Economic activity contracted in 90 per cent of the world’s countries in 2020. This exceeded the proportion hit by the two world wars, the Great Depression and the global financial crisis. A pandemic, we now know, is a comprehensive disaster. It also bequeaths ill health and social and economic disruption. Among the most long-lasting legacies could be financial ones, especially in emerging and developing countries. The spectre of a lost decade looms for vulnerable nations. Determined action will be needed to prevent this. (See charts.)
That is the theme of the latest World Development Report (WDR), entitled Finance for an Equitable Recovery, which was prepared under the direction of World Bank chief economist, Carmen Reinhart, a renowned expert on global finance. She notes, “In 2020, the average total debt burden of low- and middle-income countries increased by roughly 9 percentage points of the gross domestic product, compared with an average annual increase of 1.9 percentage points over the previous decades. Fifty-one countries (including 44 emerging economies) experienced a downgrade in their sovereign debt credit rating.” Fifty-three per cent of low-income nations are now seen to be at high risk of debt distress.
Sharp rises in indebtedness were a necessary response to the pandemic. Indeed, the problem for most emerging and developing countries was that they could afford to borrow too little, with grave results for their populations. Partly as a result, Covid has increased inequality not only inside countries, but also between them. Not least, the number of people in extreme poverty jumped by 80mn in 2020, much the largest such rise in a generation.
Alas, these losses may persist. One reason is that, though the pandemic may be receding, the supply of vaccines and other treatments remains highly uneven across the world. Another is that some important sectors, such as tourism, may take a long while to recover. Another is the disruption to education. Yet another is that the small businesses and informal enterprises on which a huge proportion of the populations of developing countries depend were forced to close during the pandemic.
Yet the most important source of “economic long Covid” is likely to be financial distress. Emerging and developing countries do not only have historically high ratios of public debt to GDP. They also have other symptoms. Among other things, notes the WDR, there have been jumps in arrears of governments in sub-Saharan Africa as well as clear signs of corporate distress.
The balance sheets of households, non-financial businesses, financial businesses, government and foreign creditors are interlinked. These links are always opaque. Yet that is deliberately true this time. As the WDR notes, “In many countries, the crisis response has included large-scale debt relief measures, such as debt moratoria and freezes on credit reporting.” Many of these policies are unprecedented. No one knows what will be revealed as forbearance comes to its necessary end. But the combination of declining government support with the scale of outstanding debt is sure to generate jumps in non-performing loans. The latter will then weaken lending, starting a negative feedback loop with the real economy. What is true within countries, is even truer among them, with the exception that debtors cannot deal with external debt unaided.
The WDR’s core recommendation is to tackle bad debt head on. As Reinhart says, “the early detection and swift resolution of economic and financial fragilities can make all the difference between an economic recovery that is robust and one that falters — or worse, one that delays recovery altogether”. But governments will then inevitably find that some of the losses will fall on their own weak balance sheets, which will aggravate problems with sovereign debt.
The history of managing needed sovereign debt restructuring is awful. On average, the process has taken some eight years. In the meantime, the economy and the people suffer. It is in the aggregate interest to resolve unaffordable debt situations quickly and so allow the country to return to growth. Unfortunately, it is not in everybody’s individual interest to do so. This problem has become worse as the composition of the creditor community has changed, especially with the far bigger roles today of the private sector and China: in 2019, the former held 59 per cent of the debts of emerging and developing countries and the latter another 5 per cent. China held as much as 11 per cent of the debts of low and lower-middle-income countries. Its holdings must at least be made far more transparent than they now are.
Ideally, we would possess the sovereign debt restructuring mechanism proposed by the IMF two decades ago. In its absence, we will need suasion from international organisations and leading governments. In the medium term, debt contracts must be made more flexible than they are. As it is now, necessary debt restructurings will be prolonged and messy.
Recovery from the pandemic will be slow in many emerging and developing countries, which lack medical and financial means to deal with it properly. In addition, we must now expect higher interest rates in the US and elsewhere. That will almost certainly generate disproportionate increases in risk spreads, as well as capital flow reversals. The sole piece of good news for many of these countries is high commodity prices.
Leading policymakers need to recognise the risks, especially the financial risks to a truly global recovery. A lost decade for a host of poor countries would be unconscionable. It would also aggravate the threat of social and political instability. They have been warned.
Follow Martin Wolf with myFT and on Twitter