Debt hawks detract from urgently needed fiscal recovery efforts

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY & KUALA LUMPUR: Developing country debt has continued to grow rapidly since the 2008-2009 global financial crisis (GFC). Warnings against debt have been reiterated by familiar prophets of debt doom such as new World Bank chief economist, Carmen Reinhart, once dubbed the ‘godmother of austerity’.

Growing debt burden

Falling commodity prices, dwindling foreign reserves, slower global growth and weakening currencies have made it harder for developing countries to meet external debt payments.

This has involved economies of all income categories, reaching historical highs even before the pandemic. By early May, more than 100 countries had asked the International Monetary Fund (IMF) for help.

Developing countries’ government debt is likely to worsen with the pandemic induced recessions, triggering appeals for urgent debt standstills, cancellations and restructuring. While accumulated debt is undoubtedly problematic, debt phobia is now limiting fiscal options for coping with the worst economic downturn since the Great Depression.

In March, the United Nations called for a US$2.5 trillion package for developing countries to cope. By May, IMF Managing Director Kristalina Georgieva warned that the need is far greater.

While the Trump administration blocked the latest IMF Special Drawing Rights (SDRs) initiative, other debt relief initiatives, e.g., by the G20 and the IMF, are quite inadequate. Even David Malpass, the Trump nominated World Bank president, has criticised the G20 for falling short on debt relief, insisting “more needs to be done”.

Debt buybacks hardly novel

Surprisingly, rather than seeking to finance stronger fiscal responses to Covid-19 recessions, Joseph Stiglitz and Hamid Rashid have joined the chorus to address “catastrophic debt crises”, offering no evidence they are “impending”.

They discuss various options for debt relief and restructuring, and offer guidelines for bond buybacks, without mentioning April proposals by the UN, UNCTAD, the African Union and the UN Economic Commission for Africa.

While recognizing some limitations, the duo insist “bond buy-backs present a highly attractive solution, offering substantial debt relief at a relatively low cost”, which “has not received sufficient attention”.

They urge the IMF to use its New Arrangements to Borrow to buy debt at a discount, supplemented by funds from donors and multilateral institutions, but offer no convincing evidence why debt buybacks should now be prioritised over fiscal resources for recovery.

Brady debt buybacks

Under a US-led debt buyback initiative, named after then Treasury Secretary Nicholas Brady, indebted developing countries purchased US Treasury bonds to collateralize more than US$160 billion in replacement ‘Brady bonds’ from 1989.

The scheme restructured the debt of 18 developing countries long after sovereign debt crises began in 1981, following the US Fed’s sharp increase of interest rates to kill inflation. Thus, governments helped banks take defaulted loans, trading for small fractions of their face value on illiquid secondary markets, off their books.

Some banks took ‘haircuts’, but still got much more than what was available in secondary markets. Unlike in the current era, US interest rates were high, and thus, countries bought the Treasury zero-coupon bonds at an attractive discount.

Bloomberg’s Sydney Maki argued on 5 May that a second Brady plan is unlikely to work. The Brady plan transformed commercial bank loans, many in default, into collateralized bonds, but government debt today is owed to more diverse creditors including New York hedge funds, Gulf sovereign wealth funds and Asian pension funds.

Maki doubts that fund managers’ fiduciary duties would allow them to be lenient, even if so inclined. Terms of many deals cannot be legally changed without approval from most bondholders.

Debt buybacks for whom?

As some have noted, the plan undoubtedly relieved “pressure on Wall Street”, saving large US commercial banks which had pushed loans to developing countries in the 1970s. Stock prices of US commercial banks with significant developing country loan exposure rose 35% by US$13 billion after countries accepted the deal.

Jeremy Bulow and Kenneth Rogoff noted that “when highly indebted countries retire their deeply discounted debt, either through buy-backs or ‘debt-equity’ swaps, they may simply be using their scarce resources to subsidize their creditors”.

