Biggest emerging sovereigns have the fastest debt growth

The shock to household and company incomes from the COVID-19 pandemic and the Russia-Ukraine war pushed emerging market governments to increase fiscal transfers to the private sector. The cost of this support explains why public debt levels in emerging market sovereigns are on average about 8 percentage points of GDP higher today than in 2019. But by developed market standards, government debt levels in the larger, wealthier emerging markets are still quite modest, at 50% of GDP. 

Fiscal complaisance is on the rise. S&P Global Ratings projects that most larger emerging market sovereigns will be unable to return debt to pre-pandemic levels by the end of this decade. Electoral pressures, aging demographics, declining growth and, in some cases, rising borrowing costs all combine to hinder debt reduction. 

Among the group of 20 key emerging market sovereigns analyzed, we expect the debt-to-GDP ratio to rise by more than 5 percentage points between 2023 and 2030 for nearly half — Brazil, Bulgaria, Colombia, Mexico, Poland, Romania, Saudi Arabia, South Africa and Türkiye. Of the emerging markets with GDP over $300 billion, only Chile, India, Indonesia and the Philippines are projected to lower their debt-to-GDP ratio during this period. To stabilize their debt ratios, emerging market sovereigns would need to adjust their underlying general government deficit between 0.5 percentage point of GDP (South Africa) and 1.7 percentage points (Romania) by 2030. In most cases, we do not expect governments to make these fiscal adjustments.  

To fully understand fiscal sustainability, it is important to examine both financing and borrowing trends. While borrowing by emerging market governments is increasing from relatively low levels, domestic financing prospects today are better than before. For example, savings rates are now higher than 20 years ago in many prominent emerging markets, exceeding 30% of GDP in China, India, Indonesia, Saudi Arabia and Vietnam. In economies with such high savings rates, public sector deficits are almost inevitable. 

Higher savings rates underpin larger domestic financial sectors, with more capacity to allocate private savings to finance the government. We estimate that current surplus financing capacity (financial sector assets excluding claims on the public sector) exceeds 100% of GDP in China and Vietnam; 70% in Chile, Saudi Arabia and South Africa; and 50% in Brazil, India and the Philippines. 

Emerging market net external borrowing is also far more muted today than prior to the Latin American debt crisis of the 1980s, Asian financial crisis of 1997–1998 or the global financial crisis of 2007–2010. Of the 20 major emerging market economies rated by S&P Global Ratings, only Romania has account deficits exceeding 4% of GDP, largely a reflection of the magnitude and recurrence of EU capital inflows. Low or no net external financing requirements from major emerging market sovereigns insulates them from the balance of payments crises that were the norm before 2011. 

Finally, foreign currency debt represents less than 30% of government debt for most emerging markets. In larger sovereigns such as China, India, Mexico and South Africa, foreign currency debt represents less than 15% of total sovereign debt. This shields these major emerging market borrowers from shocks due to volatile exchange rates or trade imbalances.  

None of the macroeconomic frailties, such as low gross savings and large external deficits that contributed to regional financial crises since the 1980s, are present in key emerging markets today. Lessons from past crises have convinced emerging market policymakers, especially, but not exclusively, in Asia, to build foreign currency reserves and limit private sector leverage. Dollarization and foreign currency exposures are primarily limited to a few smaller, more vulnerable sets of emerging markets. Surging domestic savings and more credible monetary policy settings mean the capacity of emerging markets to sustain higher levels of public debt is increasing. However, this does not eliminate risks to emerging market fiscal sustainability. 

The two main fiscal risks for emerging market sovereigns are an uncertain outlook for growth and the inability to increase tax receipts.

The future trajectory of emerging market growth will be a key determinant of fiscal outcomes for the rest of this decade. Several concerns exist in this regard. For China, an aging population, property woes, weakening consumer sentiment and few measures to support household spending suggest future moderate consumption growth and a potential risk for deflation, which would impact fiscal outcomes. Private oversaving in China, with a gross savings rate of 44% of GDP, may be a logical response to aging demographics and a narrow social safety net. But amid a slowdown in investment activity in the property sector, it can also constrain consumption growth. 

