Debt dilemma: how to avoid a crisis in emerging nations

Global institutions, creditors and lobby groups are scrambling to come up with ways of tackling what many fear will be a wave of sovereign debt crises in emerging economies in the coming year.

The economic and financial consequences of the pandemic threaten to tip dozens of nations into a fiscal crisis and to leave many others weighed down with debt and struggling to grow. 

These countries need trillions of dollars of additional public spending to help them recover from the crisis, according to the IMF, which has warned that their national resources will fall far short.

Kristalina Georgieva, the IMF’s managing director, warned this month that about half of low income countries were already in high debt distress.

“We know we must act quickly to restructure their debts . . . so there is no spillover to the rest of the world,” she said.

Not only the poorest countries are at risk. Debt burdens among the 30 biggest emerging economies rose by 30 percentage points of gross domestic product between January and September to almost 250 per cent according to the Institute of International Finance.

So far the global response has been piecemeal, with little of the co-ordinated action that followed the financial crisis a decade ago. But Joe Biden’s victory in the US presidential election has raised hopes that multilateral action could revive next year.

A range of options have been championed by debt relief advocates.

Extend debt suspension

The debt service suspension initiative (DSSI) announced by the G20 in April has so far delivered about $5bn relief to 46 of the world’s poorest countries, of 73 that are eligible. It has since been extended to mid-2021, and could be expanded further.

Pros: Immediately eases public finances, though debts must eventually be paid.

Cons: Lack of uptake: so far, agreed relief is less than a tenth of this year’s increase in external borrowing needs, according to the IMF. Critics say it fails to take account of debtor countries’ and private lenders’ concerns. Its scope is limited to loans by G20 governments and their policy banks — about 35 per cent of eligible public debt, according to the World Bank.

Level the playing field

The G20’s recently launched framework for how debt relief is implemented beyond the DSSI could be expanded to cover middle-income nations.

Pros: Equal treatment for official bilateral and commercial creditors, including Chinese lenders, banks and bondholders. Would address concerns about potential defaults and fears that they will be hard to handle on an ad hoc basis. 

Cons: Lacks enforceability. “The language is good but there are major questions on implementation,” said Mark Sobel, US chair of Omfif, a central banking think-tank, and former US Treasury official. “Until they are resolved, we won’t believe we are on the right path.”

Covid-19 reverses the profile of systemic risk in emerging markets. Chart showing the number of emerging market economies at each level of risk of fiscal crisis

Rally the IMF

Early in the crisis the IMF suggested allocating more of its special drawing rights, which countries may sell for cash.

The World Bank, the UN and governments across the world supported the call but it was vetoed by the Trump administration. As the IMF’s biggest shareholder, the US has the power to block such a move.

The IMF allocates SDRs to its 190 members broadly in line with their share of the global economy. It last allocated $250bn in 2009, in response to the global financial crisis.

Advocates of SDRs hope the Biden administration will look at this afresh.

Pros: Does not involve policy conditions, so palatable for debtor nations’ domestic politics. An immediate promise of liquidity which has in the past calmed financial markets.

Cons: Benefit wealthy countries more, under existing distribution rules, though advocates say there are ways round this. Would benefit countries that have resisted reforms. 

Relief from multilaterals

Multilateral institutions such as the IMF and World Bank are the biggest lenders to poor countries. They were owed $243bn by DSSI countries at the end of 2019 — 46 per cent of their total public debts, according to the World Bank. Of the $42.7bn those countries owed in repayments in 2020, $13.8bn is to multilaterals.

The UN, China, former and serving world leaders, NGOs and debt campaigners have all called for multilateral lenders to join the moratorium on repayments or even to cancel outstanding loans.

Pros: Equal treatment of all creditors avoids any relief granted by one set being spent on payments to another.

Cons: Multilaterals borrow cheaply in the capital markets because they are first in the queue ahead of other creditors and have the highest possible credit ratings. This lets them lend at ultra-low rates and finance grants. David Malpass, World Bank president, has said that a moratorium would “undercut” its “dependable access to global capital markets”.

They have also done more to help than any other organisation so far: the IMF has lent $102bn to 82 countries and effectively cancelled repayments from the poorest. The World Bank has set aside $160bn to lend over 15 months, with a further $80bn allocated by other development banks.

Tackle private investors

Commercial lenders, which hold about 19 per cent of the DSSI countries’ debt stock and are owed repayments of $11.5bn this year, have been encouraged to take part in the DSSI but have not done so.

Pros: Debt campaigners and others say private creditors should share the burden.

Cons: Debtor countries fear damaging their creditworthiness and losing capital market access. To address this, some argue that credit rating agencies could not regard a debt relief request as a default. But the agencies argue that would go against their duty to clients.

Change sovereign debt rules

The IMF has been trying for at least two decades to redesign the international architecture for resolving sovereign debts to private creditors. In September it launched its latest proposals.

It has also been suggested that the US and UK, the legal jurisdictions of most foreign currency sovereign bonds, could pass legislation to prevent bondholders from taking legal action. 

Pros: Reduce the disruption and stagnation inherent in lengthy disputes. 

Cons: Hard to design, with great legal, policy and enforcement difficulties.

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