingness or the capacity of governments to secure the support of international donors or to rely on bilateral creditors. This is the case of Argentina and Egypt but not yet for Tunisia.

In other words, we do not expect a significant and widespread deterioration of sovereign risk despite the increase in States’ indebtedness. In its latest report on global financial stability, IMF economists conducted an in-depth study of the links between sovereign risk and banking risk (the so-called sovereign-bank nexus) on the basis of the double observation 1/ States’ indebtedness has increased strongly 2/ Banks contributed very largely to the financing of the States. The mechanisms behind the sovereign-bank nexus are multifaceted with feedback effects that are very seriously documented in the GFSR. And it is normal for the main international donor to point out potential risks. But, unless the world economy falls in stagflation, the banking systems in emerging countries should be strong enough to absorb those risks. An example: according to IMF simulations, a haircut of at least 30% in the value of government securities of banks is necessary to breach the 4.5% minimum solvency ratio of banks. Such a devaluation would require, on average, an increase in government bond yields twice as large as the observed increase over the past six months in areas where there has indeed been an increase in yields.