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Service on Finance and Development (Mar21/09) Geneva, 30 Mar (Kanaga Raja) – More than a year into the COVID-19 pandemic, the severe fiscal impacts of the crisis are triggering debt distress in a growing number of countries and severely limiting the ability of many countries to invest in recovery, climate action, and the Sustainable Development Goals (SDGs). This is one of the main conclusions highlighted by UN Secretary-General Antonio Guterres in a new Policy Brief released on 29 March. “Such fiscal impacts, along with the rise of vaccine nationalism, have also resulted in developing countries facing enormous difficulties in accessing vaccines against COVID-19, which threatens to prolong the recovery period,” said the Secretary -General. “Unless we take decisive action on debt and liquidity challenges, we risk another “lost decade” for many developing countries, putting the achievement of the SDGs by the 2030 deadline definitively out of reach,” he added. The Policy Brief was released just as a high level virtual event on debt and liquidity took place on 29 March. The event was organized by the Secretary-General together with the Prime Minister of Canada Justin Trudeau and the Prime Minister of Jamaica Andrew Holness. In his opening remarks at that high level event, Secretary-General Guterres said: “We are at a turning point in the COVID-19 crisis. The pandemic has cost over 2.7 million lives. More than 120 million people have fallen into extreme poverty.” “We are in the worst recession since the Great Depression. Richer countries have benefited from an unprecedented $16 trillion of emergency support measures, preventing a downward spiral, and setting the stage for recovery.” “But many developing countries cannot invest in recovery and resilience, because of financing constraints. The least developed countries have spent 580 times less in per capita terms on their COVID-19 response than advanced economies,” said the Secretary-General. He underlined that this division is starkly reflected in global access to vaccines. “Many developed countries are on the brink of mass vaccination. In developing countries, this could take months, if not years – further delaying a global recovery. We face the spectre of a divided world and a lost decade for development,” said the Secretary-General. According to the Secretary-General’s Policy Brief, titled “Liquidity and Debt Solutions to Invest in the SDGs”, the international community’s response to the socio-economic crisis caused by COVID-19 was significant, but not sufficient. “Initial measures included monetary easing, access to fresh concessional financing, a suspension of debt service payments on bilateral debts, and targeted but limited relief on some multilateral debt. More action is needed,” it said. According to the Secretary-General, over the last 12 months, countries have taken unprecedented policy actions to control the spread of the deadly virus and mitigate its socioeconomic impact. To reduce pressure on overwhelmed health systems, governments imposed exceptional social distancing policies, including lockdowns, business closures and travel bans. These emergency policies succeeded in flattening the curve of contagion and saved lives, but they also resulted in a 4.3 per cent contraction of world GDP, the first increase in extreme poverty since 1998, and the loss of the equivalent of 114 million full-time jobs relative to the level in 2019. The Secretary-General said that these impacts could have been significantly worse in the absence of extraordinary national fiscal support measures, which amounted to a global total of $16 trillion as of March 2021. However, the capacity to respond to the crisis differed markedly across country groups. While advanced economies increased their fiscal expenses by more than 12 per cent of their GDP, middle-income and low-income economies mobilized less than 4 per cent and less than 2 per cent of their GDPs, respectively. These differences reflect the existence of constraints to fiscal spaces and difficulties of access to external financing, he added. In fact, many least developed countries entered the crisis with already elevated debt risks. Globally, debt risks had been on the rise since the 2008-2009 global financial crisis, as the world experienced the largest, fastest, and most broad-based episode of sovereign and corporate debt build-up in the past 50 years. In March 2020, at the outset of the pandemic, capital flows massively exited developing countries, threatening to cause a major financial crisis, but a massive expansion of central bank liquidity in developed countries stabilized global financial markets and facilitated a return of capital flows to some developing economies. However, the recovery in portfolio flows has been highly uneven. While some middle-income countries have returned to international bond markets since April 2020, only two countries in Sub-Saharan Africa have been able to issue new bonds. “Going forward there is a risk that many middle-income SIDS and LDCs with very high re-financing needs in 2021 will not have access to financial markets at affordable rates,” said the Secretary-General. “The rapid growth of financing needs and the collapse in revenues and GDP growth caused by the pandemic have exacerbated debt burden risks across the globe.” The Secretary-General said over half of least developed and low-income