Soaring Interest Payments Threaten $29 Trillion Emerging Market Debt Pile

Developing nations are facing a growing debt crisis as ballooning interest payments on a $29 trillion debt pile threaten to derail their economic recovery, reports Bloomberg.

A record 54 countries are now spending more than 10% of their government revenue on interest payments, according to the United Nations. Some countries, including Pakistan and Nigeria, are allocating more than 30% of their revenue to debt servicing alone.

The total interest burden, estimated at roughly $850 billion in 2024 for both foreign and local debt, is forcing governments to divert funds from essential domestic spending on healthcare, infrastructure, and education. This is raising concerns among investors in emerging markets.

"Interest burdens are massive," said Roberto Sifon-Arevalo, global head of sovereign ratings at S&P Global Ratings, to Bloomberg. "There's a lot of muddle through, but there's a tremendous amount of risk."

This mounting debt crisis comes at a time of significant uncertainty for emerging markets. The impact of US interest rate hikes and a strengthening dollar under President Trump's policies, coupled with rising geopolitical tensions and concerns about the Chinese economy, are creating a challenging environment for these nations.

Despite the mounting debt burden, no sovereign defaults were recorded in 2024. Emerging-market watchers, including RBC BlueBay Asset Management and Morgan Stanley, do not anticipate any defaults in 2025 either. This is largely attributed to the intervention of international institutions like the International Monetary Fund (IMF) and the reopening of international capital markets to some borrowers.

This backdrop has facilitated stalled debt negotiations, leading to fewer countries operating at distressed levels and improved performance for some of the riskiest bonds, including those issued by Pakistan and Egypt.

However, as pandemic-era borrowings mature and interest costs continue to rise, investors are questioning the sustainability of this situation.

"Default risk is lower in the short term," said Anthony Kettle, senior portfolio manager at RBC, to Bloomberg. "But it does set up an interesting situation if you look a little further forward: Can they sustain these interest costs?"

Emerging-market debt has more than doubled in the last decade to approximately $29 trillion, with most of this increase stemming from local borrowing, according to the UNCTAD's annual debt report. This has resulted in significant interest payment obligations and bond maturities that require repayment or refinancing. Over the next two years, roughly $190 billion in foreign bond obligations are due, according to JPMorgan Chase & Co.

Some of the riskiest countries are already paying coupons exceeding 9% to access international debt markets and refinance maturing debt.

Analysts at S&P predict higher default rates in the coming decade compared to the past, citing elevated debt levels and borrowing costs. The World Bank has also warned of record-high interest payments by developing nations.

The potential for another wave of defaults underscores the risky nature of investing in emerging market debt, particularly given the string of defaults following the pandemic. Ethiopia was the last developing nation to default on debt payments in late 2023.

Pressure is mounting on the IMF to continue providing support to struggling nations. The Fund is currently negotiating a new deal with Argentina, one of its largest debtors, aiming to replace and potentially expand the current $44 billion agreement by year-end. Argentina, notorious for its nine previous defaults, faces approximately $9 billion in interest and principal payments on its hard currency bonds in 2025 alone.

In Asia, the IMF has already intervened to support Sri Lanka and Pakistan, contributing to significant increases in their debt levels this year. Angola has also indicated its intention to potentially seek a new program with the Fund, but for now, the IMF is providing technical assistance.

According to Morgan Stanley, about 27% of an emerging market debt index is currently engaged with the IMF, and the number of countries relying on the Fund's programs is expected to rise.

"The IMF will still play a key role," wrote Morgan Stanley strategists in a December 3rd note to Bloomberg. "We still think that a large share of upcoming programs ending will be refinanced largely due to fiscal concerns."