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World Needs A New Order To Avoid Covid-fired Debt Crisis
By Naresh Minocha
Feb 19, 2021

THE Covid-19 virus is turning out to be more lethal than dozens of Hydrogen Bombs. Leave aside for a while human tragedy reflected in the death of a few million & health issues faced by countless survivors. Think of pandemic-linked economic destruction including steep rise in unemployment and poverty.

Worry now over the Covid-crafted foundation for the next global meltdown. This might occur in next 5-10 years if there is no multi-faceted global cooperation. The West should take the lead in debt restructuring & fair global trade in all spheres.

According to Global Risks Report, 2021 released last month, "businesses might suffer future paralysis or collapse under debt obligations. Reports already predict defaults on a significant proportion of public and private loans in Brazil, India, and the United Kingdom. Global Risks Perception Survey (GRPS) respondents echo these concerns: 'asset bubble burst' and 'debt crises' appear as critical threats in the medium term".

The Virus coaxed regimes to embrace lockdowns, pushing the global economy into unprecedented contraction. Lockdowns thus wiped out the income gains of 10 years in several developing countries. The lockdowns also exacerbated other diseases such as tuberculosis and AIDS due to disruption in non-Covid healthcare services.

As put by the World Bank President, David Malpass, Covid has "knocked more economies into simultaneous recession than at any time since 1870. It has ended a two-decade streak of steady global progress in poverty reduction, pushing up to 150 million people into extreme poverty by 2021".

In the foreword to International Debt Statistics (IDS) 2021, Mr. Malpass adds: "The risk is that too many poor countries will emerge from the COVID-19 crisis with a large debt overhang that could take years to manage. To build durable economic recoveries, countries will need to achieve long-term debt sustainability".

The lockdowns have sapped tax & non-tax revenue streams, forcing confused governments to borrow more to finance economic stimuluses, transient welfare schemes and the soaring fiscal deficits. The lockdowns have also disturbed capital flows across the world in varied ways.

Covid, in turn, saw lockdown as an apt eco-system to spawn thousands of its new strains. Some of these variants are now causing fresh surges in infections in different regions. Time would tell whether the societies or the Virus benefited more from prolonged and recurring lockdowns.

The pandemic recession-hit world is now faced with grave danger of meltdown similar to the 1930 depression. Unsustainable debt has driven several poor countries towards default or debt distress.

The precise data on total size of debt balloon comprising government or public, corporate and household borrowings is hard to come by. This is because institutions are constantly struggling to secure debt transparency and accordingly modifying the norms to quantify total debt.

In a document captioned 'Attack of the Debt Tsunami' dated 18th November 2020, Institute of International Finance (IIF) observes: "Global debt has surged by over $15 trillion since 2019, hitting a new record of over$272 trillion in Q3 2020. As the fiscal response to the pandemic continues, we expect global debt to hit $277 trillion (365% of GDP) by end-2020".

Washington-based IIF is the global association of the financial industry, with more than 450 members from more than 70 countries. It, among other studies, publishes quarterly Global Debt Monitor.

In its weekly insight dated 3rd December 2020, IIF updated its data. It notes that "global debt is estimated to reach nearly $275 trillion in Q3 2020-some $2.5 trillion higher than our previous estimate".

Another IIF document states: "Global debt has piled up at an unprecedented pace since 2016, increasing by over$52tn vs a $6tn rise over 2012-16; Less bang for the buck: the capacity of debt to generate growth is diminishing, and investment remains subdued; EM (emerging market) governments face increasing interest burdens, notably in Turkey, India, South Africa, and the Philippines; Small businesses have seen a much bigger increase in debt-to-revenue ratios than have larger firms".

It is here pertinent to bring in a 2010 WB study titled 'Finding The Tipping Point - When Sovereign Debt Turns Bad'. The Study team looked at certain data from 101 developing and developed economies spanning period from 1980 to 2008. It arrived at a threshold of 77 percent public debt-to-GDP ratio. If debt is above this threshold, each additional percentage point of debt costs 0.017 percentage points of annual real growth.

The Study concluded: "The effect is even more pronounced in emerging markets where the threshold is 64 percent debt-to-GDP ratio. In these countries, the loss in annual real growth with each additional percentage point in public debt amounts to 0.02 percentage points. The cumulative effect on real GDP could be substantial".

Unlike sovereign debt, there appears to be no threshold above which total global debt is considered to act as a constraint on the growth. There is no defined danger mark, where debt pileup triggers series of sectoral or country-specific defaults. These, in turn, create knock-on effects across economies, resulting in global or regional meltdown as has happened on three earlier occasions.

The current debt accumulation, considered the 4 th wave of debt, started in 2010. Experts should decide whether Covid-led continuing spikes in global debt should constitute the fifth debt wave or a surge that would turn 4 th wave into global tsunami.

As put by a World Bank (WB) Report, "The pandemic has made the fourth wave of debt even more dangerous by strengthening its risky features. The sheer magnitude and speed of the debt build-up runs the risk that not all of it will be used for productive purposes. For now, unprecedented monetary policy accommodation has calmed financial markets, reduced borrowing costs, and supported credit extension. However, amid the economic disruption caused by the pandemic, historically low global interest rates may conceal solvency problems that will surface in the next episode of financial stress".

The WB Report 'Global Economic Prospects' released last month explains: "This wave was preceded by three previous debt waves since the 1970s, all of which ended with widespread financial crises. The first global wave of debt spanned the 1970s and 1980s, with borrowing by governments in Latin America and in low-income countries, particularly in sub-Saharan Africa. This wave saw a series of financial crises in the early 1980s. The second wave ran from 1990 until the early 2000s as banks and corporations in East Asia and the Pacific and governments in Europe and Central Asia borrowed heavily, and ended with a series of crises in these regions in 1997-2001".

