Sovereign default risks exist outside the US too

Summary

The United States has managed to avoid default by coming to a debt ceiling resolution; however, in the event the U.S. did default on its sovereign debt obligations the repercussions would have been severe. Sovereigns around the world likely would have followed the U.S. into default, with emerging market countries arguably most vulnerable. Despite the worst case scenario being avoided, sovereign default risks in the emerging markets still exist. We highlighted elevated default risks in a recent report citing rising debt service costs, and in this report, we note that financial markets are also pricing relatively high default risk for sovereign borrowers across most emerging market regions. While we remain constructive on emerging market currencies, sovereign default risks represent a tail-risk to our outlook, and should defaults materialize and gather momentum, our outlook could change over time.

Emerging market sovereign default risks still present

The U.S. debt ceiling standoff has finally come to a resolution, and while the worst case scenario has been avoided, a U.S. sovereign debt default could have had significant implications for the global economy and financial markets. Ripple effects of an American default would have likely reverberated in such a way that a wave of sovereign debt defaults around the world would have followed soon after. Spillover effects of a U.S. default would have been felt most acutely in the emerging markets where economic conditions are more fragile and public finance profiles more worrisome. But even though the United States has avoided default, multiple sovereign debt defaults across the emerging and developing economies could still materialize in the near future. We pointed out default risks in a recent report where we highlighted how debt service costs in the emerging markets are on a worsening trajectory and at the highest they have been in the last fifteen years. Rising debt service costs, along with additional external challenges such as a strong U.S. dollar, have placed pressure on sovereign repayment capacity over the last few years. With interest rates set to remain elevated for the time being, the U.S. dollar resilient, and growth prospects subdued, multiple borrowers are likely facing an elevated probability of default.

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