How can financial institutions ensure the global economy continues to function during the coronavirus outbreak? Elias Papaioannou, Professor of Economics at London Business School and Academic Director of the Wheeler Institute for Business and Development was joined in conversation with Pierre-Oliver Gourinchas, Professor of Economics, S.K. and Angela Chan Professor of Global Management, Haas School of Business and Director at the Clausen Center for International Business and Policy, to discuss measures that need to be put in place that will enable low-and-middle-income to invest in health services and protect their economies.
- Gourinchas has worked with a mix of top international economists to try and set out a clear path for emerging market economies through the COVID-19 crisis;
- Many middle-and-low-income countries will need relief on sovereign debt payments to external creditors and the suspension of payments for bilateral lending;
- The situation has become even more acute as the crash in commodity prices has a magnified impact in many emerging market economies as they are typically commodity exporters, hurting a source of revenue at their time of greatest need;
- A facility should be created where money owed to creditors is deposited, monitored by the World Bank or a regional development bank, and then allowed for flow back to the relevant country to pay for healthcare costs and measures to support their economy during the pandemic;
- There is also a role for the global community to reorient resources where they are needed through international health exchanges when the pandemic peaks in emerging markets;
- Warns against policies that reverse much of the progress that has been made in emerging economies and will cause long-term damage and unravel their capacity to cope with shocks, such as monetising debt, printing money or imposing additional controls.
Delaying interest payments and principal repayments on debt could provide emerging economies $800bn of short term support to fight COVID-19
Working with other international economists and lawyers, Gourinchas and his colleagues have advocated in CEPR that immediate action is needed to prevent disorderly defaults, litigations, and a collapse in the international debt market caused by measures that have inflicted severe costs on the global economy. This proposal would mean instead of paying back creditors, any money owed would be placed into a facility monitored by the World Bank or the African Development Bank, for example. This money would be recycled back to the country to help fund COVID-19 related expenses, such as healthcare or economic support. The creditor has a claim on the funds, but the interest payments and principal repayments are suspended throughout the period of the crisis. This could open up close to $800bn, or around 4.5% of these countries’ GDP.
Gourinchas stressed that this is necessary because the global nature of the pandemic means every country will have to face healthcare costs, as well as costs of supporting their economy. Rich countries can finance this by raising debt while emerging economies will also need to rely on the market to raise funds. However, they will find greater constraints, as while they will have enormous fiscal needs, access will be limited because the fiscally ‘safe’ countries are more attractive investment opportunities. Governments also need to look at how private borrowers and private creditors honour their debt obligations and consider if it is possible to provide relief when these contracts are under strain. Similarly, financial institutions in the advanced world are being supported by their central banks; they need to provide some of this relief to middle and low income countries.
It is not enough for low-and-middle-income countries to receive relief on the debt payments due to governments and supranational bodies, such as the IMF, or the suspension of payments for bilateral official lending between countries. According to Gourinchas, the private sector needs to be involved in a debt standstill for COVID-19. For this to happen, institutions such as the World Bank and other multilateral development banks need to create credit facilities for countries requesting temporary relief on interest payments, as well as principal repayments, to official and private creditors for use for emergency funding to fight the pandemic. He advocates that there needs to be a 12-month debt standstill from both bilateral and private-sector creditors.
Creditors will be amenable to the proposal, according to Gourinchas, because postponement of payments is a relatively small issue for them, while they would be generating a lot of goodwill. There is also the security of the World Bank or a Regional Development bank, who would be able to attribute preferred creditor status. Gourinchas believes that the doctrine of necessity recognises the fact that countries will need to suspend payments during the crisis, as they need to prioritise taking care of their citizens during the pandemic. The threat of courts deciding there is basis in the doctrine should be enough to encourage creditors to engage in this process.
A global financial system facing a ‘time bomb’
Further strain has been caused by the slowdown in global economic activity, which has led to a large-scale reduction in commodity prices. This has an outsized impact on emerging economies, which are often commodity exporters. This means their revenues have reduced just at the time when they have severe needs. Gourinchas also warned countries against unravelling the progress emerging economies have made running their fiscal and monetary policies. There will be a temptation to monetise debt, print more money or impose strict controls, which will set the country back in the long-term after the pandemic eases.
Gourinchas has also written about the ‘COVID-19 Default Time Bomb’. The world is facing a potential flood of disorderly sovereign defaults at a time when developing-country governments need to be spending huge sums on keeping their citizens healthy. To avoid a catastrophic outcome, the International Monetary Fund should coordinate a broad debt moratorium.
The IMF has calculated the gross financing needs of middle-and-low-income countries around $2.5 trillion; while the fund itself only has a trillion dollars of resources. The debt repayment standstill being proposed could release $800bn to flow back to countries, yet this is only part of what needs to a broader effort. There has been an attempt to scale up the fund as well as raise money through a Catastrophe Containment Relief Trust. However, central banks also need to extend measures to support middle-and-low income countries. Gourinchas also highlighted how the US Federal Reserve’s introduction of FEMA, which has put in place a repo facility that provides US dollars in exchange for US Treasuries temporarily, allowing dollar flows to reach all corners of the global markets and increasing the firepower of global institutions.
Monitoring efforts will be less prescriptive than post-2008 Global Financial Crisis
Historically, people have perceived the IMF as a vehicle for draconian austerity, which they are keen to avoid. There will need to be checks and balances in place to ensure that funds reach the right place, as many countries do not have the institutional capacity to ensure it goes to frontline healthcare costs or support measure for the local economy. This means there needs to be conditionality in place to make sure any money freed up through these initiatives have control from the ADB or World Bank to make sure funds are dispersed for specific uses. This crisis has been caused by an external shock, so these measures shouldn’t seek to change policy decisions made by governments in a similar way to how austerity measures were linked to IMF funding after the Global Financial Crisis.
Gourinchas also believes healthcare capacity that has been built up in industrialised economies in Europe that are through the peak of the COVID-19 crisis should be recycled to support emerging economies, who haven’t felt the full force of the virus yet. We should be thinking how spare beds and spare ventilators in Germany or in France can find their way to Nigeria or to India or Mexico.
Elias Papaioannou’s conversation with Pierre-Olivier Gourinchas is part of the Wheeler Institute’s COVID-19 series – bringing together the expertise and experience of our extended community to understand, illuminate and offer solutions to the challenges created by COVID-19. Our differentiating factor is the role of business in addressing these challenges, with a focus on the implications and actions for those in developing countries. If you’re interested in following the Wheeler Institute COVID-19 series, check out our previous episode.
Elias Papaioannou is academic director of the Wheeler Institute for Business and Development and professor of economics at London Business School, focusing on international finance, political economy, applied econometrics and growth and development.
Pierre-Olivier Gourinchas Pierre-Olivier Gourinchas is Professor of Economics, S.K. and Angela Chan Professor of Global Management, Haas School of Business and Director of the Clausen Center for International Business and Policy. Professor Gourinchas is the director of the International Finance and Macroeconomics research program at the NBER (Cambrige MA) and a Research Fellow with CEPR (London). Professor Gourinchas is also a co-editor of the American Economic Review and a former managing editor of the Journal of International Economics.