By: George Soros and Chris Canavan
The Covid-19 pandemic is a one-two financial punch for developing economies. Not only has it put extraordinary pressure on the budgets of governments, which need to ramp up public health spending and prop up their reeling economies, but it has also caused a sharp exodus of capital from emerging markets. JPMorgan Chase & Co. predicts that 1 in 5 emerging-market countries will default on their debt obligations.
These are extraordinary circumstances calling for extraordinary measures that must include a comprehensive debt standstill. Developing countries, even those considered middle-income countries, must be allowed to defer all debt-service payments to all international creditors — official and private — for at least one year. Group of 20 leaders, in their April 15 communique, acknowledge the need for debt relief. But they call for it only for the poorest countries and only from official lenders. Private lenders are asked to consider giving poor countries a break on debt payments, but they are under little pressure to oblige. This does not go far enough, for reasons we explain below.
The simplest way to achieve the debt relief we call for is to push back by a year all debt repayments due in the next 12 months and to require creditors to forgo one year’s interest income. This would be a one-time-only arrangement. It should not set a precedent for the future, and it should not constitute permanent debt relief. Some government borrowers may need their foreign obligations to be reduced for good, but those negotiations must await more normal times.
Without a standstill, debtor countries will be forced to impose harsh austerity measures, relegating their economies to a lost decade or more, compromising the health of their citizens and, in turn, the health of the rest of the world. In this scenario, many countries will opt to default, precipitating a debt crisis far more serious than the one in Latin America during the 1980s and the one in Asia during the 1990s. The wave of sovereign defaults in the 1930s may be the closest historical parallel.
This means that lenders, both private and official, will have to choose between cooperating to bring about orderly standstills or standing by while one government after another defaults unilaterally or punishes its citizens with austerity — or both. This would overwhelm the capacity of the International Monetary Fund and Paris Club. Indeed, more than 90 countries have already asked the IMF for emergency assistance. It would also add to the economic stress in the U.S., Europe and China.
For private lenders, this is a bleak scenario. A comprehensive standstill is not merely a way to protect debtor countries from international creditors; it is the only way private creditors can preserve the value of their claims, official creditors can protect their countries’ economic health, and international institutions such as the IMF and World Bank can fulfill their missions. Even if farsighted creditors see a standstill as in their best long-term interest, negotiating them requires overcoming high hurdles. The prevailing international system has no equivalent of Chapters 9 and 11 of the U.S. Bankruptcy Code to help corral different kinds of lenders.
The key is to define the goal narrowly, as a reprieve of at least a year from repayments to any international lender. This falls short of a call for permanent debt relief, which many are calling for, but it will give developing countries the fiscal space they need to fight the health and economic consequences of the virus.
Once this narrow goal has been agreed to, the tools exist to bring it about. The official creditor community must first declare that it will defer debt payments as long as private creditors do the same and on the same terms. It must also use existing mechanisms to coax private creditors to cooperate. These mechanisms already exist: The Paris Club would insist on its principle of “comparable treatment,” while the IMF would insist on its principle of “private sector involvement.” Countries without an IMF program or significant Paris Club debt could seek emergency assistance from the official sector, which would be conditioned on private-sector involvement.
Official creditors have additional measures they could use to encourage participation by private creditors. These include precedents such as the Vienna Initiative, which maintained credit to eastern European countries during the global financial crisis; arrangements to maintain international bank lines to Korean banks during the Asian crisis; and the arrangements to keep international bank exposures to Latin American governments during the debt crisis of the 1980s.
Some private lenders might balk at going along with a standstill and hold out for full repayment, as the so-called “vulture” funds did with Argentina. But this shouldn’t be a serious problem. Potential holdouts are unlikely to go to the same trouble and expense to recover just one year’s interest income as they did to make large capital gains. The G-20 has expressed a willingness to allow the poorest countries to get a debt reprieve from their official lenders. This is a step in the right direction, but it is inadequate in two important respects.
First, standstills should also be available for middle-income developing countries, not just the poorest. All countries should be provided the fiscal space needed to contend with this shock. Any concern about moral hazard is misplaced, because it is outweighed by the urgent need to confront the pandemic in a coordinated fashion.
Second, standstills should apply to all international debt obligations, whether to rich-country governments, private bondholders, multilateral development banks, China or other lenders. All creditors should grant the same forbearance. Otherwise, the forbearance of some lenders will be exploited to allow other lenders — private ones in particular — to get repaid.
This process requires strong leadership from a core group of debtor and creditor countries and from the U.S. It should be led by the U.S., China, the U.K., France and Germany, with participation by the IMF and other international institutions, and complemented by a committed group of large private creditors. Time is short. The G-20 should provide the leadership necessary to launch these initiatives at the Spring Meetings of the IMF and World Bank that are now underway.