A House of Cards: Mapping the Intersection of Debt Distress and Commodity Shocks

Commodity prices and global debt levels have both shown extreme volatility over the previous decade. According to the Institute of International Finance, by the first half of 2023, worldwide debt totaled a staggering $307 trillion. Meanwhile, as the World Bank notes , commodities prices are sensitive to economic growth cycles, inflation swings, geopolitical conflicts, and other unknown variables. For developing nations that rely on commodity exports for money, this has far-reaching consequences. Commodity price fluctuations pose serious threats to their fiscal and economic stability, especially in light of their rising debt levels. 

Ever-growing debt loads

The debt and commodities markets throughout the world are intertwined, with one sector typically affecting the other. Both established and emerging markets are seeing tremendous debt buildup. The developed economies of the United States, Japan, the United Kingdom, and France were responsible for more than 80% of the rise in total debt that occurred in the first half of 2023, an increase of $10 trillion. Governments in major developed countries are facing dramatically increasing interest expenses as a result of growing borrowing and rates, but consumer debt loads are still manageable. Similarly, emerging markets, led by China, India, and Brazil, saw their debt levels rise. IIF data from 2023 shows that portions of Eastern Europe, sub-Saharan Africa, and the Middle East will have significant rises in their requirement for external finance. The degree of leverage in the globe now is larger than it was before the Global Financial Crisis (GFC). Debt will still be in high demand, though, for a variety of reasons. These include assisting consumers with inflation, fighting rising temperatures, and repairing crumbling infrastructure. The debt load is increasing as interest rates rise and economies stagnate. It may be necessary to make sacrifices in spending and saving in order to lessen the impact of a financial collapse.

Signs of emerging distress

There is a worrying pattern developing in emerging nations, where domestic government debt levels have risen to unsustainable levels. Pakistan, Thailand, and Turkey are just a few examples of nations where the national debt exceeds 100% of GDP. Meanwhile, IIF data shows that there has been a dramatic change in the composition of emerging market debt, with more debt being held in local currency rather than in foreign currency like dollars or euros. If they are in debt difficulties and can't get cheap refinancing, this puts them at danger from falling exchange rates. As of mid-2023, global debt would exceed 336% of global GDP, making emerging commodities exporters increasingly vulnerable.

The commodity price-dollar connection

A recent BIS Bulletin examined how rising commodity prices no longer move independently of a weakening currency, which previously mitigated inflationary effects. This development has increased the likelihood of stagflation. This shift appears to be driven by both short-term events like the conflict in Ukraine and longer-term structural changes like the increased export of US energy.  The combined supply and risk avoidance shocks of 2022 appear to be back again uniquely propelling both commodities and the dollar higher, suggesting that the causes of the changing connection are largely temporary. However, structural causes, such as the US shale revolution, which is transforming it into a net energy exporter, alter links more permanently. The US gains in terms of trade during commodity booms as the dollar begins to behave more like a "commodity currency" linked to energy costs. Some have speculated that the changing dynamics may eventually lead to a reevaluation of the petrodollar system and the dollar's preeminent status as a global currency. Increased stagflation risk poses a challenge to current macro-financial policy settings, which may call for either new or alternative policy trade-offs or broader frameworks. Volatility in commodity prices adds another layer of difficulty. Recent years of soaring inflation have been a temporary reprieve for countries in Latin America, Africa, and certain areas of Asia by lowering the actual worth of their loans denominated in U.S. dollars. However, factors like economic growth cycles, geopolitical tensions, reserve policies, and more may cause wild fluctuations in the value of commodities like oil, minerals, and agricultural products that are sent throughout the world. According to the World Bank (2022), IDA countries spent a record 10.3% of exports on debt servicing in 2022, with 66% of that total due to China. Because of this, funding for social and economic initiatives had to be cut.

Inflation relief fades amid looming hardship

As global inflation moderates and monetary conditions tighten, future hazards increase. Several major commodity exporters, including Brazil, saw their debt levels rise again in 2022, making their economies more vulnerable. According to IIF projections, they will still have sizable rollover needs on expiring bonds until 2023-2030. As debt levels and borrowing rates in US dollars and euros grow, countries will become more vulnerable to fluctuations in commodity prices. The lack of external finance for growth and climate change projects has been a problem for emerging nations outside of China for over a decade.

Closing Thoughts

The evolving interlinkages between global debt trends and commodity market movements pose serious challenges that require serious consideration and coordinated action. As the value of the dollar rises, the prices of oil and other goods also go up. This makes the risk of stagflation worse by making local currency costs go up. Problems with these connections could also cause problems with long-held policy frameworks and assumptions.,As we look further into the future, one starts to wonder about the global financial system and how well it can help with green financing and debt restructuring on a large scale. Reforms that make it easier to deal with unsustainable levels of state debt, even at the national level, could make things stronger. It's likely that stakeholders will need to keep working together to strengthen economic buffers, fill funding gaps for important public goals, and come up with responses that are right for this changing risk landscape.

Written by:

Mihir Mahagaonkar,

Junior Analyst, STN

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