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TWN Info Service on Finance and Development (Apr20/06)
27 April 2020
Third World Network


COVID-19: South needs global debt deal to head off economic disaster
Published in SUNS #9107 dated 24 April 2020

Geneva, 23 Apr (Kanaga Raja) – A global debt deal for the developing world is needed to head off a looming debt disaster in developing countries, suffering from the economic fallout of the COVID-19 pandemic, the United Nations Conference on Trade and Development (UNCTAD) said on Thursday (23 April).

In an update to its Trade and Development Report (TDR), UNCTAD said developing countries now face a wall of debt service repayments throughout the 2020s.

In 2020 and 2021 alone, repayments on their public external debt are estimated at nearly $3.4 trillion – between $2 trillion and $2.3 trillion in high-income developing countries and between $666 billion and $1.06 trillion in middle- and low-income countries.

“The international community should urgently take more steps to relieve the mounting financial pressure that debt payments are exerting on developing countries as they get to grips with the economic shock of COVID-19,” said UNCTAD Secretary-General Dr Mukhisa Kituyi.

“Recent calls for international solidarity point in the right direction, but have so far delivered little tangible support to developing countries as they tackle the immediate impacts of the pandemic and its economic repercussions,” said Mr Richard Kozul-Wright, Director of the UNCTAD Division on Globalization and Development Strategies.

According to the UNCTAD report, the Covid-19 shock is posing unprecedented challenges to advanced country governments.

As most have come to recognize, the economic crisis entailed by the pandemic is unique in that it combines a deep supply shock – arising from wide-ranging and prolonged lockdowns of entire economies – with consequent demand shocks – arising from a collapse in corporate investment plans, retrenchment of household spending, rapidly increasing unemployment and patchy social welfare systems reduced to their bare bones after decades of rentier capitalism – as well as radical uncertainty and heightened fragility in financial markets.

As a consequence, policy makers have focused on the provision of massive stabilization packages, designed to flatten both the contagion curve of the pandemic as well as the curve of economic meltdown and financial panic, through a raft of cash transfers, credit lines and guarantees from governments to households and firms.

Doing so depends on the ability of governments to borrow from their central banks – or for central banks to revert to their original role as bankers to their governments – on the required scale, a concept often referred to as “fiscal space”.

How to deal with this necessary accumulation of government debt in response to the crisis, and in particular, how to avoid the mistake of turning to austerity to make adjustments once the crisis has passed, is already beginning to tax the minds of policymakers in the advanced economies.

If the challenges are huge in advanced economies, they are enormously more daunting in developing economies, UNCTAD added.

While advanced country governments struggle to revamp administrative and regulatory frameworks and to break ideological taboos, developing countries cannot easily flatten the contagion curve by closing down their largely informal economies without facing the prospect of more people dying from starvation than from the Covid-19 illness.

Moreover, even the most advanced high-income developing countries with relatively deep financial and banking systems do not have anywhere near the fiscal space that advanced economies can, in principle, unlock.

The vast majority of developing countries are heavily reliant on access to the “hard currencies” of advanced countries – earned primarily through commodity and service exports, such as food, oil and tourism, and received through remittances from their diasporas as well as from access to concessional and market-based borrowing – to pay for imports and to meet external debt obligations.

Their central banks cannot act as lenders of last resort to their governments at the required scale without risking catastrophic depreciations of their local against hard currencies, and therefore also steep increases in the value of their foreign-currency denominated debt as well as unleashing, potentially, destructive inflationary pressures.

This situation is all the more critical where developing countries already face high debt burdens, said UNCTAD.

“The Covid-19 shock has put a glaring spotlight on the difficulties arising from high and rising developing country indebtedness since it is set to turn what was already a dire situation into serial sovereign defaults across the developing world. It has, therefore, turbo charged the need to move from discussion to action on debt matters in developing countries.”

UNCTAD noted that Covid-19 has hit developing economies at a time when they had already been struggling with unsustainable debt burdens for many years.

At end-2018 the total debt stocks of developing countries – external and domestic, private and public – stood at 191 per cent (or almost double) their combined GDP, the highest level on record.

A developing country debt crisis, already under way prior to the Covid-19 shock, had many facets, but two are worthwhile putting upfront in the context of ongoing debates about debt relief for the developing world in the aftermath of the Covid-19 shock, said UNCTAD.

First, the unfolding debt crisis was not limited to the poorest of developing countries but affected developing economies of all income categories.

Second, it has, by and large, not been caused by economic mismanagement at home, but by economic and financial mismanagement at the global level.

Over the past decade, developing countries have witnessed a rapid and often premature integration into heavily under-regulated international financial markets, including the so-called shadow-banking sectors, estimated to be in control of around half of the world’s financial assets.

In this context, developing countries became highly vulnerable to massive but volatile flows of high-risk yet relatively cheap short-term private credit, on offer from financial speculators in search of higher yields on their investments than available to them in the near-zero-interest monetary policy environment of their advanced home countries.

This “push factor”, and the volatility of private capital inflows in combination with wide open capital accounts, has affected developing countries whether or not they had so-called strong economic fundamentals, such as relatively low public debt, small budget deficits, low inflation rates and high reserve holdings.