Supply side constraints cap growth rates in emerging markets. In Mexico, years of underinvestment, especially in infrastructure such as energy and electricity, have constrained the economy. Hungary’s big bet on the electric vehicle sector and its trade-intensive economic model make it vulnerable to deglobalization while its population declines and ages. In South Africa, recurrent power outages and logistical bottlenecks have weighed on activity, limiting per capita GDP growth to just above 0% for nearly five years. Those factors also challenge South Africa’s manufacturing, mining and export sectors. While some investment in alternative energy infrastructure has progressed, the new coalition government faces challenges in reducing high structural unemployment and stimulating private investments (see “Planning for the future: Growth targets for the next decade” to learn more). 

Türkiye's growth challenges differ: cooling down a recently overheated economy while restoring trust in the Turkish lira. Second-quarter 2024 GDP results confirmed a significant deceleration in Turkish consumption growth. However, the bigger question is whether Türkiye's private consumption, about 60% of GDP in 2023, can stomach real income cuts for long enough (i.e., until 2026) so that inflation can return to single digits without significantly hampering the country's growth prospects.  

Weaker-than-projected emerging market growth may pose a serious risk to their public finances over the longer term — particularly if accompanied by deflation (i.e., China) — as aging demographics and excessive private savings may lead toward Japanese levels of public debt but without Japanese levels of development, wealth generation and currency status. 

The second risk to emerging market fiscal sustainability is low tax receipts. Emerging market sovereigns collect an average of 23% of GDP in government revenues, more than 10 percentage points less than the Organisation for Economic Co-operation and Development developed sovereign average. Indonesia collects less than 15% of GDP in revenue, while Mexico and Vietnam collect only 18% each. There are political and institutional limitations to taxing the informal economy, particularly where populations have low confidence in the quality of public services and the integrity of government officials. We project that most emerging market countries in our analysis will grow their revenues by no more than 1% of GDP over the next seven years, while their primary balances will remain negative. 

Fiscal pressures are more acute in frontier sovereigns, another category of emerging markets. S&P Global Ratings defines frontier sovereigns as those with low per capita income, below $2,500 in GDP. Compared to emerging markets, frontier sovereigns typically face more pressing economic and financing challenges, more concentrated economies and export baskets, and political institutions at earlier stages of development. Other characteristics of frontier markets are low private savings rates, volatile external accounts, and more modest domestic financial sectors and markets. In Angola, Ghana, Nigeria, Pakistan, Uganda and Zambia, the surplus financing capacity of domestic banking sectors is below 20% of GDP, three to five times lower than that of key emerging markets. 

Faced with a series of external shocks, frontier sovereigns, like other governments, needed to raise additional financing to mitigate the fallout on households caused by the COVID-19 pandemic and higher food and energy prices following Russia’s 2022 invasion of Ukraine. Their search for additional financing coincided with the world’s most influential central banks shifting to a tightening cycle, raising borrowing costs and effectively shutting down access to foreign capital markets.

Foreign currency debt comprises a far higher share of debt in frontier markets compared to other emerging markets — about 66% of general government debt versus less than 30% for other emerging markets. Due to a large reliance on imported food, fuel and consumer goods, economies such as Egypt and Ghana have also found difficulty regaining external competitiveness and rebuilding foreign currency buffers via exchange rate devaluations, as the pass-through effects of devaluations on domestic inflation have generally been higher since 2020 compared to historical levels. 

All of the above pushed many frontier governments to the brink of bankruptcy. Between 2019 and 2023, gross general government debt for frontier economies increased by 12.8 percentage points to 75% of GDP on average. The cost of interest payments on this debt exceeded 30% of all government revenues in Egypt, Ghana, Nigeria and Zambia. 

By 2030, we forecast that, on average, the aggregate frontier sovereign debt-to-GDP ratio will decline to 63% of GDP. Frontier sovereigns should manage to reduce debt through front-loaded fiscal consolidation, as seen under International Monetary Fund programs in Egypt and Kenya; real effective exchange rate appreciation, as projected in Angola; or defaults, as have occurred in El Salvador, Ethiopia, Ghana and Zambia. Frontier market policymakers are adopting these measures to rein in spending and introduce new taxes, as domestic and external financing constraints leave them with no other viable options.