Emerging-Market Debt in Peril on Tight Fed, Morgan Stanley Says

  • Big shifts in U.S. rates, dollar brings risk: Morgan Stanley
  • Chile, Malaysia, Brazil, Mexico are among countries affected

The Biggest Risks Facing Bond Markets

Policy makers in emerging markets should be hoping the Federal Reserve continues on its path of gradual interest-rate rises as some are exposed to any sharp increases in the U.S., according to Morgan Stanley.

The exposure is a result of substantial external debt linkages. Most emerging-market external debt -- 20 percent of gross domestic product -- is denominated in a foreign currency, with the largest component being corporate debt in U.S. dollars.

Overall foreign currency debt in the emerging markets excluding China rose from 22 percent of GDP in 2011 to 30 percent in the first quarter of this year. Most of the increase comprises longer-term obligations, with the level of short-term loans remaining relatively low at 8 percent of GDP.

“While this means that EMs will be better protected from short-term FX volatility, they remain exposed to big shifts in USD and U.S. rates,” Morgan Stanley economists, led by Chetan Ahya, wrote in a note. “Besides foreign currency debt, exposure to U.S. rates comes via large foreign holdings in local government bonds.”

Countries where there are risks associated with the rise in foreign currency debt include Chile, Malaysia, Brazil, Turkey and Mexico, while South Africa, Colombia and Indonesia are exposed to foreign ownership of local government bonds.

Overall EM debt has risen sharply since the global financial crisis, led by China where the debt-to-GDP ratio rose from 143 percent in 2007 to an estimated 280 percent in the first quarter of this year. The ratio in developing nations excluding China climbed from 107 percent to 130 percent over the same period. The analysts said the situation is manageable, and the recent rise in nominal GDP growth has helped to stabilize the ratio.

The high levels of debt in China have caused concern, but Morgan Stanley said the dynamics there have been improving as a result of lower deflationary pressures and policy reforms. The increase in China has been driven solely by domestic debt.

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