Opinion – Martin Wolf: The imminent threat of the financial long Covid

Economic activity contracted in 90% of the world’s countries in 2020. This exceeds the proportion achieved by the two world wars, the Great Depression and the global financial crisis. A pandemic, as we know, is an all-encompassing disaster. It also means poor health and social and economic disruption. Among its most enduring legacies may be financial ones, especially in emerging and developing countries. The specter of a lost decade hangs over vulnerable nations. Decisive action will be required to avoid it.

That’s the subject 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 finance expert. global.

She comments: “In 2020, the total average debt burden of low- and middle-income countries increased by approximately 9 percentage points over previous decades. Fifty-one countries (including 44 emerging ones) experienced a downgrade in their debt credit rating. sovereign”. Fifty-three percent of low-income countries today are considered to be at high risk of a debt crisis.

Sharp increases in debt were a necessary reaction to the pandemic. In fact, the problem with most emerging and developing countries was that they could only borrow very little, with serious consequences for their populations. Partly as a result of this, Covid has increased inequality not only within countries but also between them. The number of people in extreme poverty grew by 80 million in 2020, the biggest leap of its kind in a generation.

Unfortunately, these losses can persist. One reason is that while the pandemic may be receding, the supply of vaccines and other treatments remains highly uneven around the world. Another is that some important sectors, such as tourism, can take a long time to recover. Another is the interruption of education. Yet another is that small businesses and informal businesses on which a large portion of the populations of developing countries depend were forced to close during the pandemic.

But the most important source of “long economic Covid” will likely be financial hardship. Emerging and developing countries not only have historically high percentages of public debt in relation to GDP. They also have other symptoms. Among other things, comments the WDR, there have been leaps and bounds in sub-Saharan African governments, as well as clear signs of corporate crisis.

The balance sheets of households, non-financial corporations, financial corporations, government and foreign creditors are interlinked. These links are always opaque. However, this is deliberately true this time around. As the WDR notes, “in many countries, the response to the crisis has included large-scale debt relief measures such as debt moratorium and credit reporting freezes.”

Many of these policies are new. No one knows what will be revealed when tolerance reaches its necessary end. But the combination of lower government support and the scale of outstanding debt is sure to lead to jumps in nonperforming loans. This last problem will weaken credit, starting a negative feedback loop with the real economy. What is true within countries is even more true between them, with the exception that debtors cannot handle external debt unaided.

The WDR’s main recommendation is to face bad debts head-on. As Reinhart says, “Early detection and rapid resolution of economic and financial weaknesses can make all the difference between a robust economic recovery and one that falters — or worse, delays the recovery altogether.” But governments will inevitably find that some of the losses will fall on their own weak balance sheets, which will exacerbate sovereign debt problems.

The history of managing the necessary sovereign debt restructuring is a terrible one. On average, the process takes about eight years. Meanwhile, the economy and people suffer. It is in the aggregate interest to quickly resolve unpayable debt situations and thus allow the country to grow again. Unfortunately, it is not in everyone’s individual interest to do so.

This problem has worsened as the composition of the creditor community has changed, especially with the much larger roles today of the private sector and China: in 2019, the former held 59% of emerging and developing country debt and the latter held another 5 %. China held up to 11% of the debts of low- and lower-middle-income countries. Their participation should, at the very least, become much more transparent than it is today.

Ideally, we would have the sovereign debt restructuring mechanism proposed by the IMF two decades ago. In their absence, we will need the persuasion of leading international organizations and governments. In the medium term, debt contracts should be more flexible than they are. As it stands now, the necessary debt restructurings will be protracted and messy.

Recovery from the pandemic will be slow in many emerging and developing countries, which lack the medical and financial means to adequately deal with it. Also, we should now expect higher interest rates in the US and elsewhere. This will almost certainly generate disproportionate increases in risk margins as well as capital flow reversals. The only good news for many of these countries is high commodity prices.

Leading policymakers need to recognize risks, especially financial ones, for a truly global recovery. A lost decade for a number of poor countries would be inconceivable. It would also exacerbate the threat of social and political instability. They’ve been warned.

Translated by Luiz Roberto M. Gonçalves