The Investment Implications of COVID-Induced Debt Overhang
- A large debt overhang is one of the most salient economic legacies of the COVID pandemic, as some emerging and frontier economies could face distress servicing their debt.
- In this piece, we present a parsimonious analytical framework aimed at spotting the discrepancies among emerging and frontier markets in their ability to weather the risks of COVID-induced debt overhang. We then leverage the framework to identify investment opportunities.
- Our model shows countries that exhibit higher debt sustainability and liquidity scores display lower debt burdens and face lower financing needs. They also tend to rely more heavily on external financing and enjoy larger FX reserve buffers relative to their external short-term liabilities.
- We further assess how our debt sustainability and liquidity score might help explain sovereign spreads and used the regression to identify potential market mispricing based on model-implied and actual sovereign spreads. We find countries undergoing highly idiosyncratic dynamics from both ends of the valuation spectrum, highlighting the need to supplement the analysis with country-specific appraisals.