Preventing a crisis in emerging markets

The economic crisis in Sri Lanka is deepening. The rupee has slumped to record lows against the dollar due to blackouts, food shortages and soaring prices. The country may have as little as $500m in foreign exchange reserves left, though a $1bn bonus is due within months. With the IMF ready to intervene, there is hope that the situation will stabilize. But fears are growing that Sri Lanka could be the first in a string of emerging markets to slip into economic turmoil.

The war in Ukraine represents another shock that, in the wake of the pandemic, could be enough to send several countries into debt distress. The scope of the problem is likely to be global, so solutions should be of a similar size and scope. Unfortunately, mustering enough international political will to patch the holes in the global framework for sovereign debt relief appears to be a herculean task.

Russia’s war in Ukraine leaves developing countries facing a double whammy. Soaring oil and grain prices have put importing economies under pressure, with countries like Egypt facing the prospect of drastically reducing their foreign exchange reserves to pay for them. On top of this comes the prospect of monetary tightening in the developed world.

In 2013, the slightest hint from the US Federal Reserve that it would scale back quantitative easing (the so-called gradual tantrum) was enough to drive money out of emerging markets. It remains to be seen what will happen in the event of a significant Fed balance sheet reversal. However, the outlook is not good: rates will rise and some developing economies may find that their debt burdens become unsustainable.

The road from there could be bleak. Spending cuts are likely to be made in an effort to meet bond payments as they come due. This kind of tax cut tends to exacerbate poverty, cut off growth paths and cause unpredictable social upheaval.

However, this course of events is not inevitable. For starters, the IMF should dust off its pandemic playbook and offer quick loans to vulnerable economies. This could be accompanied by relaxed conditions to adapt to the urgency of the situation, ensuring that countries spend what is necessary to meet the challenges of the moment.

In the medium term, gaps in the global approach to sovereign debt relief must be corrected. It is no longer enough to focus on the old clubs of Paris and London lenders: the days when emerging market creditors concentrated on this group are long gone. China now represents by far the largest bilateral lender to developing countries and the bonds have also been sold to a variety of private investors. According to the World Bank, at the end of 2020, low- and middle-income countries owed five times more to commercial creditors than to bilateral ones.

These lenders will have to cooperate if there is any hope of meaningful and proactive debt relief for emerging markets. The common framework agreed by the G20 in November 2020 offers a potential vehicle, but the will to use it is lacking. Creditors still fear that their concession agreement will simply become a covert means of redistribution to other lenders unwilling to play ball.

At a time of growing division, and with priorities elsewhere, the hope of rectifying these problems with the global sovereign debt framework may fade. It would be a great shame if this were so. Economic turmoil in emerging markets need not lead to serious crises. It is clear what needs to be done. The task now is to find the necessary political will to do so.

Letter in response to this editorial comment:

Linking debt relief to climate change is the way forward / By Kevin Gallagher, Director, Center for Global Development Policy, Boston University, Boston, MA, USA

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