The debt and climate crises are getting worse – it’s time to tackle both

A major debt crisis is brewing in the countries of the South. The IMF had sounded the alarm about growing debt sustainability problems in many low-income countries already before the coronavirus crisis. More than two years into the pandemic, the debt situation has deteriorated significantly. According to the IMF, 60 percent low-income countries are now at high risk of debt distress or are already in debt distress. In addition, a growing number of middle-income countries are also suffering from heavy debt service burdens. The number of emerging markets whose sovereign debt is trading at distressed levels – with yields more than 10 percentage points higher than those on US Treasuries of similar maturity – has increased. more than doubled in the last six months. Monetary tightening in the United States and other advanced economies is driving up the cost of debt and making international refinancing increasingly difficult for countries that still retain access to international capital markets. The the composition of funding continues to shift towards new, more expensive sources.

The Russian invasion of Ukraine further aggravated the situation, creating a perfect storm. The war sent shock waves through the global economy and caused the the biggest shock on commodities since the 1970s. While oil, gas and grain exporters may benefit from short-term temporary relief, many developing and emerging countries, including in sub-Saharan Africa, are net importers of fossil fuels and grains. The effects of the war in Ukraine are likely to significantly worsen the social and economic situation in many developing and emerging countries, further undermining debt sustainability.

High levels of public debt service and insufficient fiscal and monetary space have already limited the responses to the crisis in most low- and middle-income economies. While advanced countries were able to implement extremely expansionary fiscal and monetary policies in response to the pandemic crisis, few countries in the South had this option.

The precarious debt situation has not only threatened collections. It has also hampered much-needed investments in climate resilience. These investments are essential and urgent: Governments must protect their economies and public finances against climate change or face an ever-increasing spiral of climate vulnerability and unsustainable debt burdens. In various empirical studies who were reproduced by IMF and others, we have shown that physical climate vulnerability drives up the cost of capital for climate-vulnerable developing countries. As financial markets increasingly price climate risks and global warming accelerates, these countries’ risk premiums, which are already high, are expected to increase further. There is a danger that vulnerable developing countries will enter a vicious cycle in which greater climate vulnerability increases the cost of debt and decreases the fiscal space to invest in climate resilience.

Figure 1. The vicious cycle of climate vulnerability and the cost of capital

Source: Volz, “Climate change and the cost of capital in developing countries”, Presentation at the Understanding Risk Finance Pacific Forum hosted by the Government of Vanuatu and the World Bank Group Catastrophe Risk Finance and Insurance Program in Port Vila from 16-19 October 2018.

The impact of COVID-19 on public finances risks reinforcing this vicious circle. In many countries, including many Small Island Developing States, high public debt service is crowding out critical investments that are needed for climate-resilient economies and enabling a green, resilient and equitable recovery. With the effects of the climate crisis becoming increasingly damaging economically, there is an urgent need to tackle sovereign debt issues head-on and to put countries in a position not only to meet the short-term needs posed by the pandemic and the invasion food price crisisbut also investing in the climate resilience that we so badly need.

There is a danger that vulnerable developing countries will enter a vicious cycle in which greater climate vulnerability increases the cost of debt and decreases the fiscal space to invest in climate resilience.

In 2020, we presented a proposal for Debt relief for a green and inclusive recovery as an ambitious, concerted and comprehensive debt relief initiative that frees up resources to support recovery in a sustainable way and enables governments to invest in strategic areas of development, including climate-resilient infrastructure, health, education, digitalization and cheap and sustainable energy. A key tenet of this proposal is that debt relief should not just provide temporary relief. It should empower governments to lay the foundations for sustainable and climate-resilient development. As part of our proposal, debtor countries that receive debt relief would commit to reforms that align their policies and budgets with the 2030 Agenda and the Paris Agreement. Country commitments would be designed by country governments with the involvement of parliaments and in consultation with relevant stakeholders.

Ahead of the 2021 UN Climate Change Conference in Glasgow, the V20 finance ministers, who represent 55 climate-vulnerable countries with a combined population of 1.4 billion people, issued a Statement on Debt Restructuring for Nations Vulnerable to Climate Change, based on our proposal. In the statement, the V20 finance ministers called for “a major initiative to restructure the debt of over-indebted countries – a sort of large-scale climate debt swap where the debts and debt servicing of developing countries are reduced on the basis of their own plans”. to achieve climate resilience and prosperity”.

With the debt and climate crisis escalating, it is time these calls were heard. The Common debt treatment framework that the G20 set up in November 2020 to address protracted insolvency and liquidity issues has fallen short. Not only does it exclude middle-income countries, but it also lacks incentives and mechanisms to bring debtor governments and private creditors together. As the World Bank points out,[t]The absence of measures to encourage private sector participation can limit the effectiveness of any negotiated agreement and increases the risk of a migration of debt from the private sector to official creditors..”

To encourage the participation of private creditors – who hold more than 60% of all claims on Southern countries – in debt restructurings, a combination of positive incentives (“carrots”) and pressure (“sticks”) is necessary. In terms of incentives, we offer the creation of a new Guarantee Facility for a Green and Inclusive Recovery which aims to encourage the commercial sector to engage in debt restructuring. The facility, which could be set up relatively quickly at the World Bank, would guarantee the payments of newly issued sovereign bonds that would be exchanged at a significant “haircut” against old, unsustainable and private debt. Private creditors would benefit from a partial principal guarantee, as well as an 18-month guarantee of interest payments, analogous to the Brady plan that helped break the deadlock of the 1980s debt crisis.

In terms of pressure, the financial authorities of the jurisdictions in which the main private creditors reside (both banks and asset managers) and which govern the majority of sovereign debt contracts – in the first place the United States, the United Kingdom United and China – could use strong moral suasion and regulations on accounting, banking supervision and taxation to improve the willingness of creditors to participate in debt restructuring.

Economic history teaches us that delaying the resolution of over-indebtedness is very expensive for debtor countries. In the absence of an appropriate international sovereign debt restructuring mechanism, creditors and borrowers alike continue to kick the road. This is a long-standing problem that has repeatedly caused lost decades of development and preventable human suffering. What makes matters worse now is that the stakes are even higher in the face of an evolving climate crisis.

The international community, especially the major advanced economies and China, must break the current impasse and work towards a solution to the debt crisis that will allow all countries to respond to the multiple crises they face. The consequences will be dire if they don’t.

Source link

John A. Bogar