EM currencies and the high public debt club

There has been a lot of weakness in EM currencies so far in 2022. They can be generally grouped into regions. The east European currencies have broadly followed the sell-off of the Euro, the north Asia currencies have weakened in line with the CNY, with ASEAN currencies holding up reasonably well as their economies begin to open from Covid lockdowns. There is one group of countries that have the weakest currencies by far in EM this year, and one common link that they share is high public debt/GDP. We have identified five countries that have the highest public debt/GDP levels in EM at over 80%: Sri Lanka, Egypt, Pakistan, Argentina, and Brazil. As a group, these currencies have been the worst performers by far year to date, with the exception of Brazil. The World Bank guides that 64% public debt/GDP is the threshold for developing countries, after which every additional percentage point of debt added is a drag on real GDP growth. How has the Brazilian Real avoided the sell-off? It basically comes down to commodities; Brazil is a commodity exporter and is benefiting from higher commodity prices. The Real also started the year at one of its lowest REER levels in decades. The fact is, and Brazil is not immune to this, that high public debt levels significantly limit a government’s ability to use countercyclical spending during times of crisis. And as global liquidity is pulled from the system and interest rates rise, these countries are most vulnerable. Brazil looks to be the best positioned of the bunch, but growth will still be anemic there. The high public debt club in EM is not a group you want to join.