For them, buybacks and debt-equity swaps “are by themselves a boondoggle benefiting … creditors”. Stiglitz and Rashid dismiss this as just a “possibility”, citing the 1988 Bolivian debt buyback and the 2012 Greek bond buyback as two “good examples” of success stories.

In fact, when Bolivia bought back US$308 million in debt at face value in 1988, the price rose to 11 cents from 6 cents on the dollar, lowering the market value of the remaining debt (US$362 million at face value) to US$39.8 million.

As the earlier market value of its total bonds (US$670 million at face value) was US$40.2 million, the buyback only reduced its debt by US$400,000. This miniscule reduction cost donors US$34 million, which Bolivia would have been better off investing otherwise.

Furthermore, debtor countries participating in the Brady plan were required to deregulate, liberalize and privatize, i.e., implement structural adjustment, to qualify for Fund-Bank money to supplement their own foreign currency reserves for buybacks.

Greek tragedy

Financed by European taxpayers, the Greek buyback experience was no better. The price of 10-year benchmark Greek bonds also rose, as yield fell 147 basis points following announcement of the buyback.

Former Greek Finance Minister Yanis Varoufakis observed, “rumours of a debt buyback have pushed these bond prices to above 43%”; “its effect will be a net debt reduction 40% less than the Eurogroup’s stated target”, constituting “a reward to hedge funds and a ruthless,… massive involuntary haircut for Greece’s embattled banks”.

The New York Times agreed that the “bigger winners were hedge funds, which pocketed higher profits than many had expected”, while Moody’s Analytics correctly predicted that the “bond buyback will not end Greece’s debt woes”.

Greece was forced into excruciating austerity, plunging it into economic depression. As the economy contracted by 24%, unemployment hit 26%, the highest in the euro zone, by September 2009, less than a year later. Thus, debt buybacks may well help financial markets, litigious funds and global finance, rather than indebted countries.

Bond buybacks no panacea

Undoubtedly, debt buybacks may sometimes work in favourable circumstances when well planned as part of a broader financing strategy. Ecuador’s 2008-2009 bond buybacks were part of its external debt restructuring to secure relief from illegitimate ‘odious debt’.

With no pressure from acute financial stress, Ecuador repurchased over 90% through financial intermediaries, at 35 cents on the dollar, as its bond prices fell during the GFC.

Jeffrey Sachs agreed with Bulow and Rogoff that debt buybacks are “not necessarily a panacea for heavily indebted countries” unless “part of a comprehensive arrangement” for reduction of all debt with the full participation of all creditors involved.

Writing before Brady, he doubted the feasibility of such debt reduction as the US had previously blocked such arrangements in the interest of US banks. The political influence of US financial lobbies has only grown in recent decades. And, as Maki notes, a comprehensive arrangement involving all creditors is an even taller order now as they are more heterogenous.

Furthermore, it was reasonable then to assume that debtors only had a certain amount to repay, with other prices adjusting accordingly. However, bond market prices today easily ‘overshoot’, while debt restructurings are rarely sufficient, often delayed and very costly.

Promoting buybacks, backed by institutions like the IMF, also runs the risk of encouraging holdouts in future debt restructurings.

Instead of using scarce financial resources to buy back bonds, multilateral institutions and donors should help developing countries retrieve fiscal space to urgently prevent Covid-19 recessions becoming depressions.

Multilateral Bank Intermediation Must Help Developing Countries' Recovery

Jomo Kwame Sundaram, Anis Chowdhury

SYDNEY and KUALA LUMPUR, Aug 07 (IPS)  - International Monetary Fund (IMF) Managing Director Kristalina Georgieva has warned that developing countries would need more than the earlier estimated US$2.5 trillion to provide relief to affected families and businesses and expedite economic recovery.

With their limited fiscal capacities, developing countries will need to borrow more, increasing their often already high public debt burdens. Developing country debt has grown rapidly since the 2008-2009 global financial crisis (GFC), reaching historical highs even before the pandemic.

