Regional risk profile trends in developing countries

Moritz Nebe, Sector Manager, Economics at MIGA Economics and Sustainability Group, discusses risk trends for global regions seen over the past year.

Macroeconomic backdrop

Economic recovery in developing countries has largely been underway during 2021, following the crippling impact of the COVID-19 crisis on the global economy during 2020. However, the recovery and risk environment appear fragile and uneven in light of the differences in economic conditions at the onset of COVID-19, lingering uncertainty and unpredictability of the pandemic’s course, its continued impact on some economic sectors, low vaccination rates in some regions (especially in sub-Saharan Africa (SSA)), and concerns around resurgence and mutations.

The macroeconomic deterioration and the need for expansionary fiscal policies exacerbated existing economic vulnerabilities in many countries, while more recently the phasing out of expansionary fiscal policies and introduction of austerity measures have heightened socio-political tensions in others. Disruptions related to climate change and natural disasters have compounded the effects of the pandemic. Inflationary pressures currently materialising in a number of developed and developing economies have the potential to slow the recovery and may adversely impact countries already facing debt sustainability concerns.

Risk trends

Across all regions,^[1] the impacts of the health crisis and the macroeconomic crisis have led to higher sovereign credit risks. The health and macroeconomic crises have contributed in many instances to worsening political risks, as countries’ ability to provide a fast and effective response to the crisis was constrained by limited fiscal space and in some cases insufficient capacity to implement effective emergency measures. This has left populations with little support, exacerbating social tensions, especially in countries with high pre-existing income inequality. Countries in Europe and Central Asia (ECA), as well as East Asia and Pacific (EAP), on average, experienced less deterioration of their sovereign credit profiles compared with the remaining four regions, primarily due to an initial less vulnerable position and greater fiscal space when entering the pandemic.

The pace of deterioration of countries’ sovereign credit profiles slowed in 2021 in light of the economic recovery, but the scarring resulting from the pandemic creates lingering uncertainty over the rapidity and strength of the recovery.

In Latin America and the Caribbean (LAC), some countries continued to experience downward pressures on their sovereign credit profiles over the course of 2021, mostly driven by a worsening of their fiscal positions. In addition, various countries in the region have seen increased risks to political stability and an increase in social tensions, as well as climate-related risks.

Following 2020’s sharp economic contraction of 6.7%, real GDP in LAC is expected to rebound to 6.1% growth in 2021 (Figure 2),^[2] mainly driven by vaccine rollouts, relaxation of mobility restrictions, and broadly favourable external economic conditions. In the first quarter of 2021, economic recovery was robust. However, given the resurgence of COVID-19 cases, it weakened in the second quarter in some countries. There have been signs of recovery in the third quarter in various countries resulting from the easing of COVID-19 cases and the lifting of restrictions. In the Caribbean, tourism recovery has been subdued and a stronger growth rebound is not expected until [some time in] 2022.

After starting to reopen borders in early-2021, a resurgence of COVID-19 cases led some countries to reimpose restrictions and lockdowns, and while tourism rebounded, it is still significantly below pre-crisis levels.^[3] Although the average fiscal deficit in the region narrowed in 2021, it remains wider than its pre-pandemic level (Figure 4). LAC countries are exposed to climate-related risks, having been affected by extreme weather-related shocks, namely tropical storms and hurricanes, droughts, and wildfires, which exacerbated the impacts of the pandemic and are hindering the recovery.

Macroeconomic and political risks affecting sovereign credit profiles have also increased in Sub-Saharan Africa (SSA), mainly driven by an increase in debt vulnerabilities, political instability, armed conflicts, and social discontent. Economic recovery is expected in the region with real GDP growth estimated at 3.3% for 2021, compared to a 2% contraction in 2020, driven by the significant improvements in global trade and commodity prices. However, the region has had a very slow vaccination rollout, having the lowest vaccination rate in the world with only 5% of the population fully vaccinated as of November 2021 (Figure 1), making the region more vulnerable to the resurgence of cases. Debt sustainability risks are also a rising concern in SSA where debt levels are projected to increase to 59% of GDP by end-2021, compared to pre-pandemic levels of 51% in 2019 (figure 3). As per the joint World Bank-IMF debt sustainability assessments (DSAs), half of the region’s low income developing economies are at high risk of debt distress or in debt distress.