An essential “pull factor” leading developing countries to borrow at high risk in international financial markets was their dwindling access to concessional multilateral finance and a shift of Official Development Assistance (ODA) away from central budget support towards wider goals, such as climate change mitigation, migration management, good governance and post-conflict support, oftentimes determined by donor interests.

As a result, developing countries have seen a rapid build-up in private sector indebtedness, in particular since the Global Financial Crisis of 2008-09, accounting for 139 per cent of their combined GDP at end-2018.

This trend has been most pronounced in high-income developing countries with relatively deeper domestic financial and banking sectors but has also and substantively affected middle- and low-income developing economies.

It represents the largest contingent liability on public balance sheet in the event of a full-blown debt and financial crisis, not least in the shape of fledgling public-private partnerships, widely promoted throughout the developing world, but that may now quickly unravel in the wake of “sudden stops” to their refinancing due to the Covid-19 crisis.

The fragility of developing country debt positions prior to the Covid-19 crisis was further increased by concomitant changes to the ownership and currency-denomination of their private and public debt.

Thus, domestic bond markets were increasingly penetrated by non-resident investors and sovereign external debt held to a much larger extent than in previous episodes of developing country debt distress by private rather than official creditors, in particular in high- and middle-income developing economies.

In the wake of these developments, much of the higher-risk borrowing by sovereigns has been accompanied by rising debt servicing costs with a negative impact on the fiscal space of many countries, compounded by a slowdown in growth relative to the period before the Global Financial Crisis of 2008-09 as well as by commodity price slumps, said UNCTAD.

Predictably, developing countries will be facing a wall of debt service repayments throughout the 2020s, and in the context of deeply distressed economic circumstances.

In 2020 and 2021 alone, these amount to between $2 to $2.3 trillion in high-income developing countries, and to between $700 billion to $1.1 trillion in middle-and low-income countries.

UNCTAD noted that on 13 April, the IMF cancelled debt repayments due to it by the 25 poorest developing economies for the next six months. This debt cancellation is estimated to amount to around $215 million.

Moreover, on 15 April, G20 leaders announced their “Debt Service Suspension Initiative for Poorest Countries”.

This suspension of debt service payments (including principals and interest) from 01 May to the end of 2020 applies to 73 primarily low-income developing countries that are either eligible to borrow from the International Development Association (IDA) or are classified as least developed countries (LDCs) by the United Nations (UN LDCs).

For now, the initiative applies to all official bilateral creditors, with calls on private creditors to join on comparable terms, and on multilateral banks to consider joining should such a step be compatible with maintaining their current high credit ratings and low-cost lending capacities.

Current estimates suggest that this initiative covers around $20 billion of public debt owed to official bilateral creditors in the eligible countries in 2020.

An additional $8 billion of such debt payments might be included, if all private creditors joined the initiative, and a further $12 billion if the same was the case for all multilateral creditors.

However, this amounts to a relatively small part of the long-term public and publicly guaranteed external debt stocks these countries had accumulated at the end of 2018, said UNCTAD.

Initiatives such as these are welcome since they provide urgently needed fiscal “breathing space” to crisis-ridden developing countries, but they do not constitute debt relief of any kind, it added.

Quite the contrary, by linking eligibility to new or ongoing borrowing, even if on concessional terms, the initiative prioritizes concessional lending (and therefore new debt) over debt relief.

Moreover, suspending debt repayments only through the end of 2020 relies on the all but heroic assumption that the Covid-19 shock to developing economies will be swift and short, and “business as usual” will resume in 2021 to the extent that developing countries joining the scheme will be in a position to shoulder debt service repayments suspended in 2020 over the next three to four years, said UNCTAD.

“But given the wall of debt service repayments already facing many developing country governments in 2021 and beyond, in combination with the wider macroeconomic impacts of the Covid-19 crisis on export revenues, commodity prices, government revenues and reserve holdings, as well as new concessional borrowing incurred during the crisis, this is unlikely to be the case.”

In the wake of the Covid-19 crisis, developing countries will require massive liquidity and financing support to deal with the immediate fall-out from the pandemic and its economic repercussions, said UNCTAD.

As both UNCTAD and the IMF have estimated, these liquidity and financing needs amount to at least $2.5 trillion.

Clearly, debt relief measures will cover only a part of these needs, with new allocations of Special Drawing Rights and a grant-based ODA Marshall Plan to support health and social expenditures providing faster avenues to deliver urgently needed cash injections.

Well-designed debt relief – through a combination of temporary standstills with sovereign debt re-profiling and restructuring – is essential in that it addresses not only immediate liquidity pressures but has the potential to resolve problems of structural insolvency and long-term debt sustainability, said UNCTAD.

As has been pointed out, the Covid-19 shock only puts the spotlight on what had already been a fast-evolving sovereign debt crisis across the developing world.

“The devastation it is likely to cause unless decisive action is taken, should be more than sufficient motivation for the international community to finally move towards a coherent and comprehensive framework to deal with unsustainable sovereign debt.”

