South needs $2.5 trillion support package to deal with COVID-19
A $2.5 trillion support package is needed for developing countries facing unprecedented economic damage from the COVID-19 crisis, the UN Conference on Trade and Development (UNCTAD) has said.
IN an update released in March to its Trade and Development Report, UNCTAD has proposed a multi-pronged strategy for developing countries to deal with the coronavirus shock. This includes a $1 trillion liquidity injection made available through the expanded use of Special Drawing Rights; a $1 trillion debt jubilee for distressed economies; a $500 billion Marshall Plan for health recovery; and the use of capital controls to curtail the surge in capital outflows, reduce illiquidity driven by sell-offs in developing-country markets, and arrest declines in currency and asset prices.
Richard Kozul-Wright, Director of the UNCTAD Division on Globalisation and Development Strategies, noted that advanced economies have promised to do ‘whatever it takes to stop their firms and households from taking a heavy loss of income’. But if leaders of the G20 major economies are to stick to their commitment of a global response in the spirit of solidarity, ‘there must be commensurate action for the six billion people living outside the core G20 economies’, he added.
Global economic contraction
According to the UNCTAD report, projections of the potential impact of the COVID-19 shock on economies around the world for the year 2020 vary widely. However, there is broad agreement that the global economy will contract given the sudden stop to large swathes of activity and the resulting income loss in the manufacturing and services sectors across most advanced countries and China, combined with the adverse effects on financial markets, consumption (through both income and wealth effects), investment confidence, international trade and commodity prices.
For advanced-country governments, now scrambling to contain the economic impact of the COVID-19 pandemic, the challenge is compounded by persistent fragilities surrounding highly speculative financial positions, in particular, the already unsustainable debt burdens associated with highly leveraged corporate loans. These have been built up over the last decade of easy money and against a backdrop of heavily under-regulated ‘high-tech-cum-gig economies’ and deeply ingrained income inequalities. In addition, the avalanche of cheap credit since 2008 has also spilled over to developing countries, creating new financial vulnerabilities and undermining their debt sustainability.
UNCTAD noted that in the past days a series of stimulus packages – unprecedented in both scale and scope – have been announced by the major developed economies and China to extenuate the mounting economic damage and respond to the health crisis.
Aside from financial injections to keep banking and corporate balance sheets on relatively stable footing, the critical measures to avert contractions of economic activity include government spending (particularly on healthcare), extended unemployment benefits and cash transfers.
Using its Global Policy Model, UNCTAD said it has estimated a boost to the national incomes of advanced economies and China of about $1.4 trillion in 2020, substantially smaller than the headline values of the packages.
‘Although this will, in all likelihood, not prevent a global contraction this year, it should (hopefully) avert the recession turning into a prolonged depression. It should also contribute to stemming the fall in the prices of both financial assets and commodities and will partially alleviate the negative growth impact from the crisis on developing countries.’
Developing countries, however, face distinct pressures and constraints which make it significantly harder for them to enact effective stimulus without facing binding foreign exchange constraints, said UNCTAD.
As these countries do not issue international reserve currencies, they can only obtain them through exports or sales of their reserves. What is more, exports themselves require significant imports of equipment, intermediate goods, know-how and financial business services.
The financial turmoil from this crisis has already triggered sharp currency devaluations in developing countries, which makes servicing their debts and paying for necessary imports for their industrial activity far more onerous.
Many developing countries were already slowing down in the final quarter of last year, with several entering recession. However, the speed at which the economic shock to advanced economies has hit developing countries – in many cases in advance of the health pandemic – is dramatic, even in comparison to the 2008 global financial crisis, said UNCTAD.
For example, net portfolio flows, both debt and equity, from main emerging economies amounted to $59 billion in the month since the COVID-19 crisis went global (21 February to 24 March). This is more than double the portfolio outflows experienced by the same countries in the immediate aftermath of the global financial crisis ($26.7 billion).
Concomitantly, the spreads on developing-country bonds have been rising sharply, while the values of currencies against the dollar have dropped significantly since the beginning of this year; again, in both cases equal to or faster than in the early months of the global financial crisis.
UNCTAD noted that commodity prices have also dropped precipitously since the crisis began. A fall in oil prices, which would be expected from a drop in global demand, has been amplified by disagreements among the main producers on how to deal with this, with Brent crude falling 63% in the year to date. In the last 25 years, similar declines occurred only after the global financial crisis. When other commodities are added to the analysis, the overall price decline has been 37% this year, with the other major falls concentrated in metals (with some notable exceptions) and mineral products.
