Emerging countries: Covid’s debt hangover

There have been a number of exogenous shocks since Covid-19, posing a risk to global debt dynamics. Since 2019, this series of common but asymmetrical shocks (the pandemic, the Ukraine war, higher commodity prices, global monetary tightening and dollar appreciation) has had varying effects depending on countries’ economic and funding structures.

In terms of the overall trajectory over the period, public debt initially rose sharply in 2020, after which debt-to-GDP ratios partly stabilised from 2021 to 2022. However, this apparent improvement masks persistent vulnerabilities: higher debt servicing costs, shorter maturities in some countries, and, for the most vulnerable borrowers, more limited access to external funding.

Meanwhile, while many countries’ external debt has continued to grow, the major change since 2022 stems less from the level of outstanding debt than from the deterioration in financing conditions. Rising US and European interest rates, the stronger dollar and investor risk aversion have pushed up sovereign spreads and refinancing costs.

For economies dependent on sources of foreign currency (commodity exports, tourism, remittances and/or capital inflows), debt sustainability thus depends more on the ability to generate external receipts and maintain adequate foreign exchange reserves and investor confidence.

The main short-term risk in emerging countries is not a widespread crisis but rather refinancing problems affecting certain sovereign issuers that markets consider “frontier”. This segmentation between, on the one hand, major countries perceived as being more robust, and on the other, more fragile frontier sovereigns, above all reflects domestic vulnerabilities – public debt, inflation, external position, foreign currency debt, governance, credit quality and so on. There is, as yet, no indiscriminate aversion to the emerging market asset class.

Nevertheless, the sovereign-bank nexus and quasi-public liabilities warrant close attention: in many countries they are increasingly superseding traditional external risks. For other countries, stress continues to be transmitted through the more traditional channels of exchange rates, inflation and portfolio outflows. And, above all, the current situation, with wars in both Iran and Ukraine, is particularly unfavourable to net importers of energy and/or grain with relatively inflexible exchange rate regimes. Lastly, reductions in bilateral aid are pushing up funding requirements for the least developed countries at a time when private creditors are becoming increasingly selective. The IMF estimates that around 15% of low-income countries are already in debt distress and 40% are at high risk of debt distress.

Public debt paths diverge after the Covid shock

Across all emerging and developing economies, gross public debt increased from 55% of GDP in 2019 to 74% in 2025. This rapid increase, which mainly occurred during the Covid-19 shock, reflects the fiscal support policies put in place at the time, ranging from public health expenditure (vaccines, masks, additional resources for hospital systems) to transfers to households (furlough schemes, direct transfers) and businesses (reductions in business charges) and subsidies offsetting higher food and/or energy prices. Since this increase in spending was accompanied by a decline in economic activity and a consequent fall in tax receipts, the snowball effect was particularly pronounced and may in some cases have been exacerbated by currency depreciation.
 

The post-Covid period, characterised by a shock to commodity prices (food and energy, following the start of the war in Ukraine), saw emerging countries follow sharply divergent trajectories. Differences in the pace of economic recovery, inflation, exchange rate depreciation, changes in tax receipts, the extent of subsidies and, above all, the gap between nominal growth and the effective interest rate on debt accentuated divergences between countries.

Three typical profiles

In terms of public debt, countries can be broken down into three groups. First are commodity-exporting countries, less affected by inflation, which have benefited from higher international commodity prices (Angola, Saudi Arabia and Indonesia) and whose debt ratios have stabilised or even fallen. In the case of Saudi Arabia, the rise in oil prices in 2022−2023 was indeed a boon for the public finances, helping reduce the debt ratio and limiting the need for foreign currency financing. However, this trend reversed, with the ratio resuming its upward trajectory from 2024 onwards, making Saudi Arabia the second-largest emerging-market issuer of foreign currency debt after China.

