A looming debt crisis

In his article in the New York Times on April 30, 2020, Prime Minister of Ethiopia and the 2019 Nobel Peace Prize winner Abiy Ahmed highlighted the fact that the temporary debt relief provided by G20 group of countries, however a welcome step, it was not ambitious enough given the 'punishing fallout of the pandemic'. He therefore, urged: "At the very least, the suspension of debt payments should last not just until the end of 2020 but rather until well after the pandemic is truly over. It should involve not just debt suspension but debt cancellation. Global creditors need to waive both official bilateral and commercial debt for low-income countries."

In fact, a few days earlier in April (prior to the publication of this article), the Prime Minister of Pakistan, Imran Khan, made the call for a 'standstill' in debt repayment to G20 group of countries. Moreover, when Pakistan applied for this standstill to the group of G20 countries, it was the first among a large number of developing countries to do so. Since then the country has received a postponement of $1.8 billion in terms of bilateral repayments for the current year, and secured a zero-interest loan from IMF (International Monetary Fund) to the tune of $1.4 billion.

Having said that, like most emerging markets, Pakistan is also facing a complicated situation while asking for debt rescheduling with private creditors (Ministry of Finance reportedly highlighted this concern as 'we would have to weigh the costs and benefits' of such rescheduling) since doing so would most likely make it difficult to borrow in future from these creditors at the back of possible credit rating downgrades happening as a result of such requests. In this regard, Jonathan Wheatley in an article 'Emerging economies hold back on asking creditors for debt relief' in Financial Times elaborated on this concern in the following words:

"But debt restructuring or requests for a standstill on repayments risk triggering downgrades in countries' credit ratings, which would make it more expensive for governments to borrow in future. Some bond investors, including many large pension fund managers, would have no choice but to sell their holdings of downgraded debt, making it harder for nations to raise commercial funding for infrastructure and other vital investments; some issuers would risk being shut out of markets for years. Countries including Pakistan, Benin and Rwanda have expressed concern about it - although others, including Ethiopia, have called for a blanket debt write-off."

Pakistan should follow the course of Ethiopia mainly because of the fact that a 'temporary' nature of debt-repayment stay may most likely falls short in the face of deep global and national GDP contraction, where the recovery is now being expected as a prolonged (and therefore slow) U-shaped one on account of acute outflow of financial capital from emerging markets to the safety of countries mainly to the global north, and expected marked drop in exports earnings and remittances in turn; problems of a longer nature given the strength of the shock, and the deep level of uncertainty associated with the pandemic. In fact, according to estimates, this year remittances to developing and emerging world are likely to fall by $100 billion. Moreover, oil and gas revenues of net exporters among developing countries are expected to fall by around 82 percent this year, and exports to feel the heat given global trade to shrink by as much as 32 percent; while financial capital that has already flown out of these countries has been remarkably high at more than $100 billion since January 21, 2020, according to International Institute of Finance!

Temporary debt stays of the nature that were offered after the global debt crisis of 1982 in the shape of the 'Baker Plan' of a more transient nature that failed to deliver any meaningful cushion to developing countries back then and being unfortunately repeated by the G20 group of countries in the current crisis. That a more long-term debt-moratorium should be offered by bilateral and multilateral creditors - given the deep nature of crisis for emerging and developing countries in particular as indicated above - is all the more necessary on two counts. Firstly, private companies in emerging and developing countries borrow primarily in terms of dollars. The dollar-denominated debt of emerging countries since the global financial crisis in 2008 has already doubled.

Secondly, except for four emerging economies - South Korea, Singapore, Mexico, and Brazil - the rest among the group of emerging economies do not have swap lines with the US Federal Reserve. It means that the dwindling capacity of emerging and developing countries to deal with debt repayments and balance of payments issues (for the reasons indicated above) will be on a reducing trajectory, and Baker-type plans will be too little given the gravity of the current crisis. Berry Eichengreen in his recent article 'Managing the coming global debt crisis' points out this weak global response to cushion developing countries against difficult debt situation they face, by arguing: "The Baker Plan likewise proceeded on the premise that the shock was transient and that a temporary debt standstill would be enough. Creditors would roll over their loans. Growth would resume. Interest arrears then would be paid off once the crisis passed. This of course was not the case... Today's crisis is also being treated as temporary, with a moratorium on interest payments and a promise of commercial credits remaining valid only through the end of the year. The reality is different. Weak global growth and depressed primary commodity prices will persist. Supply chains will be reorganized and shortened, auguring further disruptions of trade. Receipts from tourism and remittances will not pick up anytime soon. And unless the debt overhang is addressed, capital flows will not resume."