‘Things will get much worse before they get better’
‘The economic fallout from the COVID-19 shock is ongoing and increasingly difficult to predict but there are clear indications that things will get much worse for developing economies before they get better,’ UNCTAD said.
First, the full effects of the health crisis have yet to hit many developing countries, and we have yet to reach the ‘end of the beginning’ of the economic crisis in the advanced economies.
Following the collapse of Lehman Brothers in September 2008, the global economy registered five consecutive quarters of negative growth, albeit at a decelerating rate after the second quarter of 2009.
Even if the massive stimulus packages now being implemented prevent a long period of depression, they will not, as already suggested, avert a recession in the global economy this year.
Second, many of the conditions that produced a sharp bounceback in developing countries after 2010 are no longer present or a good deal weaker.
China's massive stimulus in 2009 and rapid return to double-digit growth had strong positive effects on demand for the exports of developing countries while the search for yield by Northern investors operating under the loose monetary policy adopted by leading central banks heightened their appetite for risky assets, producing a rapid rebound in capital inflows in emerging and other developing countries.
Moreover, confidence in the developing world was boosted by expanding South-South trade and financial links that had begun before the crisis hit, encouraging the idea that developing countries had ‘decoupled’ from the economic troubles of developed countries.
‘These conditions are unlikely to be repeated this time around. In addition, weakening state capacity, diminishing fiscal space and a rise in illicit financial flows over the past decade, place further constraints on effective recovery strategies in many developing countries,’ said UNCTAD.
Third, the strong recovery in developing-country trade that occurred in 2010 seems less likely this time.
Even if the damage to global supply chains is not irreparable, as lead firms recover from the crisis they will likely have to rethink their business model, including fewer links in these chains, and with more that are closer to home. Moreover, China has steadily diminished its dependence on external suppliers in its chains through an increase in domestically produced intermediate products.
At the same time, there has been too little diversification of economic activity in many developing countries over the past decade – with greater commodity dependence in many countries – leaving them more exposed than ever to new shocks and disturbances.
Fourth, the current fall of commodity prices has started from a lower value compared with what happened in the global financial crisis when the world economy was at the peak of the ‘super commodity cycle’, and appears to be more broad-based.
Commodity prices have been well off their post-recovery highs since the price slump in 2016 but it seems unlikely that there will be the same kind of pick-up in prices seen between 2009 and early 2011 which was well ahead of the recovery in global output.
Fifth, new vulnerabilities have emerged that are likely to hold back growth. Emerging economies, in particular, have seen a rapid build-up of private debt in reserve currencies and increased penetration of their markets by non-resident investors, foreign banks and other financial institutions, as well as allowing their own residents to invest more freely abroad. There has also been a strong shift in the ownership of central government debt, including public external debt, from official to private creditors and shadow-banking actors.
‘These trends heighten developing countries’ external vulnerabilities and entail large transfers of resources to advanced economies through various financial channels,’ said UNCTAD.
Finally, developing countries’ ability to build up international reserves as a buffer against macroeconomic shocks has been weakening.
In the aftermath of the global financial crisis, developing countries’ international reserves increased steeply, precisely in response to an evident need for ‘self-insurance’ in a volatile global economic environment. However, since the onset of the commodity price downturn in 2012, reserve holdings, while still high by historical standards, have fluctuated widely, reflecting multiple pressures on the ability of developing countries to maintain high reserve holdings.
‘Given the massive expected impact of the COVID-19 crisis, reliance on such self-insurance is not an option, with reserves likely being drained very fast,’ said UNCTAD.
The analysis of the impact of the COVID-19 shock has been mostly concentrated on China and advanced economies, since they were initially more affected by the pandemic, account for three-quarters of world output and have the monetary and fiscal policy space to respond, UNCTAD noted. ‘However, since two-thirds of the world population live in the (remainder of the) developing world, the responses to the current shock must include dedicated actions for developing countries, at all income levels.’
In general terms, there are three main transmission mechanisms or channels through which the COVID-19 shock can be expected to increase financial pressures on developing economies over the coming months.
The first channel is the pressure on government budgets from the public health crisis, said UNCTAD.
