Victor Lequillerier, economist at BSI Economics, answers three questions on the deterioration of public finances in emerging countries linked to the Covid-19 crisis.
BSI Economics – What is the impact of the Covid-19 crisis on the public finances of emerging countries?
Victor Lequillerier – To tackle the Covid-19 crisis, governments have had to support economic activity by increasing certain categories of spending (particularly healthcare and social transfers) against a backdrop of falling revenues (contraction in economic activity, suspension/deferral of taxes). These support policies have weighed on public finances, leading in most cases to a public deficit and an increase in public debt.
Very quickly, the following question arose: how can these public deficits be covered? To finance them, all the « traditional methods » were mobilized: bond issuance, loans from multilateral organizations (especially the World Bank and the International Monetary Fund), donations from partner countries, support for unconventional monetary policies (even monetization of the deficit by certain central banks), etc.
In addition, the Debt Service Suspension Initiative (DSSI)was launched so that 73 countries could, if they wished, defer payment of their external public debt[2] owed to bilateral creditors (states) for the years 2020 and 2021.
All of these measures, combined with a greater appetite among investors for risky investments in the second half of 2020, ultimately averted the liquidity crisis that had been feared at the onset of the crisis. Contrary to all expectations, sovereign interest rates even reached a historic low at the end of 2020 in most emerging countries, benefiting from increased global liquidity and accommodative monetary policies.
Assuming that the health crisis is quickly resolved, are the risks related to public finances now behind emerging countries?
On the contrary, we are entering an era in which sovereign risk is likely to increase in emerging countries.
Although a liquidity crisis was avoided in 2020-2021, this risk has not been definitively ruled out in the medium term. This is particularly true for countries that were already facing high solvency risk before the Covid-19 crisis( Haiti, Laos, Tajikistan, and Zambia, for example).
This solvency risk probably played a significant role in 2020. In several countries, it may have limited the capacity of governments to intervene, given their initially more limited fiscal room for maneuver (Tunisia, Sri Lanka). Even in countries where debt levels remained relatively low, fears that the fiscal situation would deteriorate too quickly may have led to smaller fiscal support measures (Peru, Philippines) compared to other countries.
Furthermore, some emerging economies without significant vulnerabilities are emerging from the Covid-19 crisis with reduced fiscal margins (Colombia, Morocco). This development will most likely lead them to consolidate their public finances in 2022, with some countries already taking this path in 2021 (Algeria, Ecuador).
What are the potential outcomes of this situation?
Apart from the ISSD, few concrete solutions have been put in place at this stage. And even then, this form of support is very limited, affecting only a small proportion of creditors (the amounts that have been deferred represented only 24% of the total debt service of the countries concerned in 2020).
While the participation of bilateral creditors that are not members of the Paris Club (notably China and Saudi Arabia) in this type of initiative is a step forward, the extension of the ISSD and the mobilization of other creditors is currently under discussion. To be effective, it cannot be extended but must be transitional, in order to allow time to consider more ambitious actions (moratorium, debt restructuring).
In the coming weeks, BSI Economics will publish analyses of the various options available, particularly restructuring, which seems inevitable in some countries, especially in sub-Saharan Africa. However, the recent case of Lebanon unfortunately shows that public debt restructuring is a highly complex process and that, in order to prevent certain economies from plunging into deep crisis, « prevention is better than cure. »
[1] Average public debt in emerging countries excluding China rose from 51.9% of GDP in 2019 to 61.4% of GDP in 2020.
[2] Debt service corresponds to the amounts of payments to be made over a given period, in this case one year, to repay creditors. These amounts include principal and interest.
[3] 51% of low-income countries were at high risk of debt distress in 2019, compared with 23% in 2013.
[4]According to the IMF, fiscal stimulus averaged +3.6% of GDP in emerging economies in 2020, compared with +10% for advanced economies.
