When the covid-19 pandemic hit last year, one fear (apart from the medical and biological aspects of the virus) was what kind of effect it would have on the global economic order. With factories across China closing at the beginning of the outbreak and shipping at a standstill, there was a widespread panic among the general public that there was going to be a shortage of essential supplies and items.
A macroeconomic concern was what negative effect the pandemic would have on different sectors of the economy and the workforce, with the service sectors projected to be the hardest ones hit. Of course, the expected impact was not the same everywhere, the “less developed” economies in most scenarios would suffer more than the “advanced” or developed economies.
In reality, however, it was the developed economies in the West that initially suffered the most, with:
“an estimated output decline of 5.6 per cent in 2020, due to the strict and prolonged lockdown measures that were imposed in many European countries and some parts of the United States during the outbreak. The contraction was comparatively milder in the developing countries, with output shrinking by 2.5 per cent in 2020.”
-UN Department of Economic and Social Affairs
A year after the outbreak of the pandemic, the outlook has changed. The vaccination drive is at full speed in most of the developed world and the initial prognosis that had their economies contracting has now been revised to point toward a more optimistic outcome. “Global GDP growth is now projected to be 5.6% this year, an upward revision of more than 1 percentage point from the December OECD Economic Outlook. World output is expected to reach pre-pandemic levels by mid-2021”.
It is the developing world that is now feeling the full brunt of the economic fallout from the pandemic, with their economies shrinking and contracting. Their already fragile, and in some cases nonexistent, healthcare and welfare systems are struggling to handle what is a combination of a financial, health and social crisis.
As of the 9th of April, low-income countries had received just 0.2 per cent of all covid-19 shots given and with The Economist reporting that “more than 85 poor countries will not have widespread access to coronavirus vaccines before 2023”, things are looking ever more dire and bleak.
The most affected regions in the developing world were those in Latin America, the Caribbean, the Middle East and North Africa, which experienced declines of 7.7 and 6.3 per cent of GDP respectively. The think tank Eurodad concludes in an analysis of IMF’s fiscal projections that:
“budget cuts are expected in 154 countries this year, and as many as 159 countries in 2022. This means that 6.6 billion people or 85% of the global population will be living under austerity conditions by next year, a trend likely to continue at least until 2025.”
Eurodad, The Global Austerity Alert
The managing director of IMF, Kristalina Georgieva, recently asserted in a meeting that the world should brace itself and be ready for an emerging market debt crisis of huge proportions. She spoke of the possibility that with the global economy recovering from the pandemic and leading to a boom, central bankers in the West (fearing inflation) might be tempted to raise the interest rates in order to stop the economy from “overheating”.
This would have the effect of tightening or contracting the economy and would trigger significant capital outflows from developing economies. As Georgieva says ”This would pose major challenges especially to middle-income countries with large external financing needs and elevated debt levels”.
In short, capital would flee from developing economies, as they would be considered too risky, and rush back into “safe havens” (developed economies) where the interest rates are higher.
Debt in developing countries
Another report from Eurodad found that the public debt of developing countries:
“has increased from an average of 40.2 to 62.3 percent of GDP between 2010 and 2020. More than one third of the increase, equivalent to 8.3 percentage points, took place in 2020. Public debt increased in 108 out of 116 developing countries in 2020“
Eurodad briefing paper, A Debt Pandemic
The obvious reason for the increased indebtedness has been the pandemic, which has necessitated extraordinary measures.
With the urging of the IMF to borrow all they can now, “First fight the war, then figure out how to pay for it”, these countries have done all they can to weather the storm and the worst consequences of the pandemic. This may, however, lead to issues when the loans need to be repaid. With no plan to finance the repayment, affected countries may find themselves unable to pay once the pandemic subsides.
There is nothing inherently wrong with a large public debt, as long as the debt is in the country’s own currency, it does not necessarily create short term problems. The issue however is that developing countries have accrued debts denominated in a foreign currency. A country borrowing in its own currency cannot run out of money since it is the sole issuer of that currency and can simply (through the central bank) “print” more of it at will.
Due to how international trade is structured, what gets accepted as a means of payment is often a reflection of how power is structured in the global economy, with currencies such as US dollars, British pounds, Euros, Japanese yen (“hard currencies”) sitting at the top of the global financial system and function informally as world reserve currencies.
A developing country, even if it has its own currency, will find that it needs hard currencies to import basic items (food & medicine) since their own currencies are hardly accepted as valid means of payment when trading. This is one major reason why developing countries go into debt in a foreign denominated currency, and it’s especially relevant now in the pandemic with the economic crisis and fall in trade hindering these countries from accessing much needed foreign exchange reserves.
IMF, the World Bank and debt justice
Institutions like the IMF and the World Bank often look to the stability of the global system as a whole and would rather see no defaulting on debts, as they fear its destabilising effects.
One of the debt relief efforts they undertook last year was the Debt Service Suspension Initiative (DSSI), which provided temporary relief from debt repayments for 73 eligible poor countries, of which 46 took part. More specifically the DSSI allowed the countries involved to suspend principal or interest payments on their debts to G20 members from the 1st of May 2020 through the end of 2020 (it has now been extended through December 2021).
Lately, the IMF and G20 have discussed another proposal, the issuing of Special Drawing Rights (SDR). SDR´s are “ international reserve assets created by the IMF to supplement member countries’ official reserves. Their value is based on a basket of five currencies.” Since they are debt and conditionality free, an SDR allocation is an easy way to provide countries with needed cash liquidity without adding to their debt burdens.
However, there are two questions that remain to be solved, firstly, how large is the issuance of SDR´s going to be? The number that is being thrown around by the IMF is US$650 billion, although some UN agencies have called for more around US$2 trillion. The think tank Eurodad considers 650 billion to be too low and too insufficient for it to actually help the countries most affected. The number they are calling for is US$3 trillion.
The second question is when the issuance will happen. The IMF expects the final approval to come in August, for the IMF member states this would mean September or August at the earliest. Regardless of when or how much will be issued, whether it is US$650 billion or US$3 trillion, it’s a good initiative that cannot come soon enough for some countries.
There are lingering questions regarding whether the multilateral institutions are doing enough to help the countries most affected by the pandemic. There are critics who maintain that what IMF and the World Bank are prescribing as solutions are nothing but the same old Washington Consensus style policies that have been criticized for the terrible effects it has wrought on populations in developing countries. These policies usually consist of: Privatization of state-owned enterprises, liberalization of price controls and capital flows, deregulation of the financial sector, in short, less involvement of the state in social affairs and involving the market more.
There are other actors that say that debt relief or debt restructuring is not the answer but that the debt should be erased. Organisations like the Committee for the Abolition of Illegitimate Debt (CADTM) have been fighting for decades for the cancellation of debts in developing countries. Deleting the debt, or debt jubilees, has become a less controversial idea in the aftermath of the pandemic with some saying it is the only way to avoid a major economic depression.
Debt is a contentious issue and it will keep being one as the whole world recovers from the pandemic in the years to come and we discuss what kind of world we should construct.