Avoiding international sovereign debt crisis

"The COVID-19 crisis has made painful sovereign-debt restructurings inevitable for many countries... The World Bank estimates that as many as 100 million people could fall into extreme poverty as a direct result of the crisis... The fiscal implications are equally dire, with tax revenues in freefall and extraordinary increases in public spending... A sovereign-debt crisis could be in the cards. Globally, emerging-market debt has increased rapidly to over $70 trillion... The debt burden in so-called frontier economies has increased to $3.2 trillion (114% of their collective GDP), from less than $1 trillion in 2005." - 'Greening sovereign debt restructuring' by Simon Zadek

The pandemic has only exacerbated the rising risks of an international sovereign debt default for some time now. According to a recent article 'Reform of the international debt architecture is urgently needed' by International Monetary Fund's (IMF's) managing director, Kristalina Georgieva, "Indeed, about half of low-income countries and several emerging market economies were already in or at high risk of a debt crisis, and the further rise in debt is alarming. Just as they are starting to recover from the pandemic, many of these countries could suffer a second wave of economic distress, triggered by defaults, capital flight, and fiscal austerity. Preventing such a crisis can make the difference between a lost decade and a rapid recovery that puts countries on a sustainable growth trajectory."

At the same time, the same article points out that while it is important to restructure sovereign debt, it is even more important to do this before a default happens. In this regard, it highlights research by Tamon Asonuma, titled 'Costs of sovereign defaults: restructuring strategies and the credit-investment channel'; according to which, "Post-default restructurings are associated with larger declines in GDP, investment, private sector credit and capital inflows than preemptive restructurings."

In the wake of the pandemic, it is all the more important that a meaningful restructuring takes place at the earliest, both for avoiding the starker consequences on economy in the face of default, but also helping countries, especially developing countries, to create needed 'fiscal space' for enabling governments to provide necessary stimulus to the economy for boosting both economic growth, and also increased welfare spending.

Emerging economies like Pakistan, which saw an increase in capital inflows during the pandemic, will likely find it difficult, going forward, to have that same cushion for their foreign exchange reserves, since according to a recent Financial Times article 'Emerging economies face rising interest rates as capital flows ebb' by Jonathan Wheatley and Valentina Romei, "The vast wave of monetary stimulus that has kept emerging economies afloat since the coronavirus pandemic hit earlier this year has begun to ebb, just as pressure mounts on these countries to finance their recovery and their huge build-up of debt. The combination risks creating a damaging spiral of falling currencies and rising borrowing costs, triggering debt crises and defaults, economists have warned."

The reversal of capital inflows is likely to put added pressure on central banks in emerging markets to start to increase policy rate, in an effort to remain competitive for attracting capital inflows. This will in turn put greater pressure in terms of both short-term and long-term debt repayments. According to the same article, "Overall, emerging economies raised about $145bn on international bond markets between January and September, and an additional $630bn on domestic markets, according to the IIF. That is about $135bn more than the same period last year." All of this points out that an international sovereign debt default is more eminent than before. And a likely second wave of the pandemic in the coming winters may only add to more of needed stimulus.

Hence, the same article by Kristalina Georgieva, among others, acknowledges that the current initiatives for debt relief internationally were 'temporary by design', and covered the 'access to finance' aspect for countries, and not the insolvency concerns, for which the article HAS proposed "[a] The Debt Service Suspension Initiative must be extended into 2021, [b] Countries with debt vulnerabilities must tackle them urgently through a combination of debt management and measures to restore growth. Where debt is unsustainable, it should be restructured, the sooner the better. Private sector claims should be included, where applicable. [and c] Perhaps most importantly, there is a need to reform the international debt "architecture" comprising sovereign debt contracts, institutions such as the IMF and the Paris Club, and policy frameworks that support orderly debt restructuring. The goal is to provide speedy and sufficiently deep debt relief to countries that need it, benefitting not only these countries but the system as a whole."

Pakistan, which is currently in an IMF programme, should look to engage the Fund and the Paris Club countries to initiate discussions on reaching needed debt relief possibilities. The country needs extensive stimulus, through both better domestic resource mobilization, and from strong recourse to international capital markets at the back of sound economic fundamentals - including a stable currency. The same goes for many other emerging economies as well, for which it is important that an extensive and improved internal sovereign debt resolution strategy comes to the fore; perhaps under the auspices of the IMF.

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund)

He tweets@omerjaved7

Copyright Business Recorder, 2020