For the first time in history, the global economy is facing a synchronized and severe economic recession, affecting both developed and developing economies in all continents at the same time. COVID-19 and the resultant lockdowns and social-distancing measures to contain the spread of the virus have induced a sharp economic downturn, accompanied by unintended economic and social costs because of the widespread collapse of almost all revenue-earning channels for many governments—including plunging commodity prices, drastic declines in foreign direct investments and trade, sudden stops in tourism, free falls in remittances and collapsing tax systems. The World Bank has estimated that COVID-19 will push 71 million people into extreme poverty in 2020, measured at the international poverty line of $1.90 per day.1Daniel Gerszon Mahler, “Updated estimates of the impact of COVID-19 on global poverty”, World Bank Blogs, 8 June 2020.
The current cumulative crises exacerbated by the COVID-19 pandemic have put the debt problems of developing countries squarely under the spotlight. Many developing countries entered the pandemic with unprecedentedly high levels of public and private debt.2UNCTAD, “The Covid-19 Shock to Developing Countries”, March 2020. More than 40 percent of low-income countries were already in debt distress or at high risk of debt distress prior to the pandemic.3IMF, “The evolution of public debt vulnerabilities in lower income economies”, February 2020. Economic contraction, need for pandemic response and debt unsustainability have fed each other, creating a dark, vicious circle spiraling down to the bottomless hole. The narrow fiscal space for pandemic response has worsened the economic and social impacts of the pandemic, which in turn has led to greater need for borrowing, increasing debt and higher debt-service burden.
The changing landscape of developing-country debt has made debt-service burdens even heavier. Many developing countries, including some without an investment-grade rating, have shifted to riskier debt, including debt on commercial or near-commercial terms, thus driving up their interest-to-revenue ratios on their external debt.4World Bank, “Debt service suspension and COVID-19”, fact sheet, 11 May 2020. Among low-income countries, more than half of government debt is on non-concessional terms.5M. Ayhan Kose and others, “Caught by a cresting debt wave: past debt crises can teach developing economies to cope with COVID-19 financing shocks”, Finance and Development, vol. 57, No. 2, June 2020. A recent analysis indicates that, in 2019, 64 lower-income governments had spent more on external debt payments than on health care.6Jubilee Debt Campaign, “Sixty-four countries spend more on debt payments than health”, 12 April 2020. With their weaker healthcare and social-protection systems, heavy debt burdens and deteriorating economic buffers, developing countries, especially those that are poor and debt distressed, do not have much room to provide for a proper response to the pandemic and require massive liquidity and financing support to deal with the immediate fallout resulting from the pandemic and its repercussions on economic and human rights. Unlike developed countries, they cannot mount huge fiscal- and monetary-stimulus packages.
According to the International Monetary Fund (IMF), global government support totalled about $9 trillion by May 2020,7Bryn Battersby, W. Raphael Lam and Elif Ture, “Tracking the $9 trillion global fiscal support to fight COVID-19”, IMF Blog, 20 May 2020. most of which was from advanced countries, which have a wide array of instruments at their disposal. It is of concern that while advanced economies have used 8.6 percent of their gross domestic product (GDP) to respond to the pandemic, emerging-market and low-income economies have respectively used 2.8 percent and 1.4 percent of their GDP on pandemic spending and tax reductions.8Martin Mühleisen, Vladimir Klyuev and Sarah Sanya, “Courage under fire: policy responses in emerging market and developing economies to the COVID-19 pandemic”, IMF Blog, 3 June 2020. Some developing governments are faced with difficult choices between saving lives or making debt payments.
Whether or not effective and timely measures can be deployed to mitigate the debt problems of developing countries and allow them to put in place appropriate pandemic responses is an important test for the international debt architecture. It is interesting to note that while the debt compositions and actors have changed significantly in recent years, the toolkits for debt crisis prevention and resolution have remained more or less the same since the 1980s, with the exception of some tightening of bond contracts. This mismatch has made the policy proposals created in response to the COVID-19 crisis appear, to some extent, to be lacking in both potency and sophistication.
Three counterfactual scenarios could have helped developing countries to stave off sovereign and private defaults and concentrate limited financial resources on fighting the pandemic: the first is to have a comprehensive debt moratorium as long as the pandemic lasts; the second is to provide massive amounts of liquidity to countries facing debt problems and hard hit by the pandemic in a “whatever it takes” manner; and the third is to have significant and meaningful debt relief quickly, including debt restructuring and debt cancellation, which would be of particular help for countries already facing solvency problems, as their debt is unsustainable and their financial capacity insufficient to pay that debt, even if bridging money is provided.
