Emerging mkt debt problems

Many METARs are old enough to remember the sovereign dollar-denominated debt crisis in emerging countries when the USD strengthened in 1998.


**As the crisis unfolded, it became clear that the strong growth record of these economies had masked important vulnerabilities. In particular, years of rapid domestic credit growth and inadequate supervisory oversight had resulted in a significant build-up of financial leverage and doubtful loans. Overheating domestic economies and real estate markets added to the risks and led to increased reliance on foreign savings, reflected in mounting current account deficits and a build-up in external debt. Heavy foreign borrowing, often at short maturities, also exposed corporations and banks to significant exchange rate and funding risks—risks that had been masked by longstanding currency pegs. When the pegs proved unsustainable, firms saw sharp increases in the local currency value of their external debts, leading many into distress and even insolvency...** [end quote]

This debt crisis caused a short-term negative blip in the SPX. However, the European sovereign debt crisis in 2010-2011 impacted the SPX significantly even as it was recovering from the 2008-9 financial crisis in the U.S.


The USD is currently the strongest it has been since 2002. This is putting pressure on emerging market debt.


**An Assessment of Emerging Market Sovereign Credit Ratings**
**by Brendan McKenna, Wells Fargo Economics, September 16, 2022**

**In this report, we dive into the outlook for sovereign credit ratings, and note that many of the larger and more systemically important emerging market sovereigns could experience credit rating downgrades in the next 12 months. According to our methodology, Chile and Mexico are likely to experience downgrades that take each sovereign to the brink of non-investment grade status, while Colombia and India are likely to lose their investment grade ratings by the end of 2023. The notable exception is Argentina. Our framework suggests Argentina is at an inflection point where conditions are gradually improving under an IMF program, which could warrant a credit rating upgrade in the near future....** [end quote]

The model shows investment grade countries (the highest being China and Israel, with A+ ratings) and non-investment grade (junk bond) countries. These include (in worsening order) Colombia, India, South Africa, Brazil, Turkey and Argentina. (Turkey is a NATO country with veto power in NATO decisions.)

Wells Fargo’s models find that Chile and Mexico are marginal although S&P and Moody’s give them an investment grade of BBB-.

Several of the Asian countries that were thrown into crisis in 1998 now have large cash cushions to protect them from a similar problem. These are investment grade though low on the scale.

The Macroeconomic impact of a soveign debt crisis on U.S. markets isn’t strong but it’s worth keeping an eye on large, strategic countries with potential debt problems, such as India and perhaps China.

The AAA rating of the U.S. must never be threatened by any word from our government that we might default on even a single interest payment. Downgrading U.S. debt would dramatically worsen our budget deficit by raising interest rates. As it is, foreign holdings of Treasury debt remain strong, with a small decline from 2021 to 2022. The vast majority of foreign holdings of Treasury debt is long-term maturities (bonds and notes) which have lost substantial value as interest rates rise. By far the largest holders of Treasury debt are Japan and China.