The social distancing necessary to stop the contagion has already led to economic shutdown in many developed and developing countries, affecting the majority of the world's population. A sharp, sudden fall in employment is already happening. While developed countries have the administrative capacity and (generally) the fiscal space to buttress their social protection systems and protect private incomes, in developing countries sharp contractions of incomes are all but inevitable along with falling fiscal revenues, said UNCTAD.
‘Tighter fiscal space and weaker healthcare and social protection systems expose developing countries to higher human and financial toll while limiting their ability to respond, triggering a potentially dangerous vicious circle.’
The second channel is international trade. Even after considering implementation of the effective $1.4 trillion stimulus by advanced economies and China, a rapidly slowing growth in these countries will take place through 2020. This will mean significantly lower demand for exports for other developing economies. The losses in export volume will be compounded by the sharp falls in energy and commodity prices, which still make up most of the goods that many developing countries export.
Altogether, UNCTAD has projected that developing countries as a whole (excluding China) will lose nearly $800 billion in terms of export revenue in 2020. Such a drastic fall in their foreign exchange earnings will add to the challenges already posed by currency depreciations vis-a-vis the US dollar, it said.
While imports will contract, by an estimated $575 billion, the overall drop in the trade balance of around $225 billion is not without consequences for their development needs, their structural transformation plans and their ability to generate output and capacity to continue to face external financial commitments.
‘Moreover, other items on the current account, such as remittances, royalty payments and profit outflows are likely to add to the financing difficulties facing many developing countries over the course of the coming year.’
The third channel is financial, UNCTAD said, noting that the flight to safety has already caused record capital outflows from emerging economies, triggering large currency depreciations against lead currencies and widening spreads.
‘In countries with a high exposure to foreign debt, be it private or public, these trends put enormous pressure on their debt sustainability, by undermining future access to refinancing outstanding external debt obligations while driving up their value in foreign currency.’
This comes against a background of a systematic build-up of financial and debt vulnerabilities in many developing countries over the past decade. Total developing-country debt stocks stood at 193% of their combined GDP at the end of 2018, the highest on record, compared with just over 100% in 2008.
In addition to rising debt-servicing costs since 2012, developing countries also already face a wall of repayments due on foreign-currency-denominated public debt over this year and the next, said UNCTAD. The total amount of sovereign debt repayments due at the end of 2021 is $2.7 trillion ($1.62 trillion in 2020 and $1.08 trillion in 2021). Of this, $562 billion are due for repayment by governments in low- and middle-income countries, with the bulk of this amount due this year ($415 billion in 2020 and $147 billion in 2021).
In ‘normal’ times, much of this debt would be rolled over, adding to future debt burdens but providing vital breathing space to honour overall obligations. But with sudden stops to external refinancing possibilities, suspending sovereign debt repayments due over this and the next year, at the very least for low- and middle-income developing countries, is key to averting immediate and widespread debt crises, said UNCTAD.
‘Clearly, the amounts that would be involved in suspending sovereign debt repayments in poorer developing countries are small change compared to the economic rescue packages hurriedly put together across the developed world,’ it added.
What can be done
Advanced economies have embarked on a dramatic change of policy direction in response to the crisis, said UNCTAD. ‘Measures that were unthinkable just a few weeks ago have been embraced and implemented in response to the scale of the crisis. So far discussion of what developing countries should and could do has, by contrast, been limited, particularly when it comes to international support,’ it added.
‘In the current dollar-centric global system, the United States’ Federal Reserve can extend its role as lender of last resort beyond the country's borders but it currently does so in a strategic way which favours a select group of countries.’
As of 19 March, the Federal Reserve has currency swap programmes with nine central banks (enabling these to provide dollars to their own banking systems that lend and trade in dollars), including only three developing countries – Brazil, Mexico and Singapore.
This comes as the role of the dollar in the developing world has been increasing since the global financial crisis, largely due to developing countries' growing recourse to international financial markets to meet external financing needs. At the end of 2007 and the peak of the pre-crisis boom, developing countries’ outstanding international debt securities – such as bonds, asset-backed securities and commercial papers issued by their governments and firms – denominated in dollar stood at $840 billion, or 70% of the total amount of $1.2 trillion. By end-2019, this figure had risen to $3.36 trillion, or 80% of the total amount of developing countries' outstanding international debt securities of no less than $4.2 trillion.
‘While advanced country governments are preparing to send checks to their citizens and open emergency credit lines for their companies, this clearly is not an option open to most developing countries which are highly dependent on access to US dollars and which lack their own financial infrastructure and financial firing power to follow suit,’ said UNCTAD.
