The author is Head of Emerging Market Economics at Citi

Over the past two years, the risk of a looming debt crisis in some low-income developing countries has made some people cry out, but these concerns now deserve more serious attention.

Even before events in Ukraine posed a new threat to global investors’ risk appetite, the double whammy of tighter U.S. monetary policy and a sharp decline in global trade growth began to limit the ability of low-income countries to hold dollars. The longer geopolitical tensions persist, the deeper the problem will become.

In early 2020, fears of an immediate debt crisis surfaced as soon as the pandemic hit. It is believed that many developing countries simply do not have foreign exchange to service their debts. That fear back then was misplaced for three reasons.

First, the Federal Reserve has significantly eased monetary policy, keeping capital markets open to emerging market borrowers by supporting global risk appetite. Second, the massive fiscal stimulus from the U.S. Treasury has spurred a surge in global trade. Third, the International Monetary Fund supports financial stability in developing countries through emergency grants, most importantly the issuance last year of $650 billion worth of Special Drawing Rights, a multi-currency reserve asset.

But now, the external environment facing low-income developing countries is rapidly deteriorating. U.S. monetary tightening is bound to weaken investors’ risk appetite for emerging markets. The debt crisis of the 1980s showed how the financial stability of developing countries was threatened when the United States had its own inflation problem to deal with.

At the same time, global trade growth began to decline sharply in the second half of 2021 – bad news for countries that rely on this growth to generate foreign exchange earnings.

All of this comes as some important measures of developing countries’ credibility have deteriorated to worrying levels. For example, in developing countries rated B, the average ratio of external debt to exports has actually returned to above 200 per cent, the last level in the late 1990s. Likewise, the export earnings of these countries to service their foreign debts have returned to over 25 percent, a figure not seen in 20 years.

Markets have begun to worry about single B-rated sovereigns as their risk premiums have increased significantly relative to creditworthy countries over the past few months. But there is plenty of room for these concerns to deepen.

The current surge in commodity prices is good news in principle for low-income developing countries, many of which are commodity exporters. But in some cases, that hasn’t been enough to offset the recent collapse in risk appetite.

Credit spreads in vulnerable commodity importers have widened significantly since the invasion of Ukraine began on February 24. However, even some vulnerable commodity exporters were hit by risk aversion.

Another reason for the rising default risk in low-income developing countries has to do with the IMF itself. The last time a developing country suffered a systemic debt crisis was in the 1980s, and the IMF’s role was more or less in keeping the balance of payments flowing. In other words, it has acted largely creditor-friendly, placing the burden of adjustment on the state itself, tightening its belt to rein in domestic spending growth in order to repay foreign debt.

Today, however, it is more sensible to describe the IMF as a debtor-friendly institution. The IMF has been working to encourage the G20 to provide further debt relief to low-income countries under the Common Framework to be announced in late 2020. Currently only three countries, Chad, Ethiopia and Angola, have applied for debt relief under the framework, and the IMF wants more participation. As it is, the fund may have its way.

Defaults by private creditors appear set to increase as the common framework requires private creditors to participate on terms similar to the G20. Maybe that’s not a bad thing: if a country can’t pay its debts, debt relief is perfectly appropriate. It is worth bearing in mind that private creditors tend to have a short memory, which allows defaulting countries to re-enter international capital markets with considerable speed. But debt defaults are often a mess — and in a world full of worries, one more thing to worry about.