2021: Time for US Leadership on Multilateralism and a Sustainable Recovery
Kevin P. Gallagher offers Biden four bold steps to put the global economy and the US' global standing back on track.
The year 2021 is year two into the most important decade of the century where drastic reductions in carbon dioxide emissions and inequalities are paramount to the survival of the world’s people and planet earth itself.
Yet, 2020 saw the biggest economic downturn since the Great Depression, pushed 150 million into extreme poverty. 2020 was also the hottest year on record, triggering forest fires, hurricanes, droughts, and other extreme events that accentuated the economic shock the COVID-19 pandemic brought to the world economy.
In this context, many emerging market and developing countries start 2021 desperate for liquidity, or in fear of default. Almost all will face a debt overhang that could take many decades to come out from under. Last year, despite being battered by the United States, the G20 took important some steps to stem the worst of these fears, but those steps fell far short of what is needed.
The United States bears major responsibility for the current global distress and must take a leadership role in solving it. The new US President Joseph R. Biden should join the calls on the G20 by former central bankers, finance ministers, and others to hold an emergency summit to provide liquidity, debt relief, and new financing that ties subsequent recovery efforts to our shared global climate and developing goals.
Without bold action to prevent and mitigate debt distress across the world, millions more people will be pushed back into extreme poverty, shared goals will be derailed, and there will be an overall drag on economic growth that will imperil the economic and political recovery in the United States and beyond. With bold action, the US can help spur a sustainable global recovery and regain its standing on the world stage.
The COVID-19 Debt Tsunami
Debt levels in many countries were raising alarms even before the COVID-19 pandemic and associated economic havoc spread across the world in 2020. More than a decade of unprecedented expansionary monetary policy in the United States in the wake of the financial crisis led to a tidal wave of debt to emerging market and developing countries. That debt appreciated exchange rates and increased aggregate demand, and created an illusion of strong collateral to take on and pour on even more debt. China and other countries with outsized current account surplus countries rode these waves to make massive bilateral loans across the developing world as well.
By December 2019, the International Monetary Fund (IMF) sounded the alarm that global debt had reached $188 trillion and that two-fifths of low-income countries were at high risk of, or already in, debt distress. One year later, global debt levels are now $270 trillion and projected to rise, emerging market and developing country debt is upwards of 180 percent of GDP.
Advanced economies with key currencies have been able to mount bold fiscal and monetary responses in the trillions of dollars, but emerging market and developing countries largely lack such options. In the midst of capital flight, exchange rate depreciation, volatile commodity prices, and ensuing recession, many emerging market and developing countries have had to pay back international creditors at the expense of addressing their essential needs in a time of crisis. In Latin America—the region hit hardest by the pandemic economically—the United Nations estimates many countries are deploying 30 to 70 percent of government revenue just to service debt.
The IMF and the United Nations Conference for Trade and Development each separately estimated the immediate financing needs of emerging market and developing countries are upwards of $2.5 trillion. The IMF only has roughly $1 trillion to help, with just $388 billion accessible to emerging market and developing countries.
Meanwhile, sovereign credit rating downgrades in 2020 surpassed the peaks in all previous economic crises. Standard and Poor’s downgraded upwards of 60 countries in 2020 and gave negative outlooks (which often lead to downgrades) for 31 more. Six countries — Argentina, Ecuador, Belize, Lebanon, Suriname, and Zambia defaulted on their debt in 2020, with Argentina and Ecuador having to restructure.
The nature of debt in the 21st century is quite complex. During debt crises of the 1980s and 1990s, most debt by developing countries was owed to a handful of Western governments and international institutions that could gather under the auspices of the Paris Club to renegotiate debt workouts.
Going in to 2020, the debt stock for emerging market and developing countries was roughly 33 percent owed to international financial institutions, such as the IMF and World Bank, 32 percent to private bondholders scattered across the world, and 28 percent for bi-lateral creditors with the remainder owed to commercial banks. What is more, the group of bi-lateral creditors is now broader—with China, not a member of the Paris Club, as the largest bi-lateral creditor to emerging market and developing countries.
Loud Call, Timid Response
Early in 2020, there was a chorus of voices calling for new liquidity and debt relief for emerging market and developing countries, from IMF managing director Kristalina Georgieva, to the President of the People’s Bank of China, European leaders, the United Nations, and outside experts. These calls fell in three categories—a major issuance of the IMF’s ‘Special Drawing Rights’ (SDRs), debt relief, and new concessional finance. SDRs are international monetary assets issued by the IMF analogous to the way central banks issue currency, and can be sold or used for payments to other central banks and international financial institutions.
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. Nonetheless, development banks and the IMF did pledge to mobilize 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 over $2 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. First, the DSSI lacks incentive for meaningful participation from private creditors. Thus, suspended payments from bi-lateral creditors may have to go to private bondholders rather than toward attacking the virus and protecting the vulnerable. International financial institutions are not participating in the DSSI either, arguing that participation would damage their preferred creditor status and make it harder to disperse new financing during the recovery. Furthermore, the scheme only extends to the poorest countries and not to middle income countries that may find themselves in debt distress. Yet, five of the six countries that defaulted in 2020 were middle income, only Suriname was DSSI eligible. Of 150 million that may have already been pushed into poverty during the COVID-19 crisis, 80 percent reside in middle income countries.
Lead by Example
At year’s end, it became clear the G20’s DSSI scheme would not go far enough and a ‘Common Framework for Debt Treatments Beyond the DSSI’ was adopted. The ‘Framework’ would grant deeper debt relief and potentially cancellation of bilateral official debt for DSSI countries that are deemed to have unsustainable debt as a consequence of an IMF-World Bank Debt Sustainability Assessment (DSA).
There remain major limits to this approach as well. Many of the details are yet to be worked out and relief deals are said to be subject to ‘domestic approval procedures.’ A case-by-case approach gives creditors an upper hand and creates incentives for miserly deals. And again, there may be a lack of incentive to participate due to looming credit downgrades and little meaningful participation by the private sector. Applicants to the new framework are asked to ‘seek’ comparable treatment from the private sector. Middle income countries are still excluded, as is debt to international financial institutions.
Given the times and the complexities involved, it is a wonder these important steps were taken at all. The United States had played a major leadership role at the G20 and IMF in 2009 in issuing new SDRs and securing more financing for the IMF and helping to coordinate across the system. In 2020, the Trump administration showed little interest in multilateral responses to the crisis, leaving the November G20 meeting to play golf. Even in the US absence however, the country stood in the way of a new SDR allocation, new forms of capital into multilateral institutions, and any hint at pressuring banks and bondholders.
President-elect Biden desperately needs to put the US economy on 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.
Four steps would put the global economy and the US global standing back on track:
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 well, as it would not take an act of Congress, but a larger allocation could potentially be part of Biden’s initial stimulus bill.
Trigger new concessional financing and grants to emerging market and development 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.
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 debt restructuring reign in the private sector to participate 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.
Under the Trump Administration the United States stood in the way of a proper economic response to the COVID-19 crisis. Biden should stand up and lead by example. The US can reverse its resistance to an SDR allocation, provide new bilateral financing, and comprehensive debt relief through pressure on the private sector that is linked to climate and development outcomes. Such action would put the world economy on a better path, restore US standing in the multilateral realm, and give the US the legitimacy to criticize others less willing to lead.
Kevin P. Gallagher is professor and director of the Global Development Policy Center at Boston University. He serves as co-chair for the ‘Think 20 Task Force on International Finance’ at the G20 for 2021. Follow him on Twitter: @KevinPGallagher