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IMF warns of huge emerging market defaults

By NexChange
Capital Markets

Tsunami

As if the US Federal Reserve doesn’t have enough to weigh up as it vacillates about raising interest rates. The International Monetary Fund (IMF) has added another factor to the mix.

Yesterday, it warned that higher US interest rates could cause a wave of default by companies in emerging economies and panic in global financial markets as liquidity evaporates, reports The Daily Telegraph.

The IMF said that corporate debts in emerging markets swelled to $18 trillion last year, compared with $4 trillion in 2004 as companies took advantage of cheap funding by raising US dollars through loans and bonds.

“As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures,” the IMF said in a pre-released chapter of its latest Financial Stability Report.

The problem is that when interest rates  rise – and longer-term yields too – it gets expensive to refinance the debt as it matures. In addition, there is often a mismatch between local currency revenues that need to be converted into more expensive US dollars (higher US rates lead to a stronger greenback) to make interest payments. And too many emerging market companies have weak balance sheets anyway.

The IMF also raised the specter of 2008. Massive corporate defaults could create a credit crunch as risks “spill over to the financial sector and generate a vicious cycle as banks curtail lending”.



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