According to Moody’s Investors Services, Pakistan will see a marked weakening in debt metrics because of large gross borrowing needs that raise interest payments when borrowing costs rise, and/or narrow revenue bases that push fiscal deficits wider when interest payments rise.
In its latest report titled “Low-rated sovereigns with large external repayments vulnerable to contagion shocks,” Moody’s stated that the central bank in Pakistan has delivered sizeable rate cuts amounting to 225 basis points in March, but this cut may not sufficiently offset the tightening in financing conditions related to local-currency depreciation.
Sri Lanka, Pakistan (B3 stable) and Egypt (B2 stable) will see a marked weakening in debt metrics because of large gross borrowing needs that raise interest payments when borrowing costs rise, and/or narrow revenue bases that push fiscal deficits wider when interest payments rise.
As for the potential deterioration in debt and debt-affordability dynamics arising from capital outflows that weaken local currencies and tighten domestic financing conditions, Sri Lanka, Pakistan, Egypt, Angola and Ghana (B3 positive) will see a marked weakening of these metrics under the stress test.
This is because of their large share of foreign-currency debt, large gross borrowing needs that raise interest payments when borrowing costs rise, and/or narrow revenue bases that push fiscal deficits wider when interest payments rise, noted the credit rating agency.
Debt burdens for these five sovereigns under Moody’s stress scenario will be well in excess of the median of around 70 percent of GDP for all non-investment grade emerging market (EM) sovereigns, while interest payments for this group will be close to or exceed 40 percent of government revenue, significantly weaker than the median of 12 percent for all sovereigns, maintained in the report.
Moody’s further stated that effective policy responses can mitigate the risk of significantly higher debt burdens and lower debt affordability from already weak starting positions.
The central banks in Egypt and Pakistan have delivered sizeable rate cuts amounting to 300 basis points and 225 basis points in March, respectively, while Sri Lanka’s central bank cut its policy rate by 50 basis points earlier in the year. That said, these cuts may not sufficiently offset the tightening in financing conditions related to local-currency depreciation.
Given stretched fiscal positions, the governments facing the largest potential deterioration in debt dynamics may also find it challenging to raise additional financing to mitigate the economic slowdown, which may compound the weak investor sentiment and spark further capital outflows.
The External Vulnerability Indicator (EVI) readings for Pakistan and Ethiopia (B1 negative) will also rise significantly to more than double Moody’s baseline readings for these sovereigns in 2021, although both countries entered into IMF programs in 2019 that have also unlocked additional funding from other IFIs.
Moody’s stated that low-rated emerging market sovereigns with large near-term international bond repayments and significant reliance on foreign currency, private sector credit are particularly vulnerable to the impact of deteriorating economic conditions on capital markets.
“The coronavirus outbreak and sharp commodity price declines are triggering significant financial market volatility and risk aversion that few emerging market sovereigns are immune to,” says Christian Fang, a Moody’s Assistant Vice President and Analyst.
Emerging market sovereigns that need to access international bond markets to refinance their foreign-currency debt or that borrow heavily from private-sector lenders in a foreign currency will currently face prohibitive conditions.
Policymakers have limited capacity to mitigate capital flight and/or the sharp increase in credit risk premia in foreign currency.
While some countries have already secured refinancing for maturing international bonds, Sri Lanka (B2 stable), Honduras (B1 stable), Turkey (B1 negative) and Tunisia (B2 stable) are susceptible given the size of upcoming international bond redemptions as a share of foreign-exchange reserves.
Non-investment grade sovereigns with a large amount of foreign currency debt owed to private creditors, such as Bahrain (B2 stable), Oman (Ba2 stable) and Angola (B3 stable) are also particularly vulnerable.
Moody’s further noted that access to financing from development partners or waivers on official debt service may mitigate this risk for some, but the pressure will remain on exposure to private sector debt.
Should the risk-off environment persist for some time, leading to capital flight, sharp local currency depreciation and higher domestic interest rates, credit metrics are likely to deteriorate significantly for some sovereigns, noted the credit rating agency.
