During this global economic crisis, the President of the European Central Bank, Christine Lagarde, has already renewed the commitment made by her predecessor, Mario Draghi, in 2012, to do whatever it takes to safeguard the European economic and monetary union. The US Federal Reserve has deployed a series of multi-million-dollar measures for businesses and citizens to cushion the impact of COVID-19 on the country’s economy. It is estimated that developed economies, as a whole, have spent more than USD 8 trillion, i.e. approximately 10 percent of global GDP, supporting their citizens over the past three months.
Developing countries, on the contrary, do not have the resources for this whatever-it-takes approach. These countries’ currencies are not strong enough to print money to fund these stimuli without scaring international investors, and their ability to obtain resources on the market is also limited. International agencies are trying to help, but, for the time being, the figures involved are preposterously far below the 8 trillion mentioned above: so far the IMF and the World Bank have lent a total of 26 billion to developing countries.
The problem is that these economies are having to implement the same lockdown measures to fight COVID-19, with the consequent paralysis of their economies. In Latin America, where many countries are now facing the peak of infection, this indefinite blockade of the economy is beginning to create situations that are very difficult to manage in some countries. Protests are beginning to increase, as we have seen in recent days in Colombia, Argentina and Ecuador. In El Salvador, people who run out of food have begun to wave white rags to signal that they need help.
What can be done?
One tried-and-tested solution, which will be inevitable in some cases, is to negotiate a debt moratorium, which frees up resources for the most urgent needs. Argentina is currently in the process of renegotiating its debt with international creditors.
But while a debt moratorium could help many countries with no better option, it could be counterproductive for economies that currently retain access to financial markets. What these countries need now are more capital inflows, not restrictions on the outflow of funds.
As MAPFRE Economics explains in its latest quarterly Outlook report, emerging countries like those in Latin America are especially vulnerable because “the growing proportion of sovereign debt (which is owed to foreign non-bank institutions) has also meant an increase in debt service costs and an avalanche of obligations on international bonds due to mature relatively soon over the next decade.” The external funding needs of emerging countries are particularly relevant (current account balance and debt repayments) and account for between 8 percent and 25 percent of GDP. In these circumstances, the ability of emerging markets to cushion the downturn of this crisis seems extremely limited.
Faced with this situation, some experts are proposing new solutions. This is the case of Colombian economist Mauricio Cárdenas, who recently proposed, in a newspaper article, the creation of a financial vehicle by the IMF and the other multilateral organizations to issue debt on international markets with which to finance the most urgent needs of these countries. This debt, issued not by countries but by international institutions, would, in turn, be procured by the central banks of developed countries and by the large institutional investors, which have huge pockets of liquidity, which paradoxically now find themselves with no major investment alternatives with a reasonable risk-return binomial, in this era of negative interest rates and volatility in equity markets.
In the words of Colombia’s former finance minister Cárdenas, “this mutual fund would issue bonds, which major central banks would buy under their own quantitative easing (QE) programs, and then lend the resources obtained to emerging economies. These loans could be securitized and traded as other financial assets. The investment vehicle would need some capital to achieve the minimum credit rating required by the central banks that would buy its bonds: Multilateral agencies, such as the IMF or the WB, as well as developed-country governments, could provide this.”
This new tool could, in turn, serve as a risk mitigation device to attract more private capital to emerging economies. For example, it could provide capital guarantees for direct foreign investment in public-private partnerships during the post-pandemic recovery phase.
“Cárdenas’ proposal touches on two crucial aspects in the current situation,” says Manuel Aguilera, General Manager of MAPFRE Economics. “First, the growing tensions that emerging economies will soon begin to experience in order to serve their debt payments and, second, the need to seek mechanisms, beyond a moratorium, to address them. This would certainly be a smart way to deal with the problem. But the idea entails facing the huge challenge of coordinating and aligning international interests — the same challenge that economists at Bretton Woods faced in 1944, when the global economy needed to be rebuilt.”
In recent months, the unprecedented situation that the world has been dealing with has led to the rise of equally unconventional economic measures, such as the indiscriminate distribution of cash among citizens by the US, or the implementation of measures such as the minimum vital income that the Spanish government has just approved. But why consider such a measure? The consequences of a collapse of emerging economies as a result of COVID-19 would be felt, not only in these countries, but throughout the world.