Debt relief mechanisms for developing countries, emerging gradually with the advent of recurrent and widespread developing country debt crises since the end of the 1970s, have been fragmented, ad hoc and insufficient to prevent sovereign debt crises or to resolve such crises sustainably, once these occurred, said UNCTAD.

A NEW “GLOBAL DEBT DEAL” FOR THE SOUTH

According to the UNCTAD report, a new “global debt deal” for developing countries should incorporate the following three basic steps:

Step 1: Automatic temporary standstills: Longer and more comprehensive

The purpose of temporary standstills is to provide macroeconomic “breathing space” for crisis-stricken developing countries to free up resources, normally dedicated to service in particular external sovereign debt, for two inter-related uses:

First, to facilitate an effective response to the Covid-19 shock through increased health and social expenditure in the immediate future and, second, to allow for post-crisis economic recovery along sustainable growth, fiscal and trade balance trajectories.

An effective “Global Debt Deal” for the developing world should therefore allow for automatic temporary standstills:

* on request by developing country governments for forbearance, independently of their per capita income levels or other eligibility criteria or conditionalities, for an initial suspension period of one year from request, and with the possibility of further annual renewals based on recent debt sustainability assessments (see step 2 below).

* on a comprehensive basis, including all external creditors – bilateral, private and multilateral – primarily to safeguard against resources freed up by the suspension of debt service repayments to some creditors being used to meet repayment schedules of un-cooperative creditors.

* entailing an immediate and automatic stay on all creditor enforcement actions. Creditors should not be able to seize assets or initiate court proceedings against any sovereign creditor that fails to make debt service payments during the pandemic.

In addition, authorities in those jurisdictions that govern most emerging market sovereign bonds should cooperate by halting lawsuits against debtor countries already under way at the time of a temporary standstill arrangement coming into force.

Step 2: Debt relief and restructuring programmes: Restoring long-term debt sustainability

The “breathing space” gained under step 1 should be used to reassess longer-term developing country debt sustainability, on a case-by-case basis, based on the following key principles:

* The size and composition of debt relief or “haircuts”, if required, as well as the new redemption schedules for debt repayment on restructured sovereign debt obligations following resumption of debt service repayments, should be compatible with restoring and maintaining sustainable and inclusive growth paths, as well as fiscal and trade balance trajectories.

* Long-term sovereign debt sustainability assessments, and consequent restructurings where required, should take account of contingent liabilities, such as those arising from wide-spread public guarantees of new financing instruments and public-private partnerships.

* Sovereign debt restructurings and revised debt payment redemption schedules should furthermore take account of investment requirements arising from the Sustainable Development Goals and the timely implementation of Agenda 2030.

* There must be a fair distribution of the burdens of required sovereign debt relief and restructurings between debtors and creditors, taking into consideration past histories of irresponsible lending by creditors as well as irresponsible borrowing by debtors, as appropriate.

* Respect for national sovereignty and expertise as well as national development strategies.

Taking the successful outcome of the 1953 London Conference on German war debt, which cancelled around half of this debt under negotiation, as a benchmark of international solidarity, a target figure of around a trillion US dollars would appear reasonable in light of the debt burdens now crushing developing countries in the face of Covid-19, said UNCTAD.

Step 3: Establishment of an “International Developing Country Debt Authority” (IDCDA)

“In our highly interconnected world, financial stability has the qualities of a global public good. As such it is vulnerable to problems arising from missing or asymmetric information, free-rider behaviour and contagion effects,” said UNCTAD.

All these are present when the sustainability of sovereign debt becomes a policy challenge, the more so when the source of debt distress lies largely outside the countries themselves.

Despite these problems having been visible in the inter-war period, the 1944 Bretton Woods agreement failed to establish an international framework for handling sovereign debt restructuring, with neither the IMF nor the World Bank tasked accordingly.

This institutional vacuum has been filled by ad hoc approaches to dealing with sovereign debt problems with a strong bias against borrowers, particularly from the developing world.

Taking forward steps 1 and 2, on the scale commanded by the impact of the Covid-19 crisis on developing country debt sustainability may thus well require putting into place an “International Developing Country Debt Authority” (IDCDA) mandated to oversee the implementation of comprehensive temporary standstills as well as case-by-case longer-term debt sustainability assessments and consequent sovereign debt relief and restructuring agreements.

According to UNCTAD, this could follow the path of setting up an autonomous international organisation by way of an international treaty between concerned states.

Essential to any such international agreement would be the swift establishment of an advisory body of experts with entire independence of any creditor or debtor interests.

A proposal, such as the above, has, in the past, run into conflict with the interests of creditors, noted UNCTAD.

But governments in some debtor countries also oppose reform measures that could have the effect of lowering the volume of capital inflows and/or raising their cost, even when such measures could be expected to reduce instability and the frequency of emerging-market crises.

Many observers have been quick to dismiss such proposals as not only politically unrealistic but also technically impossible.

In the wake of the Covid-19 crisis, both developing country debtors as well as developed nations’ creditors should make it a priority to safeguard and promote future mutual dealing to shared longer-term benefit on equal terms, said UNCTAD.

 


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