Joseph Cotterill – Christine Murray – Joe Daniels

Developing countries are moving away from dollar-denominated debt and turning to lower-interest currencies such as the Chinese yuan and Swiss franc. This shift, initiated by heavily indebted nations like Kenya, Sri Lanka, and Panama, reflects the impact of the sharp interest rate hikes implemented by the U.S. Federal Reserve, which angered President Donald Trump and increased debt servicing burdens for other countries.

The move towards borrowing in yuan—which coincides with the Chinese currency reaching its highest level against the dollar this year—is a direct result of Beijing’s $1.3 trillion Belt and Road Initiative, through which it has provided hundreds of billions of dollars in loans to infrastructure projects worldwide.

Although comprehensive data on new yuan-denominated loans is unavailable due to the bilateral nature of Beijing’s negotiations with various governments, Kenya and Sri Lanka are actively seeking to convert large dollar loans into yuan. Kenya’s Treasury Ministry revealed last month talks with the Export-Import Bank of China—its largest creditor—to switch dollar repayments to yuan for a $5 billion railway project to ease budgetary pressure. Similarly, Sri Lanka’s president recently announced in parliament efforts to secure yuan financing to complete a strategic highway project halted after the country defaulted on its debts in 2022.

With the U.S. Federal Reserve’s benchmark interest rate reaching between 4.25% and 4.5%—much higher than rates at other major central banks—the direct cost of new dollar borrowing is relatively high for many developing countries, even though the yields on these debts are the lowest in decades compared to U.S. Treasury bond returns.

In contrast, the Swiss National Bank cut interest rates to zero in June, while China’s seven-day reverse repurchase reference rate is about 1.4%, which explains—according to Thelina Banduawala, an economist at Frontier Research in Colombo—that “funding costs may be the main reason behind the shift to the yuan.”

Most Belt and Road loans over the past decade were dollar-denominated when U.S. interest rates were low, but the sharp rise in debt costs for Kenya and Sri Lanka since then has pushed them away from dollar financing towards cheaper alternatives. By borrowing in currencies like the yuan and Swiss franc, countries can access funding at significantly lower interest rates compared to dollar-denominated bonds.

Borrowing governments face an additional challenge due to a lack of export revenues in currencies like the yuan and Swiss franc, which may force them to adopt hedging strategies against exchange rate volatility using financial derivatives. Panama exemplifies this trend, having borrowed the equivalent of about $2.4 billion in Swiss francs from banks in July alone as part of efforts to control its growing fiscal deficit and avoid a downgrade to junk credit status.

Colombia also appears poised to adopt Swiss franc loans to refinance its dollar bonds. Andrés Bardo, head of Latin America macroeconomic strategy at XP Investments, explained the economic rationale behind this shift, noting Colombia can borrow at low rates of about 1.5% based on Swiss interest rates to repurchase dollar-denominated debt yielding 7% to 8%, or even local peso bonds with yields up to 12%.

Investors believe that governments issuing Swiss franc bonds may help curb rising interest bills, but such borrowing cannot permanently replace access to the larger public dollar bond market.

Emerging market companies have also started issuing more euro-denominated bonds this year, reaching a record $239 billion by the end of July, according to JPMorgan estimates. The total volume of dollar-denominated bonds issued by emerging market companies is estimated at about $2.5 trillion.