In fact, unlike the transient nature of solution in terms of mainly short-term 'stays' being offered by bilateral and multilateral creditors, including a small level of emergency financing offered, the debt situation, which was already very tough for emerging and developing countries, and is only to get even more acute in the wake of the pandemic, requires a more substantial debt-support programme by bilateral and multilateral creditors. In fact, a former staff official of IMF, Peter Doyle in his recent paper that he wrote for the National Institute for Economic and Social Research, he sharply criticised the debt relief initiative of G20 as being very weak, since rather than catering to the 'overall' needs of these countries in terms of debt relief, G20 initiative only related to the amount these countries had borrowed from them. Similarly, a former assistant secretary for US Treasury, Ramin Toloui, found the debt challenge facing the emerging economies as 'enormous' because "the withdrawal of money [from EM funds] is greater and more sudden than in 2008, the economic shock is huge and the path to recovery is uncertain than it was after the last crisis."

Moreover, UN DESA (United Nations Department of Economic and Social Affairs) highlighted the lukewarm global response and the associated dangers of this in the following words:

"The global community has offered partial debt service suspensions to 76 low-income countries, and the IMF has offered debt service relief to 25 of the poorest countries. These do not cover commercial and multilateral debt or middle-income countries, and will not suffice to avoid defaults. Debt distress will impede countries' efforts to combat the coronavirus pandemic and derail progress towards the Sustainable Development Goals (SDGs)... Despite near zero global interest rates, borrowing costs for most developing countries have risen; credit spreads on emerging market sovereign bonds more than doubled from the beginning of the year to April, widening to more than 600bps... Median public debt in developing countries grew almost 15 percentage points of GDP from 2012 to 2019 (from 35 percent to 51 percent of GDP)."

The question how to deal with emerging and developing countries' concerns with regard to rescheduling with private creditors, in terms of risking their credit ratings with a negative impact in terms of raising future debt with these creditors has been answered by Berry Eichengreen. He, for example, argues: "This debt crisis is also a humanitarian crisis and a global public-policy crisis. The appropriate entity to organize the response is therefore the International Monetary Fund, not the Institute of International Finance, the house organ of the creditors (as recommended by the G20). As a United Nations organization, the IMF could request that Chapter VII of the UN Charter be invoked to shield debtors from disruptive legal action by opportunistic investors. A crisis of this magnitude warrants no less."

Given the particular difficulty the emerging and developing countries including Pakistan, find themselves in with regard to effectively dealing with the component of debt owed to private creditors, there is a need for the IMF to readily make available its special drawing rights (SDRs) in supporting countries to better deal with the crisis, both overall and especially in terms of managing debt owed to private creditors, and without worrying about hurting their credit-ratings. But the US will be required to refrain from vetoing such a move as it currently has done.

As, David Lubin, in his article 'IMF's $1tn lending power is not all it is cracked up to be' in Financial Times points out: "One way out of this might have been an emergency allocation of special drawing rights, a tool last used in 2009. This would credit member countries' accounts with new, unconditional liquidity that could be exchanged for the five currencies that underpin the SDR: the dollar, the yen, the euro, sterling and the renminbi. That will not be happening, though, since the US is firmly opposed, for reasons bad and good. So in the end the IMF and its shareholders face a huge problem. It either lends more money on easy terms without the "collateral" of conditionality (borrowing government tighten its belt and exercise restraint in public spending), at the expense of undermining its own balance sheet; or it remains, in systemic terms, on the sidelines of this crisis."

With regard to dealing effectively with private creditors, Nobel laureate Joseph Stiglitz, among others, appreciated the strategy formulated by Argentina, recommending it as a way forward for the international financial community. This approach is highlighted by Stiglitz and others in their recent article 'Restructuring Argentina's private debt is essential'. It can be stated as follows: "Against the backdrop of this global emergency, Argentina is spearheading its public debt-restructuring process in a constructive manner, in good faith, and with the support of all domestic political sectors... Argentina has presented its private creditors a responsible offer that adequately reflects the country's payment capacity: a three-year grace period with a minor cut in capital and a significant cut in interest... At this exceptional moment, Argentina's proposal also presents an opportunity for the international financial community to show that it can resolve a sovereign-debt crisis in an orderly, efficient, and sustainable manner. The absence of an international legal framework for sovereign-debt restructuring should not deprive indebted countries of the possibility to protect their people and provide for economic recovery during the greatest global crisis in our memory." Hopefully, other emerging and developing countries, including Pakistan, will take a leaf out of this strategy.

According to Jubilee Debt Campaign, "sixty-four countries spend more on debt payments than health." This list of 64 countries includes Pakistan. In 2019, the government spending as percentage of revenue in Pakistan was only 6 percent while external debt service as percentage of revenue stood at 26.5 percent. It is therefore important that developing countries could safeguard needed spending for health sector in particular in the midst of coronavirus outbreak. One important component in this regard is better management of debt servicing. This is all the more important since poverty is expected to rise as a consequence of pandemic and its manifestation as a severe economic crisis that has quickly unfolded in the wake of the pandemic. In this regard, while the World Bank estimates addition of as many as 60 million people to the pool of 'extreme poverty' - defined by World Bank as people 'living on less than $1.90 per person per day' - the UN puts this number at 130 million people likely to be pushed below extreme poverty by the current crisis. In addition, the UN expected global economy to contract by $8.5 trillion as a result of the crisis, while global GDP growth rate this year is projected to reduce by 3.2 percent.

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

He tweets@omerjaved7