The COVID-19 pandemic brought with it a challenge as countries suspended all economic activity by introducing lockdowns in an attempt to contain the spread of the virus. Naturally, these lockdowns came with huge economic costs for businesses the world over and necessitated that governments announce stimulus packages to absorb a part of the economic shock.
Due to the nature of the problem, a strong fiscal response was important to try to revive economic activity back to pre-COVID levels. This came at a time when most governments were aware of the limitations they faced due to their inability to raise revenues through taxes due to lower levels of economic activity. Consequently, we have since then witnessed several estimates that suggest a substantial increase in the projected debt to GDP ratio of major countries across the world.
Naturally, the revival of economic activity is the only solution to ensure that governments can eventually tax and raise adequate revenue. Doing so requires greater fiscal spending, which in effect implies an increase in borrowings. The problem arises due to several countries that have borrowings in US dollars or in foreign exchange rate, as any exchange rate movement could have a substantial impact on the cost of borrowing for these countries, restricting their ability to repay or borrow more at a time of such crisis.
Moreover, with debt to GDP ratios across the world similar to the ones observed in the post-war period, we’re witnessing unconventional monetary policy in the form of aggressive bond purchases by central banks across the world. Since 2010, debt owed by developing economies has witnessed an increase of approximately 54% due to low interest rates and reached a historical 170% of GDP by 2018.
The situation emerging countries and low-income ones find themselves in largely depends upon their macroeconomic fundamentals.
Some economies have significant debt but also substantial external reserves. Some have primarily borrowed in foreign currency, while others borrowed in their own currency. Many countries borrow money from private creditors, and some lean on traditional sources, including the governments. However, countries that have borrowed in foreign currencies from the private market are expected to witness maximum stress upon their economies.
Many of the frontier market countries are at high risk of default and may find it tough to raise the necessary funds and fight COVID-19. Exposure to debt-related problems had been piling up in emerging economies prior to the occurrence of COVID-19. Differences existed but major issues leading to deteriorating finances included decline in international commodity prices, growth in private debt and hidden debts to China, the latter most prevalent in low-income economies.
For economies such as India, where the bulk of the government borrowings are domestic, there isn’t much concern, but several other countries have borrowed extensively from other countries, multilateral agencies or foreign markets. According to the IMF, over US$80 billion were pulled out of the emerging markets during the first quarter of 2020, recording the largest outflow in history.
Countries in Africa had to face the twin challenge of protecting the health of their citizens and minimising the negative impact on their respective economies. At the same time, they are burdened with debt. They are in a position wherein they have to pay back the borrowed money, leaving little room to divert their resources towards the urgent health and economic needs. Within Africa, variations exist. Countries like Zambia and Djibouti owe most of their external debt to China, while others have taken loans from bilateral(s), multilaterals or the private sector. Defaulting on loans can affect the possibility of borrowing money in the future, making the nations vulnerable to broader negative repercussions.
However, debt forms one part of the equation; the other is revenue. Countries like Zambia and Ecuador, which have significant external debt and majorly depend upon export of commodities like oil, copper or even tourism, find themselves approaching a situation of financial turmoil. Similarly, countries in the Middle East and Central Asian region had to witness two reinforcing shocks, resulting in weak growth projections and an urgent need to diversify their economic structure. This makes it important to discuss the importance of debt restructuring, especially for some of the poorest and vulnerable regions of the world. The argument against debt restructuring or forgiveness is that it will dampen the credit discipline and permanently increase the cost of borrowing for emerging market economies.
However, credit from other countries or multilateral institutions could be restructured given the extent of economic shock that the world has witnessed due to the pandemic. The reason for this is that in the absence of such restructuring, several of these countries would have to significantly cut back on their expenses in order to meet their debt obligations. Forced austerity could in turn create a deeper economic recession in the emerging markets that would spill over to the global economy, dampening recovery from the pandemic. There is an added risk that in the event of defaults, we should expect significant volatility in international financial flows, which will further create problems for the global financial system.
Jhoomar Mehta
Public policy and development finance researcher
Karan Bhasin
New Delhi-based economist