By Juan Santiago and Gary Smith
The COVID-19 pandemic is expected to hit emerging economies particularly hard. Higher density living conditions, national health systems that are under-resourced, and a generally less healthy population at the outset, will all contribute to a faster spread of the virus and ultimately lead tragically to a higher fatality rate.
Governments of several Emerging Market Economies (EMEs) have taken steps to support their economies in the face of economic lockdown. But these countries do not have the capacity to match the levels of assistance that advanced economies can provide. For instance, the IMF estimates that aid packages announced by the Philippines, Indonesia, and Malaysia each amount to around 3% of local GDP. On the other hand, the US, UK, and France have each announced assistance packages of more than 10% of GDP. The contrast is stark.
Even though these aid packages are relatively small, they are still going to have to be financed. This could be tough. Many EMEs sovereign borrowers now tend to issue local currency debt. While this has removed currency mismatch from the Sovereign balance sheet, it has transferred currency risk to creditors. As EME currencies have been hit in recent weeks, overseas investors have suffered currency losses. Overseas investors are going to demand higher interest rates as compensation for these currency risks when financing aid, or refinancing this local currency debt.
Higher borrowing rates would be a problem for many EMEs and default risks will rise. To address some of these issues the G20 held an emergency (virtual) summit on March 26. The G20 committed to do whatever it takes to minimize economic and social damage from the pandemic, restore global growth, maintain market stability, and strengthen resilience. What form might this commitment take?
In a recent article Joseph Stiglitz¹ argued that two things must be done. First, he suggested the IMF’s Special Drawing Rights (SDR) be freed up and made available to help EME’s at this time of crisis. Following the 2008 financial crisis the IMF increased the amount of SDR in existence to an amount equivalent to $280 billion. Whilst only 40% of the SDR total is tagged for the benefit of the emerging economies, Stiglitz suggested that advanced nations should donate or lend their share to emerging economies. He also recommended that creditor nations should consider offering a freeze, or “stay” on debt service payments owed by EMEs.
When considering how else to soften the blow to EMEs, we could do worse than refer to the London debt agreement of 1953. Under this, much of the debt that Germany owed was written off, and the terms of what remained were re-written such that Germany’s creditors had a vested interest in Germany’s recovery and success. A similar institutionalized mechanism for restructuring the debt of EMEs at this time of great stress might be required. The advanced economies should not be reacting to the COVID-19 crisis by pulling up the financial drawbridge and economically self-isolating. The need for international cooperation has never been greater.
¹ Stiglitz, J. E. (2020, April 6). Internationalizing the Crisis by Joseph E. Stiglitz. Retrieved from https://www.project-syndicate.org/commentary/covid19-impact-on-developing-emerging-economies-by-joseph-e-stiglitz-2020-04