Argentina’s latest default is easy for financial markets to dismiss as an aberration. There was much about the legal clashes in US courts, in the country’s politics and its record as a repeat defaulter to make it possible to ignore.
More than a Latin American accident is needed to upset the prevailing calm, engineered by a still-dovish US Federal Reserve.
The nonchalance may, however, have reached a high-water mark. The resilience of emerging economies has increased immeasurably in the past two decades – and sovereign defaults were surprisingly rare during the post-2007 crisis years. Yet the tide may be turning; the effects of the next accident in a developing economy could be more severe.
Wednesday’s default will cause significant damage in Argentina and possibly in near neighbours such as Brazil. Beyond that, there is no immediate reason for broader concern.
Just how much emerging market creditworthiness has improved is shown by the composition of JPMorgan’s diversified global EM bond index. In the early 1990s less than 3 per cent of the closely watched index had “investment-grade” status, the top end of the credit rating spectrum. That had reached 35 per cent by the 2000s and peaked at almost 70 per cent in mid-2013.
The improvement reflected the powerful forces that drove the rise of emerging market economies, at least until the outbreak of the global financial crisis in 2007 – globalisation, rising commodity demand and consumption-led growth in the advanced world.
Emerging economies curbed inflation, built up foreign reserves, moved towards flexible exchange rates and reduced reliance on funding in foreign currencies. The biggest trouble zone became Europe; Greece’s 2012 default was the biggest sovereign debt restructuring in history.
Yet even after taking account of the woes of Europe – and Argentina – sovereign default rates remained exceptionally low after the collapse of Lehman Brothers in late 2008.
Until recently, comparing governments’ default records over time was difficult. An impressive new database made available by the Bank of Canada, however, has made it easier to track sovereign defaults and debt restructuring since 1975.
It shows that just 0.1 per cent of outstanding public debt was in default from 2009 to 2011 – when the global economy was in free fall. Tensions in sovereign debt markets were nothing compared with the 1980s and 1990s debt crises, when a swath of developing and eastern European countries defaulted on bank loans and other debt. In 1987 the share of public debt in default hit a high of 5.6 per cent.
Recent sovereign default rates also look modest compared with the 1930s or episodes of turmoil in the 1800s, although differences in financial systems and economies, plus difficulties finding reliable data and taking account of inflation, make sensible comparisons hard.
The financial strength of emerging markets may have peaked, however. Globally governments’ creditworthiness declined during the crisis years. In the past 12 months the investment-grade share of the JPMorgan emerging market index has also dipped, although that may largely reflect the inclusion of lower-rated entrants, including sub-Saharan African countries.
There are other straws in the wind. Emerging economies’ foreign exchange reserves are no longer expanding; excluding China they have remained roughly constant for the past year at about $3.7tn, according to Morgan Stanley calculations. What is more, the bias of rating agencies remains towards more emerging market, and European, downgrades.
This does not mean we are on the brink of a wave of defaults. Public debt to GDP ratios remain modest across emerging markets; African entrants to global capital markets benefited from past international debt relief. More, the risk is of greater financial market volatility and disruptive capital outflows.
Those emerging markets most reliant on external financing – such as Turkey – proved vulnerable during last year’s “taper turmoil”, the volatility triggered by the first hints by Ben Bernanke, then Fed chairman, about the phasing out of US quantitative easing.
Forces that increased emerging market resilience in the past have waned; to ride future financial storms, emerging markets will have to find ways of reducing economic imbalances. The Fed is on track to end QE in October.
“When the tide goes out we will see who has fortified their positions and who has not,” says John Chambers, chairman of Standard & Poor’s sovereign ratings committee.
Enjoy the post-Argentine calm while it lasts.