Emerging market debt markets face a number of risks heading into 2016 after many years of strong growth. According to the International Monetary Fund (IMF), emerging market debt grew from around $4 trillion in 2004 to over $18 trillion in 2014. In the wake of the 2008 financial crisis, many central banks undertook quantitative easing and lowered interest rates to increase the supply of money. This allowed banks to increase their lending in emerging markets. Global growth in emerging markets was one of the main drivers of the international economy. The picture is not as rosy in early 2016. Low commodity prices, slowing Chinese growth and higher interest rates in America are serious issues for emerging market debt.
Lower Commodity Prices
Many emerging markets are dependent on the commodities they produce. They rely on resource extraction and exports of commodities such as oil, gas, coal and precious metals. As such, the emerging markets are very sensitive to prices changes for commodities.
With easy money monetary policies, many emerging market countries were able to invest in capital projects to increase their production and export of commodities. The growth of the middle class in several countries was dependent on the increased exports of commodities.
The price of crude oil, in particular, is problematic. Crude oil has fallen dramatically from 2014 to 2016. It was trading at over $100 a barrel in June 2015. The price has slid to around $32 a barrel as of January 2016, a more than 68% drop. This has hurt the economies of many emerging markets including Brazil, Venezuela and Russia. These economies are facing serious backlash from lower commodity prices. Their currencies are being hurt by the lower prices, as lower demand threatens their cash flows and revenues.
Slowing Growth in China
China's slowing economic growth is another major issue. The Chinese government announced its economic growth for 2015 was only 6.8%, the lowest level of growth in 25 years. China is the second largest economy in the world and is a major importer of commodities such as soy, oil and copper. As China’s manufacturing sector slows down, this drives down demand for the import of commodities from emerging markets. This has a negative impact on the economies of those emerging markets.
There are a number of concerns regarding China’s economy. There is a great deal of debt in the country. It is estimated nonbank borrowers had around $1.5 trillion in debt in 2015. There is also a shadow banking industry that has allowed retail investors to use a great deal of margin in the stock market. The Chinese stock market experienced high volatility during August and September 2015. This volatility spilled over into other capital markets around the globe. Further, there are also legitimate concerns of a real estate bubble in the country.
Federal Reserve and Interest Rates
After years of what was essentially an interest rate of zero, the Federal Reserve raised rates by a nominal amount in December 2015. The Fed has indicated it may raise interest rates up to four times during 2016.
This has strengthened the dollar against emerging market currencies. Since many companies in emerging countries have borrowed in cheap dollars, this makes it more difficult to repay and service that debt. Experts noted global corporate defaults reached their highest level in 2015 since 2009. The increase in interest rates in the United States may result in further capital outflows from emerging market stocks and bond markets.
It is estimated that emerging markets have borrowed around $3 trillion in U.S. dollars. This money was borrowed at very low interest rates. If the Federal Reserve continues to slowly increase interest rates, it increases the demand for sovereign debt from the U.S., which is safer from default. It reduces the amount of money available for borrowing in emerging markets. Experts have stated that for every 100 basis point increase in U.S. interest rates, the interest rate in debt markets in emerging countries increases around 43 basis points. They warn this may cause a monetary shock for emerging markets as rates go higher.