As the novel coronavirus pandemic has spurred an en masse flight to safety and battered economic growth expectations, foreign investors are yanking funds from emerging markets and driving up credit default risk spreads, creating an increasingly uncertain future for some developing countries.

Across global emerging markets, credit default swap spreads, a key measure of credit risk, have jumped markedly in recent weeks — tripling or quadrupling in some cases — as fears of a global recession have grown. In Indonesia and Malaysia, for instance, CDS spreads have spiked by more than 400% over the past month. African countries like Angola and Nigeria and Latin American countries including Brazil and Colombia have seen even sharper increases.

"We expect the developed world to be in recession this quarter and the next and that is in itself a big shock to emerging markets," said Sergi Lanau, deputy chief economist at The Institute of International Finance, or IIF. "The spread of the virus in Europe and potentially in the U.S. is [creating] really difficult financial conditions in markets."

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Weaker institutional frameworks and smaller financial markets reduce emerging economies' ability to absorb shocks, Dmitry Dolgin, ING's chief economist for Russia and the CIS, noted. "So even though the coronavirus is hitting more developed markets, emerging markets can absorb a much smaller hit."

A plethora of fiscal concerns

A run on emerging markets represents concerns on the possible impact to these countries' relatively fragile fiscal health and external liquidity positions. "Widening credit spreads are pointing to increasing problems at overly leveraged companies and countries now facing challenges from deteriorating fiscal budgets as a result of the possible impact from the coronavirus," said Andy Sparks, head of portfolio management research at MSCI.

"It's not a surprise to see spreads have risen the most in regions such as Sub-Saharan Africa and Latin America, where public finances generally are a lot weaker than in places like emerging Asia and Central Eastern Europe," echoed Edward Glossop, emerging markets economist for Capital Economics.

A dependence on the global supply chain could exacerbate fiscal concerns, especially for those with low hard currency reserves and large fiscal and trade deficits, Lilit Gevorgyan, IHS Markit's Principal Economist for Europe and CIS noted. "Supply chain disruptions and collapse in domestic demand in these markets may turn their short-term liquidity problems into solvency troubles, especially if the pandemic is prolonged."

Countries with significant levels of hard currency debt, such as Turkey and South Africa, also face refinancing risk given the difficulty in rolling over bonds under current conditions. "There's a worry that many countries with a lot of dollar debt may not be able to refinance their debt easily, so access to markets is an issue," said Nasser Saidi, President of Nasser Saidi & Associates and a former vice-governor of Lebanon's central bank.

This is specially a cause of concern for countries whose currencies are pegged to the greenback, such as Saudi Arabia and the United Arab Emirates, as well as for highly dollarized Latin America. According to Alejandro Cuadrado, emerging market economist at BBVA, the onset of the coronavirus has "[hit] the liquidity of credit lines, making curves steeper everywhere" in the Latin American region. "Some of them will be affected more in terms of servicing their dollar-denominated debt."

Commodity dependency

The fallout from the pandemic already has been precarious for the dozens of emerging market countries whose economies are commodity dependent. CDS prices for many emerging market hydrocarbon exporters have surged in recent weeks as the likely impact of the coronavirus on demand for oil — as well as an ill-timed crude price war between Russia and Saudi Arabia — spooked investors.

"There's an oil price war at a time when global demand for oil is declining and when COVID-19 is leading to large declines in demand for transport, movement of people, [and] trade," said Saidi. That affects countries that are open and also oil and gas producers."

It is an especially big issue for countries like Colombia, where crude oil and other mineral fuels represent more than half of all exports, and Angola, where oil makes up more than 90% of exports.

For copper-dependent Chile, declining prices amid the coronavirus outbreak could trigger either an economic stagnation or contraction this year. "Just as oil has come down, a lot the price of copper has also fallen quite drastically," Lanau said. "[The outbreak] adds to the shock they already suffered."

However, Chile's low public debt and relatively good external buffers serve as a cushion for further shocks, Lanau noted. "Chile will suffer as every other commodity exporter, but, specially in a region in relative terms, is in a good position to handle what's coming."

The same can be said for major liquid natural gas exporters like Qatar, which can tap on its large reserves to pay off external liabilities. "That underlines Qatar's strong balance sheet because CDS measures the risk of government default and investors still see that as very low," according to Akber Khan, senior director of asset management at Al Rayan Investment.

A rough road ahead

With no end in sight for the pandemic, the climb in CDS prices both for emerging and developed economies will likely to continue. "In order for the risk capital to return, we would need to see the number of global daily infections to start declining," Glossop said. "But as it stands, that looks to be someway off. As of the moment, we probably suspect that risky assets will remain on pressure for sometime yet."

On the other hand, it may be too early too call if some sovereigns will default on their obligations as a result of the pressure posed by the coronavirus pandemic. "The reality is that we still have much to learn about the coronavirus and the conditions under which it may proliferate," Sparks said. "The bond market is definitely signaling serious concern over the impact of the virus on emerging market countries, but market bond spreads are generally not trading near distress levels."