The Decisive | Season 7 | Ep.9 - Emerging Market Perspectives: The Cost of Capital and the Digital Divide

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Kristen Hallam [00:00:00]:

Welcome to The Decisive Podcast. I'm your host, Kristen Hallam, and joining me today is Thea Fourie, Head of our Middle East and Africa Insights and Analysis team at S&P Global Market Intelligence. And today we'll be looking at developments shaping the global outlook, in particular, sovereign yields at multi-decade highs and the opportunities and transition risks created by artificial intelligence. Thea, it's been a minute. Welcome back to The Decisive Podcast.

 

Thea Fourie [00:00:34]:

Thank you for inviting me, Kristen. Looking forward to the conversation.

 

Kristen Hallam [00:00:38]:

So let's dive in. Sovereign bond yields: hot topic right now. In several major economies, sovereign bond yields are now at multi-decade highs, as I mentioned in the intro. What is driving this increase, and why does it matter beyond the government bond market?

 

Thea Fourie [00:00:58]:

Yes, Kristen, definitely, investors today are demanding much more compensation before they lend. And some research done by our team shows that there are basically three reasons for this development. First of all, I think investors are increasingly believing that interest rates will stay a bit higher for longer. That's not really surprising because we have seen quite a significant rise in energy prices due to supply chain disruptions in the Gulf. But there are also other inflation risks on the horizon. A lot of it links to weather conditions, particularly El Niño. So there is the risk that inflation will remain high, and that will really limit central banks' ability to bring down interest rates.

The second reason is that governments are borrowing way more than before. We are seeing that many countries in the developed economies in particular have very large budget deficits, and they have to issue a huge amount of debt to finance these deficits. So at the same time, you have central banks that are no longer buying as much government bonds as we've seen during the global financial crisis and the pandemic. So at the one end, you have this massive supply of bonds and you have less demand from major buyers, which is shown in the price. And lastly, I think governments are not the only ones that want capital. There are also a lot of investors that are looking for finance to implement projects in AI infrastructure, data centers, power grids, semiconductors. So there's lots more borrowers chasing the same pot of savings, meaning that the cost of money is now going up. Why is this important? I think it's important because the higher bond rates mean that borrowing costs for the economy are going up.

Governments now have to pay way more to service their debt, which means that they have less money on their fiscal balances or finances to spend on other spending priorities like health, education, social protection, because they have to service that higher debt servicing cost. It also means that companies also have to pay higher for their investment plans. And for households, in some instances, they also pay higher costs for their mortgages as well as their loans. So all in all, the cost of money in the economy has gone up, and that is one of the repercussions of these higher bond rates.

 

Kristen Hallam [00:03:44]:

That's a really good way to think about it. The cost of money has gone up. I like that. Now, you alluded to this, Thea, but our analysis suggests that upward pressures on yields could persist through the end of 2026. How might higher global borrowing costs affect emerging markets, and particularly economies across Africa and the Middle East?

 

Thea Fourie [00:04:13]:

Kristen, I love the opportunity to talk a little bit about Middle East and Africa because I think it's such an interesting continent in the sense that you have such a variety of countries across the continent and the region. And the implications of higher bond rates are different for different countries in the region. So if we look at emerging markets, for instance, South Africa, which is very much interlinked in global capital markets, one of the repercussions of this is really that South Africa has to make sure that its macroeconomic fundamentals, which is its fiscal finances, its monetary policy, and its exchange rate policy, are very solid, because capital can very easily leave emerging markets that do not have these solid macroeconomic fundamentals. Because at the moment, investors can very easily get great returns in safe haven destinations like the US and Europe. So you have to compete now with these safe havens, and therefore your fundamentals have to be very strong. But then also, the region has frontier economies and low-income developing economies, and for them, the challenges are a bit more difficult. In many instances, these higher interest rates mean that they don't have access to global financial markets because the risk premium to attract that type of capital is extremely high. And it's just not affordable for them to access these types of capital markets at the moment.

So it means that for these frontier markets and developing economies, they now have to find a different way of financing their fiscal needs. So they very much turn to domestic capital markets, or they have to turn to multilateral institutions to get access to financing, or they just have to put some of these spending programs on hold, particularly in infrastructure development. So for them, the outlook is much more problematic and much more difficult.

 

Kristen Hallam [00:06:14]:

Thank you for walking us through that there. So, high debt burdens, which again, you mentioned earlier, large fiscal deficits and growing competition for capital, these are all contributing to higher yields. Which economies in the regions your team covers are most exposed to these pressures, and what distinguishes the more resilient economies?

 

Thea Fourie [00:06:42]:

I would like to highlight South Africa. I think in the past few years, South Africa has actually come a long way in really putting their macroeconomic fundamentals on a more solid footing, right? We are expecting the medium-term budget policy statement in October, and we have seen South Africa really implementing fiscal consolidation. We have seen a lower inflation target of 3%, which has helped our exchange rate to some extent. Yeah, so all of this is really placing South Africa, I think, on the forefront of the emerging market universe in having solid macroeconomic fundamentals. But we are concerned about those countries, and those are the ones in the frontier markets, developing economies, which in particular are reliant on a single source of commodities for external liquidity. So if you are a country like Zambia that relies heavily only on copper and copper-related exports, it means that if there's a change in copper prices, you immediately have your primary source of external liquidity under pressure. And unfortunately, there's a lot of countries in frontier and developing economies that are reliant on this single source of external liquidity, and therefore they could become more vulnerable if we go into a scenario of less growth in global commodity prices, a stronger dollar. All of them can once again come under the spotlight.

