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Debt relief focus risks crippling the economic recovery

image credit: Dileimy Orozco from climate change think tank E3G

Debt markets and capital markets both notoriously struggle to prepare for external shocks. The covid-19-induced economic crisis is no exception, says Dileimy Orozco from climate change think tank E3G

 

The covid-19 pandemic is revealing the shortcomings of the current architecture of international finance. Debt and covid-19 are creating a vicious circle; countries need access to finance to deal with the health crisis, meanwhile economies are paralysed and countries are cut off from the very finance which they need access to. The circle results in increasing costs of capital and debt levels.

The covid-19 emergency is happening irrespective of responsible economic management. Its devastating economic impacts on the global economy are shown by the International Monetary Fund (IMF) forecast of an unprecedented recession followed by an uneven and uncertain recovery.

The G20 finance ministers and central bankers will unveil a Common Framework for Debt Treatment in a meeting on November 13th. It remains to be seen whether the proposals are simply a sticking plaster for struggling economies, or can represent the first step on a path to a green, just and resilient recovery.

Emerging economies have weathered the first phase of the pandemic relatively well and have used much of their available fiscal space—budgetary room that allows a government to provide resources for public purposes without undermining fiscal sustainability—in doing so. However, this leaves many countries dangerously exposed to a prolonged crisis and the knock-on effects of the pandemic.

Historically, the IMF and Multilateral Development Banks (MDBs) have helped cushion the impact of external shocks to emerging economies. The IMF has played a key role in providing liquidity of last resort to countries in debt crisis, while MDBs provided countercyclical support and, above all, technical assistance. These support mechanisms, however, are finding their resources insufficient to meet the scale of covid-19.

Currently, emerging economies have financing needs of at least $2.5 trillion. The MDBs can provide approximately $240 billion, along with the IMF’s up to $1 trillion but this leaves a shortfall of over $1.2 trillion. Since covid-19 started the IMF has provided 22 emerging market economies with approximately USD 72 billion in financial assistance.

However, framing the current debate in terms of pure debt relief and debt cancellation is limiting. The Debt Service Suspension Initiative (DSSI) initiated by the IMF and World Bank demonstrates why. The DSSI was proposed in April 2020, with the view of providing debt relief to 76 emerging economies in the form of postponed interest payments until at least mid-2021.

However, the uptake of the DSSI by countries in debt distress has fallen short due to concerns about rating downgrades, whilst its benefits have been limited by non-participation of both the private sector and China’s state-owned enterprises. The DSSI approach ignores the fact that this is going to be a multi-year crisis; it is both too short-term and insufficient for the current circumstances.

More broadly, even in “normal” conditions debt relief measures leave emerging countries playing a zero-sum game where they have to choose between spending priorities like health, education or climate. These governments struggle to assign capital to longer-term initiatives like clean energy when money is tight.

Debt relief measures also neglect to consider that different countries have different levels of access to financial markets and that volumes of external support vary by country. In current conditions, failing to recognise that countries need different levels of support only exacerbates the vicious cycle between debt and covid-19.

The current narrow thinking on debt should be revisited. In the near term, G20 finance ministers should consider extending financing to emerging economies that goes beyond debt relief.

The most sure-fire option for the ministers to consider would be to facilitate greater financial support to emerging economies and low-income economies from MDBs or donor countries. An additional advantage of working through MDBs is that they already have the expertise to ensure that spending is effective and is directed towards specific development objectives.

There are several other options, including increasing MDB capitalisation. This may be slow to implement for political reasons but support could be ramped up more swiftly if shareholders allow them to make fuller use of their callable capital—a guarantee from shareholders which has never been “called”. This could be a way of deploying money rapidly at a time of crisis and a prelude to a wider recapitalisation initiative.

However, the G20 have yet to put forward meaningful proposals that address the increased vulnerabilities of emerging economies. To paraphrase IMF chair Kristalina Georgieva, as economies began their long ascent out the crisis they would only be as strong as the weakest climbers. It is in the interests of developed economies to help break the vicious circle of debt and covid-19.

This is not only a matter of solidarity. National economies do not exist in a vacuum and emerging and developing economies, which represent over half of the global economy, offer its best prospects for long term growth. The ability of developed countries to recover from the impacts of covid depends on the other half of the world still having functioning economies to trade with.

Developed countries should see the support they provide to emerging economies as a duty to their own economies as well. The G20 finance ministers should recognise this and act accordingly.

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