According to UNCTAD, it is therefore a matter of immediate urgency for the international community to coordinate appropriate economic rescue packages with a more global reach to address the looming financing gap which many developing countries are now imminently facing. These would have to include, as a minimum, the following measures:
(1) A coordinated global response to liquidity shortages to address immediate financing needs.
While the recent pledge by the G20 to inject $5 trillion into the global economy to limit economic losses from the COVID-19 crisis is welcome, how effective any such rescue package will be, and how much of it will reach developing countries, remains to be seen and depends on specific measures, said UNCTAD.
Furthermore, the International Monetary Fund (IMF) has signalled that it is willing to fully deploy its current $1 trillion lending capacity to help deal with the crisis. ‘However, not only is this likely to prove insufficient, but current lending facilities and financing instruments are complex, tied to inappropriate conditionalities under the circumstances and therefore difficult to access quickly, in particular for developing countries.’
While the IMF has promised flexibility in this regard, an additional and faster avenue to address, at the very least, current liquidity shortfalls is through a much more expansive use of Special Drawing Rights (SDRs), the IMF unit of account and an international reserve asset, said UNCTAD.
Under current arrangements, this instrument suffers from the bias in the IMF's quota system that continues to heavily favour advanced countries. Even so, a serious step towards alleviating liquidity constraints, in particular in low- and middle-income economies, would be to ensure that around 730 billion SDRs ($1 trillion at the current exchange rate) reaches the international reserve accounts of developing countries fast.
This could be achieved through a new allocation of SDRs and an IMF ‘designated’ reallocation of current and new but unused SDRs from advanced countries to poorer developing economies. The required new allocation of SDRs would, no doubt, have to be multiple times that agreed in 2009 (of 183 billion in SDRs or the equivalent of $287 billion at the time), depending on developing-country liquidity needs and options for a ‘designated’ reallocation of existing and newly allocated SDRs.
(2) Capital controls should be endorsed by the IMF as a necessary, permanent and fully legitimate part of any policy regime and, wherever appropriate, introduced to curtail the surge in outflows, to reduce illiquidity driven by sell-offs in developing-country markets, and to arrest declines in currency and asset prices.
Implementation should be coordinated by the IMF to avoid stigma and prevent contagion, and which, in cooperation with other appropriate international bodies, should also be tasked with lending the technical support needed to ensure their effectiveness and extending advice on complementary measures needed to deal with related disruptions.
(3) Even if large liquidity injections to developing-country reserve accounts are critical to staving off financial and economic meltdowns and serial sovereign defaults in developing countries, it will be important to ensure that the medium-to-longer-term economic fallout from this global health crisis does not also result in destructive and widespread developing-country debt crises.
One such measure in this regard is temporary standstills on debt service payments, or a formal or informal agreement between a debtor and one or more of its creditors to suspend these payments for a given period of time to allow debtors to propose restructuring plans. During this time, creditors cannot seek legal remedies, a critical provision to keep non-cooperative and litigious creditors (or so-called vulture funds) in check.
(4) In addition to temporary standstills as a kind of emergency break, new debt relief programmes need to be agreed on as soon as possible. On 25 March, the World Bank and the IMF called on all official bilateral creditors to suspend debt payments from the world’s 76 poorest economies currently in receipt of support from the International Development Association (IDA).
While a first tentative step in the right direction, more systematic, transparent and coordinated steps towards writing off developing-country debt, based on need rather than bargaining power, are critical, said UNCTAD.
(5) Official development assistance (ODA) must be ring-fenced in all donor countries. Despite a majority of donors having routinely missed agreed ODA targets in the past, and despite ODA flows being spread ever more thinly across additional donor-determined objectives, ODA remains a vital source of external financing for the poorest of developing countries.
Over the decade since the financial crisis, an additional $2 trillion would have reached developing countries had the 0.7% (of global national income) ODA target been met by the OECD's Development Assistance Committee (DAC) members, said UNCTAD.
This, therefore, is the time for donor countries to finally honour their collective commitment and deliver ODA to developing countries in full and unconditionally.
As an extraordinary measure given the immediate situation, channelling a significant amount of the missing amount of ODA – for example, one quarter of that total – into a Marshall Plan for Health Recovery would be a fitting way to demonstrate the international solidarity needed to mitigate the crisis in developing countries, UNCTAD said.
*Third World Resurgence No. 343/344, 2020, pp 16-20