Uneven growth rates among countries this year are not the only risk to the global economic recovery that must be addressed this week when officials from 190 countries gather virtually for the spring meetings of the International Monetary Fund and the World Bank. They also need to get their arms around the growing risk of a systemic debt crisis in the developing world that highlights the striking contrast between worrisome debt dynamics in the most vulnerable economies and the luxuries afforded to the richest countries in the world. This contrast is fueled by differences in policy flexibility and financial resilience that stand to amplify the inequality shock inflicted on the global economy by Covid-19. Efforts to combat these risks can become self-reinforcing through more timely and audacious pro-growth debt relief.
Almost all economies worldwide followed a similar game plan when responding to the "sudden stop" that followed the outbreak of Covid-19 last year. They deployed significant fiscal and monetary measures to minimize the disruptions to lives and livelihoods from a fatal pandemic. This included heavy reliance on deficit spending and debt financing to protect populations from the effects of the virus and lost income.
The guiding principle was a mix of whatever-it-takes, all-in and whole-of-government. The analytical foundation was the lesson learned from the 2008 global financial crisis. The enemy to overcome quickly was similar to the one in 2008, a breakdown in counterparty trust. This time, though, it was not financial and between banks but health related and among humans. One of the inevitable outcomes was unprecedented increases in debt levels around the globe.
As 2020 evolved, however, it became clear that, unlike in 2008, this was not a one-round counterparty crisis. With successive waves of the virus, it became a multiround phenomenon that increasingly exposed differences among countries' willingness and ability to deploy repeated rounds of massive fiscal and monetary relief.
At one end of the spectrum was the U.S., which, after some political delays in the second half of 2020, has deployed incredible resources. This includes last month's $1.9 trillion in relief measures — which increased fiscal support to a previously unthinkable 27% of gross domestic product in one year — and a similarly large monetary effort. At the other end are vulnerable developing countries that face debt problems, are unable to access sustainable private financing, are increasingly reliant on public assistance and, despite new waves of infections and hospitalizations, are ever more hesitant to impose health-related restrictions out of fear that they will undermine already fragile livelihoods.
While the global economy will benefit from the demand spillovers of a fast-growing U.S. economy, that also comes with the risk of the unintended domestic and cross-border implications of a pedal-to-the-metal policy accelerator when the economy is already gaining momentum in the right direction. Thus, concerns will be raised, and I fear too quickly dismissed this week, about the risks of market overreactions to an inflation overshoot and the financial market instability that would come with that.
The context for the vulnerable developing countries is the opposite. They are facing an uphill 2021 journey with limited ability for effective domestic policy accelerators. Fiscal policy is constrained by limits to both debt and inflationary financing. Too loose a monetary policy risks destabilizing currencies, with adverse consequences for the standard of living, especially for the poorest. As such, there is genuine fear that a growing number of developing countries could end up in the worst of all worlds: unsatisfactory growth, multiplying debt traps and an increasingly systemic debt problem.
To recover more meaningfully from a Covid shock that has erased, in some cases, a decade's worth of poverty reduction, these countries need more external help. Thus the attention of this week's IMF and World Bank meetings, which begin on Monday, should not just be on a new Special Drawing Right allocation but also on what can be done to enhance pro-growth debt relief, focusing on two areas in particular: extension of the debt service suspension initiative and fair burden sharing under the auspices of the Group of 20's "Common Framework for Debt Treatments beyond the DSSI" or, more simply, the Common Framework.
This policy paradigm seeks to broaden the participation of creditors in debt relief and goes beyond delaying payments to include potential restructurings. Three countries — Chad, Ethiopia and Zambia — have signaled their interest to pursue the approach with guidance from the IMF's debt-sustainability analyses.
Under the DSSI, led by the IMF, World Bank and G-20 last year, 39 official creditors have already provided cash-flow relief to almost 50 developing countries that are struggling to meet domestic priorities, including health-related expenditures. This has been supported by a significant pickup in financing from the IMF and the World Bank.
There will be many calls to extend this initiative through the end of this year, if not beyond, something that is likely to gather sufficient support over time. There may also be interest in expanding eligibility for DSSI beyond the current 73 low-income countries. As important, but much more difficult, will be the discussion on how to better implement the Common Framework, which seeks to address not just developing countries liquidity challenges but also solvency ones, lest a growing debt overhang hamper growth even more.
The main hurdle is fair burden sharing in the debt relief, which involves official creditors, private creditors and their interactions.
When it comes to official creditors, there will be renewed efforts to ensure that the Paris Club approach to relief for the poorest developing countries is emulated better by non-members such as China, which, according to data from Fitch Ratings, accounts for 64% of the bilateral debt of DSSI-eligible countries.
As for private creditors, the thorniest issue is a requirement that they provide similar relief on a timely basis, if not proactively, instead of "free riding" on what the official sector does. This private sector involvement is already specified by the Common Framework, which requires that successful negotiations between all official bilateral creditors and the debtor economy be followed by private creditors providing "comparable treatment." The requirement lacks legal enforcement, though, and is much harder to attain outside of what tend to be overly protracted comprehensive debt restructurings under an IMF program.
The official sector will need to decide between leaving an unsatisfactory situation as is or strengthening the traditional "case by case" mindset by boldly adopting more of a "stick" approach to private creditors who, in aggregate and to their longer-term harm, have yet to find the "carrot" enticing enough. This would make it is easier to align the behaviors of creditors and debtors with what is in their collective interest as well as that of the global economy as a whole.
One of the main lessons of Latin America's "lost decade" in the 1980s is that persistent debt overhangs significantly undermine countries' growth and investment potential, imposing considerable hardships on the most vulnerable segments of their population. One of the main lessons of the 1990s Heavily Indebted Poor Countries (HIPC) initiative is that appropriately designed and incentivized debt relief can clear the way for high growth and faster development for those that need it desperately in the developing world. Let's hope that all creditors can quickly internalize both lessons. Absent that, the world risks multiplying debt traps and an increasingly systemic Covid debt overhang that would impose further hardships on already vulnerable and suffering populations while also accentuating the unevenness of the Covid recovery.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is president of Queens' College, Cambridge; chief economic adviser at Allianz SE, the parent company of Pimco where he served as CEO and co-CIO; and chair of Gramercy Fund Management. His books include "The Only Game in Town" and "When Markets Collide."
Disclaimer: This article first appeared on bloomberg.com, and is published by special syndication arrangement.