A deep pandemic induced depression may also require governments to take over huge private debt liabilities. All this has increased calls for urgent debt relief, cancellation and restructuring, and for new IMF and World Bank lending lines, including new IMF special drawing rights (SDRs).

Not enough debt relief

On 13 April, the IMF approved debt service relief for 25 eligible low-income countries (LICs), estimated at US$213.5 million, for six months, i.e., from 14 April until mid-October 2020.

On 15 April, G20 leaders announced their ‘Debt Service Suspension Initiative for Poorest Countries’ from May to the end of 2020 for 73 primarily LICs. The G20 initiative would cover around US$20 billion of bilateral public debt owed to official creditors by International Development Association (IDA) and least developed countries (LDCs).

Such steps are welcome, providing some temporary relief, but far short of the eligible countries’ long-term public and publicly guaranteed external debt of US$457 billion in 2018.

UNCTAD estimates that in 2020 and 2021, middle- and low-income countries face debt service repayments between US$700 billion and US$1.1 trillion, while upper middle-income developing countries expect to pay US$2.0~2.3 trillion.

The G20 initiative is already seen as merely kicking the can down the road. It does not cancel any debt, which is to be repaid in full over 2022–2024, as interest continues to grow. Hence, it is quite unlike the Heavily Indebted Poor Country (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI).

Furthermore, money saved from debt relief “can be used to pay the private creditors on time and in full”, i.e., prioritizing private over public creditors. The G20 initiative only applies to a limited number of countries, and does not impact the US$8 billion owed to private lenders and the US$12 billion debt to multilateral creditors.

An Oxfam report estimated that eligible countries are still required to pay at least US$33.7 billion for debt servicing this year, or US$2.8 billion monthly, “double the amount Uganda, Malawi, and Zambia combined spent on their annual health budget”.

Furthermore, the initiatives presume that Covid-19 shocks to developing economies will be short and swift, and that developing countries can make debt repayments over the next 3-4 years.

IMF and World Bank falling short

The World Bank has put in place a US$14 billion fast-track package to meet immediate health and economic needs, envisaging financial support of around US$160 billion during 2020-2021.

The IMF has doubled access to its Rapid Credit Facility and Rapid Financing Instrument to meet greater expected demand for emergency financing of about US$100 billion, without requiring “a full-fledged program in place”. By mid-June, various IMF facilities had committed around US$300 billion.

Although these financing instruments involve fewer conditionalities and faster approval, eligibility still depends on familiar — and, in current conditions, very restrictive — criteria. These include, inter alia, having to satisfy the ‘revamped’ joint Bank-Fund debt sustainability framework, which critics deem “obsolete”.

Therefore, actual urgent liquidity support falls far short of the IMF’s US$1 trillion lending capacity while the attempt to issue new SDRs for Covid-19 has been blocked by the Trump administration.

Debt reduction wrong priority now

The UN warned of the dire consequences of the Covid-19 pandemic in April, and in May, argued that without bold policy action, the pandemic would set back the SDGs.

Facing the greatest economic crisis since the 1930s, many developing countries have little choice but to borrow to create fiscal space, rather than focus on complicated, time-consuming long-term debt restructuring, workouts or buybacks.

Instead of obsessing over debt, some developing countries are tapping global debt markets to meet Covid-19 financing needs. When governments can borrow on reasonable terms to invest in projects needed for sustainable development, debt may even be desirable, if not necessary, especially in resource-poor countries.

For some, in a low interest rate environment, it is reasonable for developing countries to borrow more, even raising their debt/GDP ratios to levels previously regarded as dangerous, to fund recovery. This time, it is really different as debt costs are lower and are expected to stay low for some time to come.

Furthermore, the consequences of fiscal inaction, so as to not take on debt, can be disastrous for the developing world, paradoxically making current stock of debt unsustainable. On the other hand, new borrowing to mitigate the negative impact of the pandemic on growth can make debt sustainable.

However, most non-investment grade developing countries have to pay substantially higher risk premiums, due to the prejudices and biases of market finance, even when their macroeconomic ‘fundamentals’ are sound.

