On the debt of emerging markets

The doom loop in emerging markets

In this paper, Arellano et al. integrate a standard epidemiological susceptible-infected-recovered model into a sovereign default model in order to study how the epidemic impacts both economic activity and the likelihood of a debt crisis in emerging markets. Governments borrow internationally to smooth consumption during the lockdowns. But lockdowns depress output and lower the prospects of debt repayment. As a result, a highly indebted economy, with a looming debt crisis, chooses a less strict path of lockdowns because of its limited ability to use financial markets to support consumption. This leads to a higher death toll from the epidemic. Their models indicates that:

• Lockdowns reduce output by 19% in present value and generate a debt crisis of 43 months with defaults. The first six months of the crisis feature high default intensity, the country defaults on more than 50% of the debt due; default intensity falls thereafter but remains elevated for 37 more months;
• Debt relief programs can have profound positive effects: debt relief supports consumption, can reduce the severity of the debt crisis, and can save lives.

Deadly Debt Crises: COVID-19 in Emerging Markets
Authors: Cristina Arellano, Yan Bai, Gabriel Mihalache
From: University of Minnesota, University of Rochester, Stony Brook University

How debt relief to low-income countries can be derailed

There have been two initiatives by the G20 to help low-income countries during the pandemic: the Debt Service Suspension Initiative, which became operational in May 2020 and provides immediate relief to low-income countries during the pandemic, and the Common Framework for Debt Treatments which is designed to help debt-distressed sovereigns reschedule or reduce their liabilities and render their debt burden sustainable. Credit rating agencies though are threatening rating downgrades  casting a shadow over the prospects of the countries seeking relief. In this commentary Jayati Ghosh argues that:

If the G20 countries are serious about improving developing countries’ debt positions during the COVID-19 crisis, they should begin by supporting the temporary suspension of credit ratings. In the medium term, regulators must take action to ensure that rating agencies are fulfilling their intended market-stabilizing role. Tackling conflicts of interest – such as by limiting agencies’ dependence on payments from those they rate – is essential.

Credit-Rating Agencies Could Derail Economic Recovery
By: Jayati Ghosh – University of Massachusetts Amherst