Then come those countries where high debt and persistent funding requirements, combined with constraints on growth, have meant debt has remained high or risen (Argentina, Egypt, Hungary, Romania and Tunisia). These are, of course, the most vulnerable countries. Here, political and institutional constraints mean the credibility and continuity of fiscal adjustment have a particularly decisive influence on risk premiums, access to funding and, ultimately, external balances: it is imperative that confidence be maintained and expectations stabilised.

In Hungary, the defeat of Viktor Orbán and, above all, the long-term policy anchor provided by the new government’s commitment to join the euro have reassured markets. Meanwhile, Romania, though it has so far managed to stave off a downgrade in its sovereign rating that would cost it its investment grade status, is already paying a risk premium similar to that of lower-rated countries: in reality, the extremely precarious electoral and parliamentary position of the centrist parties in the government coalition, seen by markets as the most credible, casts doubt on the continuation of fiscal consolidation against a backdrop of weaker growth and worsening inflation.

In the case of Egypt, very high interest payments (11% of GDP) mean the government is forced to pursue a policy of strict austerity. Public spending cuts have notably included reductions in welfare spending to generate a significant primary surplus (3.5% of GDP). This puts pressure on the middle class. While it has so far withstood the Hormuz shock, Egypt is one of those countries whose debt profiles warrant close attention, since it now faces two threats: the spread of the conflict to the Bab al-Mandab Strait and the renewed escalation of tensions in the Black Sea, both of which are putting pressure on wheat deliveries. Finally, during the last Egyptian crisis the Gulf states assumed the role of lenders of last resort, which means confidence in Egypt’s debt trajectory is now indirectly linked to the Emirati growth model’s resilience to war.  

Lastly, there is one final group of countries (Brazil, Chile, China, India and Malaysia) for which public debt financing is not yet a constraint but whose upward debt trajectories nevertheless merit attention. In this regard, China appears vulnerable, particularly at the sub-sovereign level (local authorities). The real estate crisis the country has endured over the past five years has weighed heavily on local authorities’ own revenue and forced central government to take direct responsibility for a larger share of spending.
 

^{AGO: Angola, ARG: Argentina, BRA: Brazil, CHL: Chile, COL: Colombia, EGY: Egypt, HUN: Hungary, IND: India, IDN: Indonesia, MYS: Malaysia, MEX: Mexico, NGA: Nigeria, PHL: Philippines, POL: Poland, ROU: Romania, SAU: Saudi Arabia, ZAF: South Africa, THA: Thailand, TUN: Tunisia, TUR: Turkey, VNM: Vietnam.}

External debt: is the 2022 pattern repeating itself amid the Iran war?

External debt encompasses the liabilities of the government, banks and businesses to non-resident creditors. Knowing how much external debt a country has is thus not enough to assess its vulnerability: you also have to consider the share denominated in foreign currency, the repayment schedule, the proportion held by portfolio investors, foreign exchange reserves and export capacity.

High external debt can remain sustainable if it is financing productive assets or is backed by stable foreign currency receipts. Conversely, it becomes riskier when short-term repayments exceed available reserves, or when the country depends on volatile capital inflows. Monitoring it is an essential part of analysing emerging economies’ country risk: the behaviour of non-resident investors is generally more volatile, and sovereign crises have often been triggered by excessive external debt.

External debt has generally followed the same pattern as public debt, though from less uniform starting positions.

Emerging countries have faced two concurrent developments since 2019. On the one hand, external financing requirements have risen against a backdrop of current account deficits, the pandemic and fiscal support measures. On the other hand, access to international funding has become more expensive since 2022. Higher official interest rates in advanced economies have pushed up the cost of new foreign-currency issues, prompting investors to favour US assets. The strong dollar has also increased the burden of dollar-denominated repayments.

