Preventing a crisis in emerging markets

The economic crisis in Sri Lanka is deepening. The rupee has plunged to record lows against the dollar on the back of blackouts, food shortages and sky-high prices. The country may have as little as $500mn left in foreign reserves though a $1bn bond repayment is due in a few months. With the IMF ready to intervene, there is hope that the situation may stabilise. But fears are growing that Sri Lanka could be the first in a series of emerging markets to descend into economic turmoil.

The war in Ukraine represents another shock which, on the back of the pandemic, could be enough to send multiple countries into debt distress. The scope of the problem is likely to be global, so solutions need to be of a similar size and scope. Unfortunately, garnering enough international political will to fix holes in the world’s framework for sovereign debt relief looks to be a Herculean task.

Russia’s war in Ukraine leaves developing countries facing a twofold shock. Spiralling oil and grain prices have put importing economies under pressure, with countries such as Egypt facing the prospect of drastically lowering their foreign currency reserves in order to pay for them. On top of this comes the prospect of monetary tightening in the developed world.

In 2013, the merest hint from the US Federal Reserve that it would scale back quantitative easing — the so-called taper tantrum — was enough to move money out of emerging markets. What happens in the event of a significant unwinding of the Fed’s balance sheet remains to be seen. The prospects, however, are not good: rates will rise, and some developing economies could find that their debt burdens become unsustainable.

The path from there could be grim. Spending cuts are likely to be made in an effort to meet bond repayments as they become due. This kind of fiscal retrenchment tends to exacerbate poverty, cut off growth paths and cause unpredictable social upheaval.

This course of events is not inevitable, though. To start with, the IMF should dust-off its pandemic playbook and offer rapid loans to vulnerable economies. This could be accompanied by less stringent conditions to match the urgency of the situation, ensuring that countries spend what is required to meet the challenges of the moment.

In the medium term, gaps in the world’s approach to sovereign debt relief must be fixed. It is no longer sufficient to concentrate on the old Paris and London clubs of lenders — long gone are the days of emerging market creditors being concentrated in this group. China now represents the biggest bilateral lender to developing countries by far and bonds have also been sold to a range of private investors. According to the World Bank, at the end of 2020, low and middle income countries owed five times as much to commercial creditors as they did to bilateral ones.

These lenders will need to co-operate if there is to be any hope of significant, proactive debt relief to emerging markets. The common framework agreed by the G20 in November 2020 offers a potential vehicle, but the will to make use of it is lacking. Creditors still fear that their agreement to offer concessions will just become a covert means of redistribution to other lenders unwilling to play ball.

At a time of increasing division, and with priorities lying elsewhere, hope for rectifying these issues with the world’s sovereign debt framework may fade. It would be a great shame if this were so. Economic turmoil in emerging markets does not need to result in serious crises. It is clear what needs to be done. The task now is to find the necessary political will to do it.