Increasingly complex debt load seen in the world’s emerging markets could raise borrowing costs and delay debt restructurings, said advisory firm Lazard.
“The proliferation of intricate debt, whether loans backed by collateral or bonds linked to economic growth or exports, has exploded since 2020, driven by aid cuts by rich nations, high borrowing costs and risk aversion due to everything from COVID-19 to Russia’s invasion of Ukraine,” the top advisory firm noted in its latest paper, while warning that the shift, often praised by a section of investors as an innovative way to diversify borrowing, could come “with a sting in the tail.”
“We need to simplify the whole thing, because it is becoming really complex, and inevitably, at some point, the borrowing countries will pay the price of that,” said Pierre Cailleteau, managing director at Lazard.
To prove its case, Lazard has put the smaller, riskier nations in the “frontier economies” category. As per the agency, some complex instruments have emerged to speed up debt restructurings, for example, in Zambia, where bond payouts were linked to improvements in debt sustainability, and in Sri Lanka, where these instruments were tied to GDP performance.
Meanwhile, Angola, Nigeria, and Senegal have tapped total return swaps—effectively borrowing against their own debt—as an alternative to international bonds. The IMF has warned these can be opaque and complicated liabilities. Uncertainty over whether multilateral lenders retain preferred creditor status—which shields them from losses when countries default—adds to the concerns,” Lazard stated further.
“The combination of a lack of clarity on the hierarchy of claims and the introduction or the proliferation of those types of contingent instruments makes, in fact, the debt very difficult to analyze for the creditors to determine where they are in the hierarchy of claims,” Cailleteau said.
“This is changing the dynamics of debt. Zambia is in the process of buying back its contingent bond. The World Bank has pushed for ‘radical transparency’ on debt, and increasing debt complexity—especially the use of state contingent debt instruments—has been a top agenda item at recent meetings of the International Monetary Fund and the World Bank in Washington. The debt transparency should be mandatory in order to access financing from the IMF—typically the lender of last resort for countries in debt distress—and other multilateral development banks,” he stated further.
“We need to make transparency enforceable,” Cailleteau remarked, while adding that the premium demanded by investors on emerging market debt was near record lows—a sign of “some degree of exuberance” and may be underpricing the risks.