Pandemic emergency financing fiasco

After the 2014 Ebola epidemic in West Africa, the Bank launched the Pandemic Emergency Financing Facility (PEF) in July 2017, using insurance-like ‘catastrophe bonds’ and derivatives to raise private sector money for LICs’ pandemic responses.

The PEF promised to “blend the best of the public and private sectors, helping to keep 1.6 billion people safe” while “transferring [financial] risk [from governments] to international markets”.

To draw investors, the PEF has stringent and controversial rules on when and how much to pay-out. To make them attractive to investors, PEF bonds were designed to reduce the probability of paying out.

Due to its complicated approval process the PEF had not paid out a single dollar until the end of March, although the World Health Organization designated the Covid-19 outbreak a “public health emergency of international concern” on January 30, and a “pandemic” on 11 March. The pay-out decision was only made on 27 April; as of 27 July, only a paltry US$146.5 million had been “transferred to support” 48 countries — “too little, too late”, even for The Wall Street Journal.

Meanwhile, its “cash window” – funded by donors – has not been replenished after being used up for the Ebola outbreak in the Democratic Republic of Congo in 2018-2019.

In April 2019, Larry Summers, former World Bank chief economist and US Treasury Secretary, described the PEF as “an embarrassing mistake” and “financial goofiness”, noting that the programme was “loved” for promoting private sector involvement.

Intermediation role required

With preferred creditor status, the Fund and the Bank can borrow ‘cheaply’, i.e., at the much lower interest rates available to them. By intermediating, they can enable developing countries, especially LICs and LDCs, to borrow cheaply for their relief and recovery.

A first step would be to ditch the last Bank president’s now discredited ‘mobilizing finance for development’ (MFD) framework to use public funds, including official development assistance (ODA), to leverage private finance for public-private partnerships (PPPs).

As with the PEF, the MFD approach has failed to leverage billions in ODA into trillions of development finance, as promised, mobilizing only US$0.37 of additional private capital for LICs for every US$1 of public money invested.

Visit this story at http://ipsnews.net/2020/08/multilateral-bank-intermediation-must-help-developing-countries-recovery

Fight Pandemic, Not Windmills of the Mind

By Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR, Jul 28 2020 (IPS) 

With uneven progress in containing contagion, worsened by the breakdown in multilateral cooperation due to mounting US-China tensions, recovery from the Covid-19 recessions of the first half of 2020 is now expected to be more gradual than previously forecast.

Pandemic response measure

In the face of the Covid-19 pandemic, many governments, especially of Organization for Economic Cooperation and Development (OECD) economies, have introduced massive fiscal and monetary packages for contagion containment, relief and recovery.

Such efforts represent a U-turn after long eschewing countercyclical fiscal policy, mostly for ideological reasons, such as dogmatic commitment to ‘budgetary balance’ and ‘fiscal consolidation’, besides giving central banks more economic policy discretion since the 2008-2009 global financial crisis (GFC).

The International Monetary Fund (IMF) estimated new government measures through mid-June 2020 at almost US$11 trillion. The Fund projected new borrowing by all governments to rise from 3.7% of global output in 2019 to 9.9% in 2020.

Projecting gradual recovery from the second half of 2020, the Fund expects average fiscal deficits to rise by 14% as global public debt reaches an all-time high, exceeding 101% of gross domestic product (GDP) in 2020-2021.

After much wrangling, EU leaders compromised on a new US$2.1 trillion (€1.8 trillion) package on 21 July. The European Commission has also activated the general escape clause in EU fiscal rules, allowing deficits to exceed 3% of GDP.

Complementary monetary initiatives include relaxing recommended Basel 3 capital buffers, lowering mandatory reserve ratios and easing terms for additional temporary credit facilities for banks and businesses.

Thus, central banks have committed an estimated US$17 trillion to extend ‘unconventional’ measures to buy corporate bonds, besides government bonds and government-sponsored mortgage-backed securities introduced during the GFC.