But the international debt architecture has gaps, straightjackets and constraints. Thus, we have had too little of each of the three: limited debt standstill, insufficient liquidity provision and little debt relief. The criticism is that the response is far from sufficient. As a result, we may face many debt restructurings in the coming years.
For debt standstill: The International Monetary Fund (IMF) and the Group of 20 (G20) announced debt standstills for poor countries in April 2020. They are welcome. However, the duration, country and debt-instruments coverage of the G20 is far too restrictive. One issue that seems to be off the radar of the G20 is that some low-income debtors have access to international capital markets and are afraid of possible credit-rating downgrades. Therefore, quite a number of eligible countries have not applied for the Debt Service Suspension Initiative (DSSI). The landscape has changed, but policymakers still use the old formulas, such as GDP per capita, for deciding the eligibility of debt relief. Private-sector participation is an issue, as up until now, they have not responded to the invitation to join DSSI voluntarily. State-contingent debt instruments that allow states to have debt standstills in times of necessity are still not common.
For liquidity provision: The IMF emergency facilities are welcome and embraced by many countries because of their severe liquidity shortages. However, it is not enough. The IMF has in total $1 trillion of such funds. Developed countries have had more than $9 trillion for stimulus packages. To increase liquidity provision, there have been proposals for a fresh issuance of special drawing rights (SDRs) and the voluntary reallocation of existing, unused SDRs from developed countries to countries in need. However, the IMF board could not reach an agreement, reflecting the need to reform the IMF’s quota system. The situation now is that countries that need SDRs the most have the least amount of them, and countries that need dollars the most do not have access to the US Federal Reserve’s swap line. So proposals are being made about developing regional swaps and special-purpose facilities, which take time to develop to a meaningful size.
For debt relief and debt restructuring: After decades of debates, there are no debt-restructuring or insolvency regimes for sovereign states, although there are such systems for corporations. The IMF’s newly published paper 9IMF, “The international architecture for resolving sovereign debt involving private-sector creditors-recent developments, challenges, and reform options”, October 2020 acknowledges this gap in the current debt architecture. This is an encouraging step forward. People would revisit the issue during each crisis, demonstrating the desire for a framework that allows faster and fair debt restructuring. But in the past, IFIs (international financial institutions) have insisted that the current system is effective and sufficient. Debt relief and restructuring can be a costly and time-consuming process. Patchwork and ad hoc arrangements for sovereign-debt restructuring still prevail. Debt-relief instruments such as debt buyback and different kinds of debt swaps still have to be handled with care to avoid legal complications and credit downgrades. However, if the country is insolvent, debt restructuring and debt cancellation would still be needed.
After a major economic crisis, the global financial architecture has always undergone significant changes. I think this pandemic will not be an exception. The gaps and imperfections in the international debt architecture make it difficult for the system to cope with a crisis of such depth and magnitude—not the least being the lack of a human-rights approach in debt crisis prevention and resolution.
1Daniel Gerszon Mahler, “Updated estimates of the impact of COVID-19 on global poverty”, World Bank Blogs, 8 June 2020.
2UNCTAD, “The Covid-19 Shock to Developing Countries”, March 2020.
3 IMF, “The evolution of public debt vulnerabilities in lower income economies”, February 2020.
4World Bank, “Debt service suspension and COVID-19”, fact sheet, 11 May 2020.
5M. Ayhan Kose and others, “Caught by a cresting debt wave: past debt crises can teach developing economies to cope with COVID-19 financing shocks”, Finance and Development, vol. 57, No. 2, June 2020.
6Jubilee Debt Campaign, “Sixty-four countries spend more on debt payments than health”, 12 April 2020.
7Bryn Battersby, W. Raphael Lam and Elif Ture, “Tracking the $9 trillion global fiscal support to fight COVID-19”, IMF Blog, 20 May 2020.
8Martin Mühleisen, Vladimir Klyuev and Sarah Sanya, “Courage under fire: policy responses in emerging market and developing economies to the COVID-19 pandemic”, IMF Blog, 3 June 2020.
9IMF, “The international architecture for resolving sovereign debt involving private-sector creditors-recent developments, challenges, and reform options”, October 2020