Emerging-market debt in the COVID-19 pandemic
We have to remember that pandemic is not only showing opportunities, but also bringing risks and threads, especially for emerging economies, with less financial reserves.
Global Economy and Finance Programme published interesting project called: ‘Rebuilding International Economic Cooperation’ which offers two proposals to help prevent sovereign debt crises in emerging markets.
Long story short (whole paper available below).
This briefing paper argues two points. The first is that while nervousness about an immediate global crisis of foreign-exchange-denominated debt currently seems unwarranted, there are good reasons to think that the conditions for such crises could easily build up over the next few years. In order to reduce those risks, policymakers and regulators should intensify their focus on emerging economies’ external balance sheets. Put bluntly: the risk of future debt crises can only really be reduced by limiting the accumulation of net foreign-currency-denominated external debt. The IMF’s metric for assessing reserve adequacy (ARA)2 should be placed at the centre of analyses of whether a country can take on additional foreign-currency liabilities.
The second point is that some emerging economies could face problems related to local-currency-denominated public debt well before they face problems related to foreign-currency-denominated external debt. This is particularly the case in countries where local bond yields are very high relative to expectations of future GDP growth. To address this threat to domestic solvency, the issuance of state-contingent liabilities – in the form of GDP-linked bonds – should be considered a priority.
Summary:
— The COVID-19 pandemic has raised concern about the risk of sovereign debt crises in emerging economies. Although most concern has centred on foreign-exchange denominated debt, governments could also encounter financing difficulties when seeking to borrow externally in their own currencies.
— To reduce the risks around foreign-currency debt, policymakers and regulators should increase their focus on emerging economies’ external balance sheets. In particular, the IMF’s metric for assessing reserve adequacy (ARA) should play a bigger role in determining whether countries can take on additional liabilities. — A number of emerging economies also face a more challenging international market for their local-currency debt. If external demand for such bonds remains weak, this could push up local-currency bond yields and increase the risk of these countries accumulating more foreign-currency debt to finance their spending needs.
— One way to address this would be to promote the issuance of GDP-linked bonds. This would boost investor returns in periods of higher economic growth, while reducing issuers’ debt servicing costs in periods of lower growth. Emerging economies can’t launch such a market on their own, however: developed countries will first need to establish the viability of such instruments by issuing GDP-linked bonds themselves, or provide high-level sponsorship of the idea.