The region has also been affected by climate related shocks with droughts and floods affecting some countries, impacting crops and livestock production.

In South Asia (SAR), real GDP is expected to rebound by 7.3% in 2021, from a 5.7% contraction in 2020, mostly driven by a recent uptick in services activity and private consumption and supported by favourable external conditions and accommodative policies. In April-July 2021, COVID-19 cases surged significantly, reaching higher levels than in 2020, but a substantial economic slowdown was averted because containment measures were more targeted and localised. However, heightened risks have resulted from the existing high debt levels in some countries and the impact of the pandemic on tourism and growth prospects, posing a threat to debt sustainability.

In contrast with other regions, East Asia and Pacific (EAP) avoided a recession in 2020 and is poised to grow strongly in 2021 with GDP growth expected to reach 7.6% including China, or 2.7% excluding China. Vaccination rates are high with about 70% of people fully vaccinated in the region. The swift policy support implemented in many countries and the continued shift of global consumption from services towards goods supported the region’s economic activity in 2021, despite bottlenecks and disruptions in global supply chains. Nonetheless, the resilience and swift recovery experienced in 2021 by countries with a highly developed manufacturing sector contrasts sharply with the worsening macroeconomic imbalances observed in island countries where the prolonged impact of the COVID-19 pandemic kept revenues from tourism extremely low in 2021, leading to further increases of fiscal deficits and debt ratios. These fiscal and debt sustainability risks add to climate risks threatening island countries, notably through the increasing frequency and intensity of natural disasters and rising sea levels.

In Europe and Central Asia (ECA), GDP growth is projected to recover to 5.8% in 2021 after a 1.5% contraction in 2020. Approximately 41% of people in ECA are fully vaccinated. A key feature of ECA is the variety of countries making up the region resulting in highly uneven macroeconomic and socio-political profiles, as well as different paces of recovery across countries in the region. Public finances remained resilient in most countries given the significant fiscal space built prior to the crisis, as well as timely EU, IMF and World Bank support, albeit with notable exceptions.

The region is also well positioned to benefit from supply chain rearrangements in a number of sectors, in particular considering Central and Eastern Europe’s proximity to European consumer markets and industrial potential.

In the Middle East and North Africa (MENA), GDP is expected to recover to 4.3% growth in 2021 following a contraction by 3.3% in 2020. Countries struggled with significant disruptions from COVID-19 and a sharp fall in oil demand and prices in 2020. In 2021, the recovery in oil prices benefitted oil exporters while the acceleration of vaccination supported the resumption of economic activities (42% of people are fully vaccinated).

Nevertheless, many countries in the region suffered from the prolonged impact of the pandemic on the tourism sector in 2021 and from worsening macroeconomic imbalances. expanded fiscal deficits renewed concerns around sustainability of public finances in a number of countries. In addition, further risks arise from depleted external buffers that many countries are struggling to replenish in 2021 despite higher oil prices, considering low revenues from tourism and slow recovery of key trading partners.

In 2021, domestic and geopolitical instability in some countries in the MENA region is also noteworthy from a risk perspective. Climate risks associated with increased frequency and severity of weather events also affect the region. In particular, due to longer and more intense droughts, water scarcity has the potential to increasingly feed tensions and disrupt economic activity if not addressed, as shown by the protests motivated by water shortages that erupted in some MENA countries in 2021.

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1. The World Bank Group (WBG) regional classification is used as reference for this: https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups ↑
2. Growth projections are from the World Bank Macro Poverty Outlook (October 2021) ↑
3. According to the United Nations World Tourism Organization, as of September 2021, tourist arrivals in the Caribbean were 38% lower than in September 2019 (https://www.unwto.org/international-tourism-and-covid-19). ↑