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May 26, 2023

Frontier markets are facing a credit crunch and heightened risk of debt distress

During the last decade, new sources of financing opened, especially for those lower-income countries catching up with emerging economies, many of which are called frontier markets[1]. The decade after the global financial crisis was characterised by ample liquidity and low interest rates in global financial markets and leading to investors seeking for yield in riskier markets. At the same time, China significantly increased its overseas lending specifically targeting emerging and developing economies. China’s agenda was to ensure access to natural resources needed to spur its fast growth and facilitate trade but also to expand its global political influence. A third avenue to increase access to financing was through deepening local financial markets facilitating the share domestic sovereign borrowing.[2]

“While increasing access to finance at lower yields helped spur growth and investments, it also pushed up levels of government debt and debt service costs. This is exposing countries with still fragile macroeconomic fundamentals to the volatility of global financial markets”, says Kristiina Karjanlahti, the Lead Economist at Finnfund, the Finnish development financier. Overall government debt levels increased in frontier markets by over 30 percentage points of GDP between 2010 and 2020, reaching nearly 70% of GDP in 2020 (see graph below)[3].

Following the recent large economic shocks and change in the interest rate environment, the surge in borrowing is being proven unsustainable for many frontier markets. The pandemic shock left significant scars in growth. At the same time, the increasing food and energy prices, sharp tightening of global financial conditions and appreciation of the USD have led to quickly accelerating inflation, strong currency depreciation, dwindling foreign exchange reserves as well as significantly increased debt levels and debt service costs (see graph). These developments have to a large extent cut many frontier economies’ access to market financing. Frontier market bond spreads have increased to 885bps, which is more than 300bps above their long-term average and more than 40% of frontier bonds maturing through 2025 trading at spreads over 1,000bps. At the same time, China has cut its overseas lending especially from Africa and official development flows are dwindling.[4]

These developments have caused a significant funding crunch for lower income countries, most of which are in Sub-Saharan Africa. The IMF assess that more than half (37 out of 69) of all low-income countries (LICs) are at high risk or in debt distress.[5] Sri Lanka, Ghana and Malawi defaulted on their public debt last year. Challenges are also mounting in other frontier markets such as Pakistan, Kenya, Tunisia and Egypt. Considering their deteriorating macroeconomic situation there is little light in sight to re-gain market access. Refinancing needs for frontier economies will be particularly high in 2024, with over 12 billion USD bond payments maturing. With the current outlook, there is a significant risk that we will see more defaults in the coming years[6].

“In Finnfund, before investing, we thoroughly analyse country risks. Considering the changing environment, sovereign stress and debt-related risks have been a key focus for us. While our investments in private companies are generally not directly exposed to sovereign restructuring, the broader effects of debt distress are felt throughout the economy. Local currency depreciation is a central risk for high-debt countries”, comments Karjanlahti.

Moreover, currency devaluation and domestic demand compression accelerate inflation and depress demand. Import and capital controls are often used to mitigate pressures on the currency and current account. This may lead to a shortage of dollars and imported items causing significant deterioration in the operating environment for our investee companies. Also, large-scale protests and social unrest are possible, as seen in Sri Lanka over 2022. Overall, investing in high-debt risk countries requires caution and a very thorough understanding of the exposure of the investee to these developments.


For more information:

Lead Economist Kristiina Karjanlahti,, tel. +358 50 525 7081

Media/material inquiries:  Communications Director, Unna Lehtipuu,, tel. +358 40 624 0896


[1]IMF definition:  A frontier market is a country that is more established than the least developed countries (LDCs) but still less established than the emerging markets because it is too small, carries too much inherent risk, or is too illiquid to be considered an emerging market. Frontier markets are also known as pre-emerging markets. Examples of frontier markets in Finnfund’s portfolio are Bangladesh, Ivory Coast, Egypt, Kenya, Nigeria, Pakistan, Senegal, Sri Lanka, and Vietnam.

[2] IMF varautuu velkajärjestelyaaltoon köyhimmissä maissa – Euro ja talous

[3] IMF WEO database April 2023

[4] IMF GFSR and IMF Regional Economic Update for Sub-Saharan Africa, April 2023

[5] IMF GFSR April 2023

[6] ibid

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