By Kevin P. Gallagher, Professor and Director of the Global Development Policy Centre at Boston University & Co-chair for the ‘Think 20 Task Force on International Finance’ at the G20 for 2021
This blog is part of a thread looking more specifically at the impacts of the COVID-19 crisis in terms of capital flows and debt in developing countries.
The COVID-19 pandemic triggered the worst economic downturn since the Great Depression. World leaders were quick to convene through the G20 to try and stem the crisis but limited by the dismissal of the process by the United States. Newly elected US President Joseph Biden has just issued a game changing new Executive Order declaring that the United States Treasury shall “develop a strategy for how the voice and vote of the United States can be used in international financial institutions, including the World Bank Group and the International Monetary Fund, to promote financing programmes, economic stimulus packages, and debt relief initiatives that are aligned with and support the goals of the Paris Agreement.”
That strategy should be built around providing new forms of liquidity, debt relief, and new development finance that is aligned with both our Paris and development goals in the short term. When the world economy is back on track it will also be time to reform those very institutions to align them with those goals as well.
Biden joins a chorus of voices calling for new liquidity and debt relief for emerging market and developing countries, alongside new financing for a green recovery, from IMF managing director Kristalina Georgieva, to the President of the People’s Bank of China, European leaders, the United Nations, and outside experts. Indeed, just days before Biden’s Executive Order a group of 23 former finance ministers and central bank governors issued a statement calling for emergency action that included a major issuance of the IMF’s ‘Special Drawing Rights’ (SDRs), debt relief, and new concessional finance all linked to a green and inclusive recovery.
“Restructured debt and newly issued debt should be linked to a green and inclusive recovery, in the form of bonds linked to climate, as well employment and development performance.” #DevMattersTweet
The United States under the Trump administration did not join those calls, but played a key role at the G20 in blocking a new SDR allocation and new capital for international financial institutions, putting pressure on the private sector. Still, development banks and the IMF did pledge to mobilise their existing balance sheets and the IMF launched a fundraising appeal for the ‘Catastrophe Containment and Relief Trust’ that would allow certain low-income countries to pay back debts to the IMF.
And the G20 did respond on debt relief by establishing a ‘Debt Service Suspension Initiative’ (DSSI) that allows 73 low income countries to defer a portion of their debt payments through mid-2021. But close to half of the eligible countries would not participate, as they feared credit rating agencies would cut their access to further credit. For those countries that have participated, China has suspended the most payments thus far, engaging with over 23 countries and suspending just under $3 billion in payments.
The DSSI scheme was seen as a step in the right direction but fundamentally flawed, because it misaligned the incentives of the actors involved and does not gear the recovery in a sustainable manner. In another step forward, the G20 created the Common Framework for Debt Treatments Beyond the DSSI’ at year’s end. The ‘Framework’ grants deeper debt relief and potentially cancellation of bilateral official debt for DSSI countries, with Chad and Ethiopia being the first to apply.
President Biden desperately needs to put the US economy on a better footing and restore the country’s reputation across the world. His new government should call an emergency G20 meeting to put the world economy back on course. New liquidity is needed, as well as multilateral debt relief across all creditor classes. The United States has the tools to create the incentives to make this happen. Specifically, Biden’s team should:
“The strategy should be built around providing new forms of liquidity, debt relief, and new development finance that is aligned with both our Paris and development goals in the short term.” #DevMattersTweet
Endorse a new SDR allocation. Such a decision would come at no economic cost to the United States and bring great economic and political benefit. Denying the rest of the world SDRs while the US poured trillions of dollars into its own economy did not go unnoticed. Reversing course would go a long way in restoring the damaged global reputation of the United States, while helping nations pay back other central banks and importantly international financial institutions, such as the World Bank. If such allocations are held to less than $600 billion over the course of a few years, then such a policy would come at little domestic political cost, as it would not take an act of Congress. A larger allocation could potentially be part of Biden’s initial stimulus bill.
Trigger new concessional financing to emerging market and developing countries through the new International Development Finance Corporation, and through leadership on capital increases at the Inter-American Development Bank, World Bank, and beyond. Leadership here would give the US legitimacy to encourage Asian and European countries to bolster development finance as well. Finance should be toward a green and inclusive recovery that includes adjustment finance for firms and workers displaced by the transition to a cleaner economy.
Pressure the private sector to engage. The majority of bond contracts are held under New York law, though many in the City of London as well. Sean Hagan, former council of the IMF and now at the Peterson Institute for International Economics has pointed out that the United States could issue an executive order to limit the ability of private creditors from holding out on sovereign debt restructuring in the private sector and to maximise their participation in debt restructuring. Through its new International Development Finance Corporation or the World Bank, it could also offer Brady-like credit enhancements. Hagan also notes that the UK could update its law that required the private sector to participate in the IMF and World Bank’s Heavily Indebted Poor Countries initiative in the 1990s.
Link finance to a green and inclusive performance. Restoring liquidity, debt sustainability, and fiscal space across the world can help countries focus on a recovery from COVID-19 that ‘builds back better’ in alignment with our climate and development goals. But that won’t happen automatically. If we are truly going to ‘build back better’ we need rules and incentives to make it so. Biden should endorse proposals whose tenets have been endorsed in a 2021 letter by numerous former central bankers and finance ministers, whereby restructured debt and newly issued debt moving forward should be linked to a green and inclusive recovery in the form of bonds linked to climate, as well employment and development performance. Similar frameworks should be established for new development finance, fiscal recovery packages, and policy reform.