Vulnerable countries – those with structural current account deficits, dependence on external funding and/or insufficient foreign exchange reserves (Argentina, Egypt, Tunisia and Turkey) – have thus been hit particularly hard by the tightening of global financial conditions since 2022. Meanwhile, higher interest rates have effectively priced the poorest countries out of debt markets. This has been especially difficult for the countries of sub-Saharan Africa, which were already in a precarious position. We thus saw a series of sovereign defaults – Ghana in 2022, Ethiopia in 2023 – and a protracted restructuring in Zambia after it defaulted in 2020. Kenya’s and Senegal’s public finances have also suffered, and both countries recently announced new adjustment programmes in conjunction with the IMF, two years after hidden debt came to light in Senegal.

After a long period of low interest rates, the rate hike cycle that began in 2022 thus triggered a sharp rise in emerging countries’ debt servicing costs. Between 2022 and 2024, developing countries paid $741 billion more in principal and interest than they received in new external funding, marking a shift towards net capital outflows.

The 2022 pattern seems to have been repeating itself since the start of the Iran war, compounded in some cases by more complex local circumstances. This time around the Gulf states, which had benefited from the war in Ukraine, are not protected, given their direct involvement in the conflict. The picture in Asia is more mixed, too: the currencies of energy-importing countries (the Philippines, India and Thailand) have come under pressure, while in Indonesia, doubts over the government’s proposed fiscal trajectory and the lack of transparency in equity markets have triggered sudden capital outflows.

As the rate hike cycle continues in developed countries, the effects observed in international capital markets since 2022 are thus likely to persist or even worsen.

More local currency borrowing has not eliminated external risk

Countries with large domestic bond markets – Brazil, China, India, Mexico, South Africa and Indonesia – have been able to continue to finance a significant portion of their deficits in local currency, limiting their direct exposure to foreign exchange risk. However, this funding model is not without its drawbacks: domestic banks are often under considerable pressure to participate in this financing effort, crowding out private sector borrowers, whose access to liquidity is consequently more constrained. In India and Indonesia in particular, persistently weak tax bases and low levels of household financial savings have exacerbated the crowding-out effect, to the detriment of the private sector.

Above all, while the expansion of local-currency borrowing has reduced the risk of direct currency mismatches for large emerging sovereigns, it has not eliminated external risk: foreign exchange risk is transferred to foreign investors in local markets, outflows from which can push up yields and trigger currency depreciation and falls in asset prices. In reality, while the internationalisation of local markets has curtailed the “original sin” of dollar-denominated debt, it further exposes countries to portfolio outflows, currency movements and global portfolio reallocations.

For example, in South Africa, a quarter of domestic bonds are held by non-residents. Weak growth combined with high bond yields also results in an unfavourable interest-growth differential, and debt service is one of the largest items in the budget. In Brazil, whose sovereign debt profile is underpinned by international reserves that exceed short-term external public debt, foreign investors hold no more than 10% of domestic bonds. However, the Treasury must offer domestic investors attractive returns: half of federal debt is indexed to the Selic rate (the central bank’s official interest rate). The risks therefore stem more from fiscal deterioration, the quasi-sovereign sector and interest costs on local currency debt. Foreign investors hold just 11.25% of domestic bonds in Mexico (down from 15% in 2023), while in Colombia, deteriorating public finances are currently reducing foreign investors’ share of the debt (currently 18.8%) and increasing the stock of domestic debt, in turn weighing on the fiscal trajectory.

In Turkey, holdings of domestic government debt by non-residents, which fell sharply in the wake of the heterodox policies of 2021−23, remain limited, but carry trade flows have helped support the lira since the economic policy shift of mid-2023. If foreign investors were to pull out, the initial impact would be on the exchange rate and foreign exchange reserves rather than on the government’s ability to finance itself. Tighter foreign-currency liquidity would nevertheless contribute to a worsening of refinancing conditions for external debt, which is mainly concentrated in the banking and corporate sectors.

Sophie Wieviorka, Tania Sollogoub, Jorge Aparicio Lopez and Nathan Quentric

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