- Former Colombian finance minister Mauricio Cárdenas warns that a global debt repayment freeze could prove counterproductive for emerging economies.
- Instead, he argues that central banks should restructure debt based on available global liquidity and the growing financing needs of those countries.
Many are calling for a temporary moratorium on all debt repayments by developing and emerging economies, to prevent the COVID-19 pandemic from triggering a tsunami of sovereign defaults. Rather than passively wait for debtors to stop meeting their obligations, the argument goes, creditors would be better off now agreeing to withhold repayments for a period of time.
But while a global debt repayment freeze may help many low-income countries that have no better option, it could be counterproductive for emerging economies that currently retain access to financial markets. What these countries need now is more capital inflows, not restrictions on outflows.
Payments suspensions pose two problems. First, emerging economies need new net financing – that is, more resources than would be allowed by freezing their debt service obligations. Second, countries participating in a repayment freeze will face legal action from some bondholders, jeopardizing their future access to capital markets.
A debt stop would be particularly problematic for countries with large foreign investments in their local currency capital markets. A scramble for foreign investor exits would put even more pressure on emerging market currencies, pushing up inflation and limiting available liquidity to mitigate the economic consequences of COVID-19. Imposing capital controls to prevent capital outflows is just as misguided: capital would leave anyway and wreak havoc on its exit.
While a debt moratorium would do more harm than good for emerging markets, it would be unrealistic to expect private capital to provide the financing these countries now need.
It is true that several emerging economies tapped the sovereign bond markets on reasonable terms in April: in addition, Qatar, the United Arab Emirates and Saudi Arabia issued debt securities totaling $ 24 billion). But these sums are small compared to the needs of emerging economies in valued$ 2.5 trillion in funding this year and next.
In addition, there can be no assurance that future bond issues will be successful. Emerging economies are unlikely to experience a V-shaped recovery, which will worsen their credit profile. The recovery will take time and, like the virus, will come in waves, creating even more uncertainty. And as the global economic figures disappoint, investors will increasingly turn to safer assets and reduce their exposure to emerging economies.
If neither a temporary moratorium nor recourse to private capital seems desirable, what to do?
The response to the status quo would be for emerging economies to seek additional support from the International Monetary Fund and multilateral (and regional) development banks (MDBs). But these institutions are unable to provide the necessary resources. The IMF has a firepower of at most $ 1,000 billion, while the MDBs can only provide a few hundred billion dollars more, reflecting the lack of capital of these institutions and the fear to lose their AAA credit rating. And rebuilding their capital will take years, due to a number of hurdles – including in the US Congress – when funds are needed now.
The solution lies in central banks which issue reserve currencies and therefore should be genuinely concerned about the health of the global economy. In coordination with the IMF and MDBs, they should set up a special vehicle (SPV) that would serve as a bridge between the large amount of global liquidity currently available and the growing financing needs of emerging economies.
Specifically, the SPV would issue bonds, which major central banks would buy as part of their own quantitative easing (QE) programs, and then lend the proceeds to emerging economies. With certain credit enhancements, these loans could be securitized and traded like other financial assets. The SPV would need equity capital to achieve the minimum credit rating required by central banks that would buy its bonds: MDBs, as well as national governments, could provide it.
The MDBs would manage the structuring, monitoring and servicing of new loans, which could be syndicated between the SPV and the MDBs. But the share of SPV loans would of course not be included in the balance sheets of the MDBs, and therefore would not affect their credit rating. And SPV loans should only be used to deal with the COVID-19 emergency (including recovery).
The central banks that fund the mechanism would decide which countries could access it. For example, the US Federal Reserve would probably be reluctant to provide liquidity to an SPV for the benefit of a country whose major creditors are Chinese. For that to happen, China would have to fund the program as well.
In addition, the SPV could serve as a risk mitigation device to attract more private capital to emerging economies. For example, it could provide equity guarantees for foreign direct investment in public-private partnerships during the post-pandemic recovery phase.
Finally, MDBs should use their own balance sheets more effectively to support economic recovery. There are many things they can and should do, starting with improving their access to alternative sources of liquidity in order to increase their leverage.
The proposed SPV could provide a safety net that MDBs currently lack. In fact, the G20 Panel of Eminent Persons recommended precisely this in a 2018 report, believing that such a facility would allow the World Bank to increase its lending by at least 10%, and regional MDBs by at least much more.
Rather than creating a new international financial architecture in these extraordinary times, policymakers should focus on adjusting the existing system. And setting up an SPV will be easier and faster than alternative options requiring legislative action.
Of course, an additional global lending mechanism would not solve all the problems emerging economies face today. But it would provide them with new tools. Putting it in place will take determination and international coordination – the same principles that will help us defeat the virus itself.