EMs are still struggling to address the economic repercussions of the pandemic (to say nothing of the effects of Russia’s war in Ukraine)? With the pandemic in its third year, the post-covid recovery has been the primary focus for the global economy, but developing countries and emerging markets are facing several hurdles to get there. The full effects of the ongoing war between Russia and Ukraine have yet to be accurately measured, but it’s safe to say they will only serve to worsen the economic landscape for households, businesses, and banks in emerging markets, which are already facing record inflation figures and aggressive monetary tightening. These conditions are creating “growing risks” for EMs, which now need “to focus on creating healthier financial sectors, according to the World Bank’s Finance for an Equitable Recovery report (pdf).

First thing’s first: What do the risks look like? For one, global inflation is soaring, with price increases in the OECD’s 38 members rising to a 25-year high of 6.6% in December, according to data released by the OECD. While global food prices rose closer to record highs in February as supply chain disruptions, rising energy prices, poor weather and labor shortages push the world closer to a food crisis.

Egypt hasn’t been immune: Knock-on effects from the global economy have pushed annual urban inflation in Egypt to its highest in almost 2.5 years in January, hitting 7.3% on the back of rising food prices and an unfavorable base effect. Inflationary pressures have impacted business confidence in demand, with February’s Purchasing Managers’ Index indicating that confidence levels are at an all-time low due to the current economic conditions.

And global inflation now looks set to climb even higher, as the conflict in Ukraine has led to one of its biggest commodities shocks in decades. Russia and Ukraine account for a bulk of the world’s commodities production, with Russia alone acting as the world’s second-biggest commodities producer and sanctions against Moscow impacting the prices of Brent crude, natural gas, metals, and coal. Ukraine and Russia are also two key sources of wheat — both of whom Egypt heavily relies on for its wheat imports — together accounting for around a quarter of global wheat supply.

With inflation on the up and up, global central banks are pivoting to monetary tightening cycles to get price rises under control. The emerging consensus is that we’re facing sooner-than-expected interest rate hikes from global central banks, which is pushing up yields on government bonds, triggering a sell-off around the world. The US Federal Reserve will likely make nine consecutive quarter-point rate hikes starting March in a bid to curb soaring inflation, JPMorgan predicts.

That’s not very good news for EM debt: The anticipated interest rate increases in developed countries is expected to put emerging-market debt at risk of outflows as it becomes less attractive to foreign investors, and raise borrowing costs for governments that have accumulated debts denominated in USD. A tighter US policy could leave EMs vulnerable to a drop in foreign inflows as risk-averse managers seek safer returns in the US.

Rising interest rates = more vulnerable businesses: A period of low interest rates prior to the pandemic “saw a significant buildup of financial risks in the corporate sectors,” as businesses took on more debt, which they were already struggling to repay before the pandemic set in. To make matters worse, much of this debt was USD-denominated, which was initially an attractive option due to low interest rates, the World Bank notes. Now, however, firms holding significant amounts of FX-denominated debt are finding their liabilities “more difficult to service,” the report says.

On the upside, this hasn't translated into a jump in non performing loans (NPLs) as of the end of 2021, but the World Bank suggests this won’t necessarily be the case in the long-term. The report explains that, as governments start to withdraw their pandemic support policies — including freezes on credit reporting, which means “banks are largely unable to distinguish illiquid from insolvent borrowers” — we should expect an increase in NPLs across countries and individual sectors.

Sovereign debt has also soared, with emerging economies now facing a massive debt pile as a result of their economic stimulus programs. Consequently, countries have either been unable to introduce policies comprehensive enough to prevent a “surge in insolvencies, loan defaults, and spillovers from households and firms to the financial sector,” or have been forced to borrow more to finance the support programs. Increasing domestic debt usually ushers in higher inflation rates, exacerbating the cycle.

Households are also bearing the brunt of the pandemic’s financial repercussions: During the first year of the pandemic, more than 50% of the world’s households were financially unprepared to sustain basic necessities for more than three months in the event of losing their source of income. Low-income households are also largely unable to get their hands on loans to plug their financing gaps, as banks look to mitigate their own lending risks. And as credit tightens, the most vulnerable borrowers — low-income households — are usually the first to be cut off from credit. Household struggling with pandemic-related unsustainable debts will result in decreased consumption, job creation, and productive investment.

So, what’s the antidote? The report lays out a number of policy reforms to help countries mitigate the risk of an onslaught of insolvent households and businesses, which include strengthening formal insolvency mechanisms, providing alternative dispute resolution systems and promoting debt forgiveness and discharge of natural person debtors.