It adds: "The third wave was a run-up in predecessors: policy frameworks were stronger in some EMDEs and debt in advanced economies was broadly flat. private sector borrowing in Europe and Central Asia (as well as in advanced economies), which ended when the global financial crisis disrupted bank financing in 2007-09 and tipped many economies into sharp recessions".

Drawing parallels between 1918 & current influenza pandemics, a United Nations (UN) report cautions: "unsustainable debt levels, an increasing risk of market volatility, and growing inequality-exacerbated by the COVID-19 pandemic-must serve as a serious warning signal".

The UN report 'World Economic Situation and Prospects 2021' says: "On a GDP-weighted basis, the global public debt-to-GDP ratio is projected to have increased from 106 per cent in 2019 to 127 per cent in 2020. Globally, government gross debt is projected to have increased by $9.9 trillion-12.3 per cent of world output-in 2020. This represents the largest increase in public debt in any given year. In contrast, public debt increased by $4.2 trillion in 2009, when Governments hurriedly deployed their financial resources to confront the fallout of the global financial crisis".

Released on 25th January 2021, the UN Report notes that as of 30 September 2020, 35 low-income countries were either in debt distress or at a high risk thereof according to the IMF/World Bank debt sustainability analysis.

Many such countries have already secured deferment of interest and principal payments from multilateral and bilateral creditors and Paris Club. It is an informal group of rich nations and other official creditors that decides by consensus how to bail out debt-burdened countries.

In April 2020, G20 launched Debt Service Suspension Initiative (DSSI) with cooperation of several multilateral entities to help debt-burdened, poorest countries fight covid. DSSI is valid till June 2021. It has provided $ 5 billion relief to 43 eligible countries. The validity should be extended till herd immunity, coupled with vaccination, sends Covid into the league of seasonal flu viruses.

DSSI is, however, a transient measure. It only postpones risk of sovereign defaults. G20 and Paris Club do this. Hence they jointly endorsed 'Common Framework for Debt Treatments beyond the DSSI' for case-to-case resolution of debt problems of poor countries.

Though guidelines and templates for this Framework have not been unveiled, the fact is that this too is not adequate to ward off risk of global meltdown.

According to an IMF policy paper (PP) dated 30th September 2020, "Should a COVID-related systemic sovereign debt crisis requiring multiple deep restructurings materialize, the current resolution toolkit may not be adequate in addressing the crisis effectively and additional instruments may need to be activated at short notice".

Issued on 30th September 2020, PP is captioned 'The International Architecture For Resolving Sovereign Debt Involving Private-Sector Creditors-Recent Developments, Challenges, And Reform Options'.

This brings us to the need for a comprehensive agreement on initiatives to contain, if not avoid, global financial crisis. Such an agreement under WB-IMF aegis should not include rich nations that too have cumulative borrowings exceeding 100% of their respective GDP.

A case in point is United States (US). In a report dated 11 th February 2021, Congressional Budget Office (CBO) has projected increase in Federal debt to 102% at end-2021 from 100% in fiscal 2000. It foresees debt rising to 107% of GDP, the highest in the Nation's history by 2031.

CBO report, captioned 'The Budget and Economic Outlook: 2021 to 2031', has based its fiscal projections with the assumption that current laws governing taxes and spending would generally remain unchanged in 10 years.

CBO has estimated federal budget deficit of $2.3 trillion in 2021. This is 10.3 percent of GDP, as compared to deficit equivalent to 14.9% of GDP in 2020. This was the largest deficit since 1945. Both deficit numbers are obviously driven by Covid and the Government's response towards the pandemic.

Referring to CBO's projection of federal debt touching 107% of GDP, Government Accountability Office (GAO) says: "This situation-in which federal debt grows faster than GDP-means that our nation is on an unsustainable fiscal path".

In a report on 'The Nation's Fiscal Health' released on 15 th December 2020, GAO says: "Since 2017, we have reported on the need for a broad plan to put the federal government on a more sustainable long-term fiscal path.3 To help change the long-term path, in September 2020 we recommended that Congress consider establishing a long-term fiscal plan that includes fiscal rules and targets, such as a debt-to-GDP target".

Like GAO, similar institutions in other countries, notably India, have been unsuccessfully pleading for phased reduction in sovereign debt. Cacophony over pandemic and the resulting economic stimuli virtually silenced rational voices over unsustainable debt.

Many Governments created National hysteria over Covid to avoid criticism over their woefully inadequate healthcare facilities. These were not geared up to fight Covid in spite of each major country planning its detailed strategy to take on next pandemic. Such plans were prepared in the aftermath of Swine flu pandemic.

Now that Covid appears manageable and is not as lethal as was made out to be, the world should move on with masks. It should focus on preventing debt crisis whose seeds were nurtured well by the pandemic.

According to IMF's world economic outlook update 20th January 2021, Debt restructuring may be unavoidable for some countries. While temporary liquidity relief can help mitigate the lack of policy space, for some countries it may not be enough in situations where sovereign debt is unsustainable.

The Update says: "In such instances, eligible countries should work with creditors to restructure their debt under the new Common Framework agreed by the G20. This move would benefit not only these countries but the system as a whole generally, improving the international debt architecture to support orderly debt restructuring".

The debt management without fresh, deadly disruption in global economy is required to create a better world for the next generation.

As put by United Nations' (UN's) 'World Economic Situation And Prospects : February 2021 Brief', "This massive rise in debt will unduly burden future generations unless a signi fi cant part is channelled into productive and sustainable investment that stimulates economic growth".


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