Which Asian frontier nation to follow Sri Lanka on the path of default? Pakistan and Lao PDR are in pole position

With commodity prices still elevated and borrowing costs higher as the FED becomes more hawkish, low-income commodity importing countries are under significant balance of payment pressure. Within Asia,?the technical default of Sri Lanka ?has obviously rung the alarm for other frontier economies that are mostly commodity importers.?

In this note, we quantify the needs and availability of external financing for the Asian frontier countries. To that end, we measure the depth of the foreign currency needs of relevant frontier markets in Asia so as to assess the potential of a forex liquidity crunch and, thereby, the probability of a sovereign default on external debt. For the external funding needs, we put together: a) the size of the current account deficit as a share of GDP; b) the size of debt servicing on foreign marketable debt, including both principal repayments and interest payments. As regards the availability of forex resources, we sum up a) external debt disbursements from bilateral / multilateral creditors; b) gross forex reserves as means of self-insurance. Then we deduct the external financing needs from the availability of forex resources to measure the financing gap.

Our results are summarized in a ranking from the least to most vulnerable: Cambodia and Nepal have the largest forex needs due to the rapid widening of current account deficit, followed by Sri Lanka due to the burden on external debt servicing. But for the forex availability, Cambodia and Nepal also have the strongest buffer in terms of forex reserves and the access to lending from official creditors, followed by Mongolia. All in all, taking into account both the needs and availability of external financing, Sri Lanka, which is already in default, is followed closely by Pakistan and Lao PDR, in terms of largest forex liquidity gap. Instead, Cambodia and Papua New Guinea are the most resilient within our sample, thanks to adequate forex reserves for the former and the commodity-led current account improvement for the latter.?

Beyond the direct external funding needs, we also complement our analysis by incorporating the fiscal situation of these Asian frontier markets. In fact, fiscal gaps may need to be financed by renewed external sources since domestic savings might be too small and financial markets too shallow to intermediate such financing. Furthermore, the ongoing FED tightening is leading to portfolio outflows by foreign investors who could otherwise help finance fiscal deficits. The data shows the same three countries as most vulnerable, fiscally speaking, namely Sri Lanka, Pakistan and Lao PDR. The enlarged size of interest payments arising from the rapid increase in the cost of local funding also means that the path for fiscal consolidation will be more difficult for these countries.?

All in all, our rankings show that Sri Lanka, followed by Pakistan and Lao PDR, are suffering from the largest external financing gaps among the Asian frontier markets reviewed in this analysis. But?news flow ?suggests that China will support through short-term forex liquidity loans, this can partially help these countries weather the crisis given China’s role as a major bilateral creditor. In turn, Cambodia and Papua New Guinea are the most resilient, in relative terms. Bangladesh and Myanmar are in between the two groups, which clearly does not mean they are out of the woods as the external environment remains highly complicated with our house view expecting the FED to hike by another 100 basis points by the end of 2022.

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