countries that use the IMF-World Bank Debt Sustainability Framework (LIC-DSF) are now assessed at a high risk of debt distress or in debt distress. Among the 151 economies that borrow from capital markets and, consequently, are rated by the three major rating agencies, 42 have experienced downgrades since the start of the pandemic, including 6 developed countries, 27 emerging market economies, and 9 least developed countries, he added. “Sovereign downgrades cause borrowing costs to rise, especially for developing countries, which can, in turn, increase the risk of more countries tipping over into unsustainable debt – especially if the COVID-19 pandemic is more protracted and deeper than expected.” As the world gradually recovers from the current crisis, catch-up growth will remain vulnerable due to the risk of a premature phase-out of current fiscal support measures, continuing debt service obligations, and the need to boost public and private investment substantially, said the Secretary-General. According to the Policy Brief, the main priority at the moment is to ensure that the developing countries will have enough fiscal space to recover from the pandemic, vaccinate their populations, and invest in the SDGs, including climate action. This will require fresh financing, in some cases combined with debt relief measures. In this context, the Secretary-General said that governments need to: * Meet ODA commitments and provide fresh concessional financing for developing countries, especially LDCs and SIDS; * Recapitalize multilateral, regional and national development banks and accelerate the timetable for agreeing on a fresh replenishment of funds; * Provide long-term financing to the developing countries for investment in inclusive growth and sustainable development. “Productive investments aligned with sustainable development should help countries improve debt management in the long run, even while raising debt levels in the near term,” he said. Multilateral development banks (MDBs) have an important role to play in offering long-term and counter-cyclical financing to developing countries, he added. “Going forward, the MDB system should significantly scale up financing, consider extending maturities, and explore more options to provide long-term financing. MDBs should provide concessional financing for all developing countries, including middle-income countries.” According to the Secretary-General, central banks across the world introduced monetary easing measures on an unprecedented scale, which helped prevent a new global financial crisis. However, massive injections of liquidity are not without risk as ultra-low interest rates can fuel high asset prices and speculation. In addition, many developing countries have not been able to access capital markets because of low credit ratings and corresponding high borrowing costs. At the onset of the pandemic, these countries faced an impossible choice between: (i) continuing to service their external debts; (ii) addressing urgent needs related to combating the pandemic and supporting jobs and income, including through basic social protection; and (iii) investing in the SDGs and a more sustainable and resilient future. To support developing countries in need, the IMF temporarily doubled access to its Rapid Credit Facility (RCF) and Rapid Financing Instrument (RFI), providing over US$100 billion to member countries, in addition to the more than US$200 billion delivered by MDBs. In addition, in April 2020, the G20 Finance Ministers endorsed the Debt Service Suspension Initiative (DSSI) to bolster crisis mitigation in IDA-eligible countries. By early March 2021, 46 out of 73 eligible countries had benefited from around US$5 billion in debt service suspension, with savings contributing to the pandemic response, said the Secretary-General. However, the financial impact of the DSSI has been blunted by the lack of participation of private creditors, to whom DSSI eligible countries collectively owe about one third of their total debt service obligations in 2021, he added. “Another gap is that the DSSI eligibility criteria excludes nine of the 34 countries with a substantial risk of debt default, which includes some highly vulnerable small island developing States (SIDS).” In addition, middle-income countries not eligible to the DSSI have US$31 billion in bilateral debt service due in 2021 compared to US$16.6 billion for eligible countries and while some of them have adequate market access to refinance their debts, many do not. “Without international support, these countries will need to cut fiscal expenditures to be able to service their external debts, curtailing their response and recovery prospects,” said the Secretary-General. He said that recommendations to provide liquidity to developing countries fall into two main categories: a Special Drawing Rights (SDRs) allocation (and reallocation) and an extension of the DSSI to temporarily bridge foreign exchange and fiscal shortfalls. In this regard, the Secretary-General highlighted the following: * Provision of a new allocation of SDRs (as discussed by the IMF Board), with a reallocation of SDRs from countries with sufficient international reserves to countries facing persistent external deficits or emergency situations, including vulnerable and conflict-affected countries; * IMF member countries are also urged to consider (i) replenishing the Poverty Reduction Growth Trust (PRGT) of the IMF and (ii) establishing a new trust fund hosted by the IMF to support middle-income countries in their response and recovery efforts. According to the Secretary-General, a new allocation of SDRs in a crisis context is not without precedent: in 2009, during the global financial crisis, the IMF issued 182.6 billion SDRs, bringing the total cumulative allocations to about 204.2 billion SDRs, equivalent to around US$294 billion in 2020. As of 19 March 2021, the G7 endorsed a “new and sizeable” allocation of SDRs, with most experts recommending between 350 billion and 455 billion SDRs (equivalent to US$500 billion to US$650 billion). According to the Policy Brief, SDRs are distributed across the IMF members in proportion to their quota shares, with developed countries receiving 60.4 percent and developing countries 39.6 percent, including 3.5 per cent to least developed countries. Thus, said the Secretary-General, to ensure that the new SDRs go to countries that need them most, IMF member countries with strong external positions could voluntarily reallocate their existing SDRs, either bilaterally or through existing mechanisms such as the IMF’s Poverty Reduction and Growth Trust (PRGT). However, only low-income countries are eligible to borrow from the PRGT. The establishment of a new trust fund to be housed at the IMF should therefore be considered to support middle-income countries, and SIDS in particular, in their response and recovery efforts, he added. “Overall, a new SDR allocation combined with a range of options to reallocate excess SDRs to countries that need them most will send a powerful signal of a cooperative multilateral response,” said the Secretary-General. The Secretary-General also said that the G20 would need to: * Extend the DSSI at least until the end of June 2022; * Include middle-income countries, in particular SIDS, conflict-affected and other vulnerable countries that have been seriously affected by the crisis; bilateral and multilateral creditors should consider offering DSSI terms to these countries on a case-by-case basis; * Ensure that debt relief is additional to existing concessional aid; * Bilateral G20 creditors, including hybrid lenders, should consider mechanisms to include private sector participation in the DSSI and in future debt standstills. Referring to the G20’s Common Framework on Debt Treatments Beyond the DSSI, established in November 2020, and which extends the provision of debt relief to all the DSSI-eligible countries, the Secretary-General said that the Common Framework faces similar limitations to the DSSI. First, vulnerable middle-income countries remain ineligible. Second, in the absence of additional measures to incentivize or compel private creditor participation, comparable treatment of commercial creditors will remain challenging in practice. Despite these limitations, the Common Framework can be an effective platform for creditor coordination, which could serve as a starting point towards a more universal and permanent framework for sovereign debt resolution, he said. The Secretary-General urged the international community to: * Build on the Common Framework to offer legal and technical advice on options for debt and debt service relief to help countries in need – including debt swaps, debt buy-backs, credit enhancements, re-profiling or exchanging debt, and/or cancellation – depending on a country’s specific circumstances and debt challenges; * Extend the eligibility to debt relief under the Common Framework to other vulnerable countries on a case-by-case basis; * Consider other mechanisms that would allow countries to access the Common Framework without creating a stigma or compromising the credit rating of the beneficiaries, including funds and other instruments within existing institutions. According to the Policy Brief, while the dramatic impact of the current crisis requires an immediate response, the crisis has also highlighted the need to address underlying challenges, both at national levels and in the global architecture. “The current debt architecture has been ineffective in both preventing repeated episodes of unsustainable debt build-ups and in restructuring debts, when needed, in an efficient, fair, and durable manner,” it said. It is characterized by numerous gaps in transparency and a lack of clarity about roles and responsibilities. More importantly, there are no processes that incentivize all creditors and debtors to act cooperatively in accordance with a uniform set of principles and standards. Architecture reform will require new tools, instruments, and legislative backing, but also a shift in mind-set towards a set of principles including responsible borrowing and lending with fair, transparent, efficient and equitable work-outs, said the Secretary-General. The reform of the international debt architecture should have two objectives: (i) to facilitate expedient, fair and orderly debt work-outs, when needed, and (ii) to address the underlying causes of unsustainable increases in sovereign debts and prevent their recurrence. An effective debt architecture should thereby give countries greater room for investing in sustainable development and play an important role in increasing the resilience and stability of the international financial system in the face of future pandemics or climate-related disasters, said the Secretary-General.
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