Moody’s warns of lowest-rated sovereigns under pressure for funding

• Says improving global funding conditions aid emerging market recovery
• Warns severe economic fallout from COVID-19 pandemic will lead to sharp increase in government borrowing needs
• Financing pressures to persist for lowest-rated sovereigns with large upcoming external debt repayments and limited track records in securing market financing

Moody’s Investors Service in a new report said yesterday that while global financing conditions had eased markedly in recent months, many emerging and frontier market economies would commence their recoveries with greater fiscal and external weaknesses.

“Emerging and frontier market economies have experienced a substantial shock through multiple channels: a drop in export values on lower commodity prices; weaker tourism and lower global demand; and volatility in non-resident capital flows. We expect fiscal and external imbalances to widen and, in the most severe cases, liquidity pressures will rise toward serious stress or default,” says Michael S. Higgins, a Moody’s Analyst.

Some of these sovereigns have struggled to find external sources of borrowing to fund fiscal and external gaps, and have tapped emergency financing from international financial institutions like the International Monetary Fund and other multilateral lenders. However, as global capital flows remain volatile, many will face substantial credit challenges through their recoveries, even if they do emerge from the crisis without defaulting. Limited fiscal space and subdued foreign direct investment are likely to inhibit greater employment creation and consumption.

And while a strong international policy response, fuelled by advanced economies’ substantial monetary stimulus, has enabled capital flows into emerging markets to normalise, funding conditions are still much tighter for the lowest-rated sovereigns, as investors remain cautious about increased liquidity pressures and risk of default among these sovereigns.

In this environment, uneven economic recoveries and weakened fiscal and external profiles will leave lasting credit challenges for many, even after global economic conditions normalise. Low-rated sovereigns will face pressure on their creditworthiness as weak reserve adequacy constrains monetary policy flexibility and increases fiscal risks for governments with large foreign currency borrowings. 

In particular, sovereigns with large upcoming external debt repayments, and reliance on tourism and commodities are among those most exposed, given a potentially more prolonged period of weaker dollar inflows from traditional export earnings.