Emerging markets today account for more than two-fifths of global GDP measured at market exchange rates, and nearly three-fifths after adjusting for differences in purchasing power. If these economies crash, then rich-country citizens will also be the victims of an economic catastrophe long foretold and clearly avoidable.
In his novel Chronicle of a Death Foretold, Gabriel García Márquez describes a tragedy that everyone anticipates but no one will stop. The same is true of the perilous plight of emerging markets today: the international community could prevent imminent macroeconomic disaster, but seemingly lacks the will to do so.
For emerging and developing countries, COVID-19 represents five shocks, not one. To the initial health shock, add a sharp drop in commodity prices, a massive contraction in export volumes (the World Trade Organization expects global trade to decline by as much as one-third in 2020), loss of remittances, and unprecedented capital outflows in March. And although the latter were partly reversed in April and early May as a result of record bond issuance by emerging-market governments, this was less an indicator of stability than the equivalent of households drawing on their credit lines to have cash on hand during the coming storm.
The upshot is that many emerging markets will soon experience deep recessions and massive job losses, which risk pushing tens of millions of people back into poverty. The debt shock of the early 1980s caused a “lost decade” for Latin America. COVID-19 could cause a lost decade for the developing world.
Advanced economies have been throwing unprecedented sums of money at the pandemic: fiscal packages totaling one-tenth of GDP or more – to strengthen health systems, pay furloughed workers’ wages, and support firms – were unthinkable a year ago; today, they are commonplace. Other countries need to do the same or more, but lack the money. The International Monetary Fund estimates that emerging markets will need $2.5 trillion in financing, which it calls “a lower-end estimate for which their own reserves and domestic resources would not be sufficient.”
Where can the money come from? Only a subset of emerging markets retain access to capital markets, and no one can be sure for how long – especially if more countries run into debt-service trouble, as Argentina, Ecuador, Lebanon, the Maldives, Pakistan, Rwanda, and Zambia already have. Nor can emerging markets engage in central-bank financing on any substantial scale: their currencies would risk depreciating even further, destabilizing the domestic economy.
Faced with this new reality, the international community has reached for an old tool: debt forbearance. The G20 has agreed to grant a moratorium on official bilateral debt-service payments for the world’s 76 poorest economies, while the Institute of International Finance, the global financial-industry body, has recommended that private creditors voluntarily grant debt relief to the same group of countries. Several independent initiatives have proposed a temporary debt standstill for all emerging and developing countries.
To be sure, poor countries should not be servicing debt owed to rich creditors during a health emergency. But debt forbearance is insufficient to prevent a developing-world depression, and could even misfire.
For starters, some of the debt-relief proposals involve a coordinated suspension of interest payments, but leave the deferral of amortizations to the goodwill of individual creditors. Under such a scheme, a country that has $100 of debt coming due, with an interest rate of 5%, could see its debt-service burden fall only from $105 to $100.
What emerging markets need is new funding, not just help with old debts. To mitigate the pandemic’s economic fallout, these countries’ governments will need to run deficits, as will private-sector firms that must keep paying wages while sales and productivity are sharply down. So, unless households save a lot (which is highly unlikely), an emerging market that adopts strong anti-virus policies will have an external payments gap that must be financed with fresh hard-currency resources.
The IMF can lend at most $1 trillion, or only 40% of what the Fund itself estimates the developing world needs. The multilateral development banks have useful advice to offer but limited firepower. And the US Federal Reserve has entered into swap agreements with only four emerging markets: South Korea, Singapore, Brazil, and Mexico.
The Fed’s repo lines are in principle available to all, but they require US Treasuries as collateral, and thus have been used sparingly. That leaves large emerging markets like Turkey, South Africa, Nigeria, and Indonesia, several Latin American countries, and many smaller economies in Africa and Asia with no secure access to dollar liquidity in an emergency.
That is the bad news. The good news is that the world’s major central banks are creating unprecedented volumes of hard-currency liquidity that could be channeled to emerging markets. But, because leading central banks cannot realistically be expected to take the risks of dozens of emerging markets onto their balance sheets, an intermediary is needed.
One option would be for the IMF to borrow and in turn lend the funds to emerging and developing countries, as the G20 Eminent Persons Group on Global Financial Governance (of which I was a member) proposed two years ago. Alternatively, the Fund, along with the World Bank and the regional development banks, could establish a special-purpose vehicle (SPV) that would issue bonds to be purchased by leading central banks – as former Colombian finance minister Mauricio Cárdenas recently suggested.
This alternative is more expeditious and politically feasible than the apparently defunct plan for a new issue of IMF Special Drawing Rights. Whereas the central banks themselves could decide whether to purchase the SPV-issued bonds, an SDR issue larger than $600 billion would require US congressional approval. Moreover, SDRs would be allocated in proportion to each country’s IMF quota, thus necessitating a time-consuming process in which larger and richer economies donated their SDRs to needy countries.
Major central banks have strong non-altruistic reasons to collaborate in such a scheme. Not only must all countries be safe for any to be safe, but massive economic contagion is also likely. Emerging markets today account for more than two-fifths of global GDP measured at market exchange rates, and nearly three-fifths after adjusting for differences in purchasing power. If these economies crash, then rich-country citizens will also be the victims of an economic catastrophe long foretold and clearly avoidable.