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Commentary: Emerging markets need fresh finance not debt moratoriums

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BOGOTA: Many are calling for a temporary moratorium on all debt repayments by developing and emerging economies, in order to prevent the COVID-19 pandemic from triggering a tsunami of sovereign defaults.

Rather than waiting passively until debtors stop meeting their obligations, the argument goes, creditors would be better off agreeing now to suspend repayments for a while.

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But although a comprehensive debt-repayment freeze could help many low-income countries that lack a better option, it could be counterproductive for emerging economies that currently retain access to financial markets.

MORATORIUMS WILL NOT WORK

What these countries need now are more capital inflows, not restrictions on outflows.

Payment suspensions pose two problems.

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First, emerging economies need new net financing – in other words, more resources than would be made available by freezing their debt-service obligations.

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Second, countries that participate in a repayment standstill will face legal action by some bondholders, compromising their future access to capital markets.

A debt standstill would be particularly problematic for countries with significant foreign investment in their local-currency capital markets.

A stampede for the exits by foreign investors would put even more pressure on emerging-market currencies, thus driving up inflation and limiting the liquidity available to mitigate COVID-19s economic consequences.

Italy needs money, but worries about spooking debt markets. (Photo: AFP/Filippo MONTEFORTE)

Imposing capital controls to prevent financial outflows is equally ill-advised: capital would leave anyway and wreak havoc on its way out.

PRIVATE CAPITAL MAY SHY AWAY

While a debt moratorium would do emerging markets more harm than good, it would be unrealistic to expect private capital to provide the financing that these countries now require.

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True, several emerging economies tapped sovereign-bond markets on reasonable terms in April: Mexico placed US$6 billion of debt, Israel issued US$5 billion, Indonesia raised US$4.3 billion, Peru US$3 billion, and Paraguay US$1 billion, while Panama and Guatemala raised smaller amounts.

In addition, Qatar, the United Arab Emirates, and Saudi Arabia issued debt totalling US$24 billion.

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But these sums are small, relative to emerging economies need for an estimated US$2.5 trillion in financing this and next year.

Moreover, there is no guarantee that future bond issues will be successful.

Emerging economies are unlikely to experience a V-shaped recovery, which will worsen their credit profiles. Recovery will take time, and – like the virus – will come in waves, generating even greater uncertainty.

And as global economic numbers disappoint, investors will increasingly lean toward safer assets and reduce their exposure to emerging economies.

EXTERNAL SUPPORT MAY BE INSUFFICIENT

If neither a temporary moratorium nor reliance on private capital seems advisable, what is to be done?

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The business-as-usual response would be for emerging economies to seek additional support from the International Monetary Fund (IMF) and the multilateral (and regional) development banks (MDBs).

But these institutions are unable to provide the needed resources.

The IMF has at most US$1 trillion of firepower, while the MDBs can provide only a few hundred billion dollars more – reflecting these institutions inadequate capital and fear of losing their AAA credit ratings.

IMF Managing Director Kristalina Georgieva (C) said she discussed plans "to secure a sustainable and orderly resolution" to Argentina's debt situation on the sidelines of a G20 meeting in Saudi Arabia AFP/FAYEZ NURELDINE

And replenishing their capital will take years, owing to a number of hurdles – including in the US Congress – while funds are needed now.

SPECIAL PURPOSE VEHICLES

The solution lies with the central banks that issue reserve currencies and which therefore should be genuinely concerned about the health of the global economy.

In coordination with the IMF and the MDBs, they should establish a special-purpose vehicle (SPV) that would act as a bridge between the vast amount of currently available global liquidity and emerging economies growing financing needs.

Specifically, the SPV would issue bonds, which leading central banks would purchase under their own quantitative-easing (QE) programs, and then lend the proceeds to emerging economies.

With some credit enhancements, these loans could be securitised and traded like other financial assets.

The SPV would need some equity in order to attain the minimum credit rating required by the central banks that would buy its bonds: MDBs, as well as national governments, could provide it.

The MDBs would manage the structuring, oversight, and servicing of the new loans, which could be syndicated between the Read More – Source