 

Kristen Hallam [00:08:10]:

All right. Thank you for that, Thea. I appreciate you providing some color and some context around the issue of sovereign bond yields. Really hot topic, as I mentioned. So turning now to artificial intelligence, AI, firms are reporting meaningful productivity gains there, but the employment effects are uneven. How do you see that trade-off playing out across emerging markets?

 

Thea Fourie [00:08:42]:

So yes, Kristen, I think what has been extremely useful is a year or two ago, S&P Global's PMI survey sent out some questionnaires to our companies with some preliminary feedback from AI adoption and what it means for companies. And I think, like you say, I think one of the first things that was picked up in these surveys is that companies are seeing an improvement in their productivity. And ultimately, there was a net negative impact on employment, very small, but still. And I think that's not really surprising because with a new technology, the first step is really the adoption of this new technology and you are not yet seeing the transfer of skills or the creation of new jobs due to these technologies. So, it's not really surprising that that has happened. That being said, I think it's still going to be a challenge over the longer term for emerging markets. And again, our research has shown that over the longer term, labor markets made up of highly skilled workers could probably benefit more from this AI technology adoption and transformation we're seeing over the longer term.

And that is very much focused around advanced economies, whereas emerging markets have a bigger pool of middle-income skilled workers. And those are the type of jobs in administration, in support, in return service roles that are probably going to be automated. So there you can probably see a bigger impact on overall employment. And I think what's also interesting is that the lower-skilled labor market, which includes many people in Sub-Saharan Africa, for instance, there the impact is also very much neutral. So it's this diverse composition of the labor market that can ultimately be a drag on employment creation in emerging markets over the longer term.

 

Kristen Hallam [00:10:41]:

I do believe our PMI team is going to do that survey again. So it'll be interesting when those results come in, I think in a few months. So we shall see. So we recently did a scenario analysis and it identified countries, including Nigeria and Egypt, as potentially facing significant employment disruption from AI. What makes some economies more vulnerable, and what could governments and businesses do now to improve their preparedness?

 

Thea Fourie [00:11:15]:

So, Kristen, I think what is difficult for Sub-Saharan Africa in particular is just having access to the infrastructure, right? So we are in a situation where countries do not have sufficient electricity and the population does not have sufficient access to digital services for AI adoption. So for some frontier and low-income countries, it's not even about AI adoption. It's just about being AI-ready in the sense that you have access to that infrastructure. And I think that is the one thing that if you want to make sure that there doesn't emerge a digital divide going forward, it is very important for governments to make sure that they have the infrastructure ready for AI adoption. And I think that, to me, would be the first step in answering this question.

 

Kristen Hallam [00:12:04]:

And just zooming out for a moment, more broadly, could AI widen the gap between economies that have the infrastructure and the skills and the capital to adopt AI and those that do not? What would a successful AI transition look like for African economies?

 

Thea Fourie [00:12:25]:

Yeah, no, absolutely. Like I said, we mentioned this risk that emerging markets could fall behind. So it's got to do with the infrastructure, but also the composition of your labor force. Over the longer term, it's important, I think, to make sure that you not only see AI as the adoption of the technology, but also transformation of your labor force and to upskill your labor force. So it starts at a very young age, at the education level, how to make sure that your labor force is also AI-ready, and also not lose those essential skills as well. I think that's one close to my heart, make sure that that one is not getting lost in this transformation.

 

Kristen Hallam [00:13:06]:

Important point there, for sure. So, Thea, what's coming up next for the Middle East and Africa team? What research are you all working on right now? Anything you'd like to share with our listeners at this stage? Any hints?

 

Thea Fourie [00:13:21]:

Kristen, we of course are working very hard to look at our key themes for 2027. I don't want to let the cat out of the bag. I want our clients to really look forward to that. But I think one of the themes that is emerging for next year is El Niño. And El Niño is a big story for a lot of emerging markets, particularly in Latin America, APAC, but also Sub-Saharan Africa. So yes, this, in our view, could bring down growth by 0.6 to 0.8 percentage points in Sub-Saharan Africa. Global growth could be lower by 0.4 percentage points. Higher inflation, higher interest rates, social security. To what extent can governments provide subsidies to help the general population, given the higher bond rates, given the fiscal constraints, given the debt constraints. So I think that is one risk factor we are monitoring at the moment, and one of the key themes we are looking at for next year.

 

Kristen Hallam [00:14:21]:

Yes, very hot topic indeed, literally in some geographies.

 

Thea Fourie [00:14:25]:

Yes.

 

Kristen Hallam [00:14:26]:

And I'll be sure to drop some links to some recent research on El Niño. Thanks for mentioning that. And yes, big themes are coming, so stay tuned. And all that's left for me to do is to thank you, Thea, for taking the time to share your insights with us on The Decisive. Always a pleasure to have you on.

 

Thea Fourie [00:14:46]:

Thank you for inviting me, Kristen. Really enjoy these conversations.

 

Kristen Hallam [00:14:52]:

All right. And thanks to our listeners for tuning in. Until next time.