The developing world is facing a wave of government bankruptcies as a result of the coronavirus outbreak that will probably leave past bouts of emerging markets turmoil in the shade.
Creative solutions are needed to prevent the crisis from becoming a cataclysm that exacerbates pressure on the financial system.
The scale and breadth is exceptional. More than 100 countries have already appealed to the International Monetary Fund for help, which warned in its flagship outlook on the global economy that emerging markets are facing “the perfect storm”. A flurry of sovereign defaults is inevitable.
Fortunately, the international community is not blind to the brewing debt crisis. The IMF has already cancelled six months of debt payments due from 25 countries such as Afghanistan, Haiti, Rwanda and Yemen, while the G20 countries have agreed to freeze the bilateral debts of 76 poorer developing countries.
They have called on private sector creditors — largely banks, bond funds and other commercial lenders — to do the same.
Unfortunately, for a host of reasons, organising a voluntary, broad-based debt payment freeze for emerging economies is exceptionally challenging — perhaps impossible.
There is no supranational legal mechanism to compel a disparate group of investors into debt standstills for an equally motley bunch of stricken countries. Even creditors that agree might see their generosity only benefit others that refuse to countenance one.
Moreover, some countries might blanch at an enforced de facto default that could stain their creditworthiness for years to come.
That raises the possibility of a rolling series of ad hoc, chaotic defaults and individually negotiated standstills and debt restructurings. The ramifications would be immense for swaths of the developing world, and the damage inflicted would ratchet up tensions in the still-vulnerable global financial system.
However, a handful of prominent financial and legal academics have offered up an intriguing and at least theoretically viable solution that would offer vital relief to many developing countries, avoid technical defaults and even appeal to many creditors.
At the heart of the proposal is the World Bank setting up a “central credit facility”. Countries that want relief should deposit any debt payments to this facility, rather than the accounts of creditors. The CCF would be topped up by money from the World Bank or IMF, and then lend the money back to the countries at concessional rates to mitigate the effects of the coronavirus crisis.
In practice, this amounts to a standstill, with any debt payments funnelled straight back to stricken debtor countries, with beady-eyed monitoring to ensure it isn’t wasted.
Countries would have to ask creditors to formally accept that making payments into the CCF — rather than their designated fiscal agent — would constitute a full legal discharge of their obligations, thereby avoiding a default. When the coronavirus crisis has abated, a more considered decision can then be made on whether a country does need debt relief, and if so how much.
Creditors agreeing to this may seem like a stretch, but there is a carrot: the money in the credit facility would be mingled with aid money from the supranational organisations. The World Bank and IMF are considered “super-senior” in any debt restructuring, and never take a haircut. So any money that creditors agree to funnel into the CCF would be shielded.
Of course, a stick may also be necessary to compel reluctant creditors to go along with this. The proposal suggests that the G20 declare that the coronavirus had triggered a “state of necessity” to encourage recalcitrant creditors.
This is a reference to the International Law Commission’s articles on responsibility of states for internationally wrongful acts, where a clause stipulates that countries can invoke “necessity” to excuse not fulfilling an “international obligation” if this is the only way to counter “a grave and imminent peril”.
It is hardly a silver bullet, but it is a legal ploy that could help shield countries against aggrieved creditors that seek redress through the courts.
It is an elegant solution. Moreover, it is one that could probably be implemented quickly. But it does have some pitfalls. For example, despite the “necessity” doctrine it would still likely require heavy-handed moral suasion by a US administration that might be disinclined to help developing countries jilt often US-based creditors.
Yet the sense that the international community is open to radical solutions was underscored by IMF managing director Kristalina Georgieva last week, who said that the fund “may need to venture even further outside our comfort zone” and consider “whether exceptional measures might be needed in this exceptional crisis”.
She is right. This is no time for intellectual cowardice and muddle-through. Emerging markets desperately need help, and this proposal offers a viable palliative. Officials should consider it seriously.
Twitter: @robinwigg
