[Global Focus] Pakistan's 'Benchmark Interest Rate 20%' Highest in Asia... Debt-Ridden Emerging Markets Face Default Emergency

1%P Increase Last Month Followed by 3%P This Month
High-Intensity Tightening to Curb Inflation
China's Belt and Road Participation, COVID-19, Ukraine War Triple Challenges
US Rate Hikes Compound Debt Burden Difficulties
Emerging Markets' Total Debt Hits $98 Trillion... Need Solutions to Prevent Chain Defaults

The blade of high-intensity tightening in developed countries is cutting through Asia. In the case of Pakistan, the benchmark interest rate reached 20%, marking the highest level in Asia. It was raised by 3% just this month. This is a desperate measure amid all the warning signs of a national default crisis, such as soaring inflation and currency value collapse. There are even warnings that a 'chain debt default (domino default) crisis' could occur, centered on emerging countries including Pakistan.

Some voices express concern that the worst-case scenario, similar to the 1997 Asian financial crisis, could occur, and call for the international community to actively come together to resolve the emerging countries' debt crisis.

Pakistan's Benchmark Interest Rate at 20%... Highest in Asia

On the 2nd, the State Bank of Pakistan announced that it would raise the benchmark interest rate by 3 percentage points from the previous 17% to 20%. This is an ultra-tightening move just one month after raising the rate by 1 percentage point last month. For the State Bank of Pakistan, this is the highest rate hike in 27 years since October 1996. It is also the highest among Asian countries. Regarding the reason for the rate hike, the State Bank of Pakistan explained, "It is important to anchor inflation expectations, and a strong policy response is necessary." In fact, looking at Pakistan's recent inflation and currency value, this rate hike cannot be considered excessive. Pakistan's consumer price index surged by a whopping 31.5% compared to a year ago last month, the highest since 1974. The currency value is also in a sharp decline. The value of the Pakistani rupee fell more than 6% against the US dollar on the 1st, the day before the central bank's surprise rate hike. As the International Monetary Fund (IMF) bailout support was delayed, foreigners dumped Pakistani currency, causing the foreign exchange market to convulse.

Several factors have pushed the economy of Pakistan, the world's fifth most populous country with 230 million people, to the brink of national default. First, by participating in the China-led Belt and Road Initiative (BRI), a large-scale infrastructure investment was executed, and in the process, external debt increased astronomically. It is estimated that about 30% of Pakistan's external debt is owed to China.

In addition, the already fragile financial situation worsened due to the triple shocks of the COVID-19 pandemic, the Ukraine war, and more. Along with geopolitical uncertainty, the massive floods last year also dealt a heavy blow to the national economy. To make matters worse, last year the US implemented four rounds of giant steps (0.75% interest rate hikes), initiating high-intensity tightening, which depreciated Pakistan's currency value and increased debt repayment burdens, deepening the default crisis. Fortunately, China recently allowed a $1.3 billion debt repayment extension, enabling Pakistan to narrowly avoid default. However, this only put out the immediate fire, and the risk of crisis recurrence remains at any time.

International credit rating agency Moody's recently downgraded Pakistan's sovereign credit rating by two notches to 'Caa3.' Moody's expressed concern, stating, "Liquidity and external positions are increasingly vulnerable, significantly raising default risk," and "Pakistan's efforts to continuously implement various policies to receive large-scale financial support are being undermined due to a fragile government and rising social risks."

Emerging Market Debt at $98 Trillion... Concerns Over Domino Defaults

Among emerging countries, several face problems similar to Pakistan's. According to the IMF, 60% of the poorest countries are in debt crises, doubling from 30% in 2015. In fact, Sri Lanka and Ghana have already declared defaults on external debt, and Egypt, like Pakistan, has reached the brink of default. Many countries that increased external debt by participating in China's Belt and Road Initiative, such as Sri Lanka and Pakistan, are facing unbearable debt levels due to the combined effects of COVID-19, the Ukraine war, and interest rate hikes.

According to the Institute of International Finance (IIF), the total debt of emerging countries was $98 trillion at the end of 2022. This is a 2% increase from a year earlier, and a staggering 28.6% surge compared to the end of 2019, just before the COVID-19 outbreak. Of the $96 trillion total debt of emerging countries, $7 trillion is due within the year. There are concerns that if the US's high-intensity tightening continues for a long time, a vicious cycle could occur: 'US interest rate hikes → stronger dollar → depreciation of emerging market currencies → outflow of foreign investment → further depreciation of emerging market currencies → increased burden of external debt repayment.'

In major emerging countries, the ratio of interest payments to government revenue continues to rise. According to international credit rating agency Fitch, the average ratio of interest payments to government revenue in 20 major emerging countries rose from 7.3% during 2016-2020 to 8.3% in 2022. It is expected to rise further to 8.8% this year. Several countries are expected to exceed 10% this year. India has the highest level at 27%, followed by South Africa (18.8%), Brazil (17%), Indonesia (15%), Colombia (14.5%), Mexico (13.8%), and Malaysia (12%), all expected to face heavy interest repayment burdens.

The International Finance Center pointed out, "As emerging countries' debt accumulates, if high inflation, high interest rates, and high exchange rates persist, there is concern that emerging countries' debt risks will be highlighted, including deterioration of fiscal soundness, increased debt repayment burdens, and expanded credit risks." It added, "Although the default crisis is still concentrated in low-income countries, it should be noted that debt risk concerns are also being raised in some middle-income emerging countries."

While some voices worry about a 'second foreign exchange crisis,' the possibility is considered low. The Korea Institute for International Economic Policy stated, "Asian emerging countries have generally better economic fundamentals compared to past crises due to the adoption of flexible exchange rate systems, strengthened foreign currency liquidity management, and improvements in debt structure and financial systems," and diagnosed, "Although Asian emerging economies face difficulties, concerns about a repeat of the 1997 foreign exchange crisis are somewhat excessive." However, it added, "If a strong dollar persists, countries may be exposed to varying inherent vulnerabilities."

There are also calls for China to actively restructure debt. The US urges China to take active measures, arguing that since President Xi Jinping took office at the end of 2012 and promoted the Belt and Road Initiative, China has poured funds into developing countries and worsened debt problems.

This content was produced with the assistance of AI translation services.