Windmills of financial minds

Macroeconomic economic policy makers must resist quixotic impulses to fight against financial ‘windmills of the mind’, instead fulfilling their responsibility to pursue consistently counter-cyclical macroeconomic policies.

Financial market analysts exaggerate real concerns, even using discredited research. Citing old research, even doubted by The Economist, a Forbes columnist insisted that “the surge in government debt” would cause “economic growth to decline”, claiming that government debt beyond 85% of GDP would slow growth.

Global public debt came to 83% of world output in 2019, up from 60% in 2008, before the GFC. This sharp rise happened despite austerity measures since 2010 when many G20 and OECD countries adopted fiscal consolidation.

That turn to austerity followed advice from the IMF, OECD and European Central Bank, who invoked influential, but misleading academic research. But fiscal consolidation “after the Great Recession was a catastrophic mistake”, concluded a Forbes columnist. It failed to deliver robust recovery, let alone sustained growth.

Subsequent IMF research found fiscal consolidation raised short-term unemployment, with even harder impacts in the long-term, hurting wage-earners much more than profit- and rent-earners. IMF chief economist Olivier Blanchard and his colleagues found Fund advice for early fiscal retrenchment inappropriate.

Windmills can block recovery

Reversing emergency expansionary measures too soon risks aborting recovery and may even trigger new recessions. Even an assets fund manager has acknowledged, “Like a course of antibiotics, an economic relief package is most efficacious when administered to completion”.

When President Franklin Delano Roosevelt tried to balance the budget in 1937 after securing re-election, the ensuing downturn ended the recovery, only revived after deficit spending resumed in 1939. Also, countries that abandoned fiscal expansion for consolidation from 2009 had worse recovery records than others.

Deficits and debt have, in fact, not been reliable indicators of long-term growth prospects. Obsessed with debt and deficits, while ignoring spending composition and efficiency, ‘deficit hawks’ tend to downplay the potential growth impacts of expansionary fiscal policy.

Nevertheless, the Fund continued to warn in January 2019 that high and rising public debt constituted “a potential fault line”. Pre-pandemic economic stagnation, tax cuts and poor commodity prices induced larger fiscal deficits, requiring more government debt, now compounded by Covid-19 containment, relief and recovery efforts.

Clearly, government macroeconomic policies should not be guided by financial market whims. Leaving policy making to such influential market signals can push an economy in recession into a lasting depression. The recent IMF leadership transition appears to have led to greater pragmatism just in time.

Investing for the future

The Fund’s April 2020 Fiscal Monitor urged governments to take advantage of historically low borrowing costs to invest for the future—in health systems, infrastructure, low-carbon technologies, education and research—while boosting productivity growth. After all, a year ago, advanced economies were spending only 1.77% of their combined GDP on debt interest—the lowest since 1975.

Unusually, it also advised governments to enhance automatic stabilizers, including a tax and benefit system to stabilize incomes and consumption, involving progressive taxation and social security payments or unemployment assistance.

Undoubtedly, politicians are often tempted, by lower debt costs, to borrow to spend more on “populist” programmes while cutting taxes. Such irresponsible fiscal policies need to be corrected.

Clearly, governments need to look at how money, borrowed or otherwise, is spent. If, for example, borrowed money goes into investments enhancing productivity, public assets can contribute not only to growth, but also to revenue.

Covid-19 recessions are quite different from recent ones following financial crises. Yet, all recessions threaten to become depressions if not quickly and appropriately addressed.

We are in for a long hard struggle, on both public health and economic fronts. Policies must not only be appropriate for the problems at hand, but should also create conditions for a better future, rather than simply trying to return to the status quo ante Covid.

As visionary leaders did during and after the Second World War, we need appropriate plans, not only to revive economies and livelihoods, but also to build a more dynamic, sustainable and equitable economy.

Also available online here: https://www.ipsnews.net/2020/07/fight-pandemic-not-windmills-mind/