While COVID-19 is being most virulent today in Europe and North America, the pandemic has now started taking hold in the emerging and developing world, with many countries experiencing increased numbers of cases. Africa, for example, is likely to become the next epicenter as infection and death rates are on the rise. [1] Countries, in particular those that are more connected to the world economy, are already experiencing the economic impact: collapse in commodity prices, falling tourists’ revenues, drop in remittances, massive capital outflows. There is need for a global and effective response to the virus. Failing to do that, the risk of becoming endemic in the developing world and coming back to the developed world in a second or a third wave, is looming.

As the pandemic spreads, emerging market and developing countries are facing a triple shock: a health shock (not well equipped health system, density of populations in some areas), a global spillover (falling trade, access to finance, falling remittances and tourism), and a commodity price shock (tumbling oil prices). To overcome this halt, they need financing. Delivering a generous debt relief package is essential to allow countries respond to the crisis. But this would not be enough. There is need for a major multilateral response in building and supporting health systems. The institutional infrastructure and the funding mechanisms are there (e.g. Gavi, the Global Fund), as well as the track record of dealing with health crises (e.g. HIV, Polio). What is missing, are the financial resources.

There are four particular features that developing nations exhibit, that make the economic aspect of this crisis very difficult. First, is low income. While for a middle class family in London or Germany not working for a month or two may be possible and manageable, that is not the case for families in emerging countries whose income is very much at subsistence level. [2]

Second, is labor market informality. Under a formal labor contract, a company provides insurance (while it may also receive some support from the central bank or the government) and thus keeps paying its employees even if they are not producing. This is good for the company, as it retains specialised workforce in place, but also for workers, as they get insurance and income. However, in many emerging economies – even in middle income or upper middle income emerging economies – one half to two-thirds of the labor force is employed informally. [3] Therefore, the feature that could provide insurance is absent.

Third is monetary financing. Most emerging economies cannot resort to monetary financing in the way that developed countries have. During the 2007-08 crisis the US Fed multiplied its balance sheet by a factor of 5.2 [4] and inflation did not budge. [5] However, if a developing country (e.g. Argentina) tried that, inflation and the value of the peso would indeed jump. Thus, by simply printing domestic currency to deal with the emergency in any substantial quantities is not a way out.

Fourth, is foreign currency. What emerging countries need, is not just domestic currency but foreign currency. If both the private and the public sector run a deficit, the current account (the sum of the two) will skyrocket. And the question is where do you get the money (e.g. USD, EUR, or JPY) to finance a large current account? While more developed countries are able to put together anti-crisis packages that are as large as 10% of GDP (e.g. Australia, Germany, the US), emerging countries cannot afford to reach these levels (even though their needs are many).

Assuming that emerging countries were to put in emergency plans that required a large government deficit of around 3% of GDP, [6] it will imply (keeping the private sector deficit frozen) a current account deficit of about 3% of GDP. Put that into perspective, 3% of Latin America’s GDP, for example, is around $164 billion. [7] For comparison, the amount that has been disbursed by the IMF in response to the COVID-19 crisis is less than $1 billion, [8] while the IMF’s total capacity to lend to Latin America, is less than 1% of the region's GDP. [9] This is a very large cap that could not be financed by business as usual.

Latest projections put the gross (internal and external) public debt of emerging-market and developing countries at the range of 62% and 47% of their GDP in 2020, respectively (Figure 1), [10] while the sudden stop in capital flows in emerging markets, has created a hole of around $66 billion since the beginning of March. [11] Given the insufficient levels of internal reserves and borrowing from local markets, emerging market countries would need at least $2.5 trillion in financial resources in order to get through the pandemic. [12] The question then arises: How such gap can be financed?

One way is via debt markets. Social bonds, for example, can channel important amounts of money to fight the COVID-19 global emergency. [13] Supranational banks, governments and corporates have an important role to play in that direction. Over the last weeks, the African Development Bank (AfDB), the World Bank and the International Finance Corporation (IF), among others, have raised capital by issuing social bonds that support emerging markets and developing countries. [14] As for the sovereign social bond market, while it presents an opportunity for governments to apply its external debt towards public policy goals, it is still in a nascent stage. [15]

Although governments can issue social bonds to fight COVID-19, this will increase debt levels, retard growth, reduce spending flexibility and crowd out private investors from capital markets. [16] It will also make some countries reluctant to use their money for paying the debt of an emerging country. Moreover, it is hard to imagine a very large package going to an emerging country while the country remains under great pressure to be current on their payments. Therefore, alongside a support package there should be some kind of a temporary debt standstill. [17]

An alternatively, and perhaps more viable solution, is through a different type of swap arrangements than those that are currently available between the world's leading central banks and emerging economies. For example, only a very small group of emerging countries (i.e. Brazil, Mexico, Korea, Singapore) can currency benefit under the FED’s swap arrangements. On one hand this is understandable, as the Fed does not want to take on the risk associated with a dozen or more of emerging economies. However, the FED could potentially take on IMF risk, and then the IMF will have a swap arrangement with the FED (or the bank of England, the ECB, the BoJ) and in turn re-lend those resources. In that case, the major central banks have IMF risk on their books and not from emerging economies.

By hook or by crook, the operative phrase here is ‘whatever it takes’. Mario Draghi said he would do whatever it takes to save the Euro, while President George W. Bush said he would do whatever it takes to defend American security after 9/11. The question therefore is whether the world community does whatever it takes to address this huge, dangerous and painful crisis in developing countries.

1. See https://www.afro.who.int/health-topics/coronavirus-covid-19.

2. See OECD (2019), “Society at a Glance 2019: OECED Social Indicators”, 27 March.

3. Emerging markets rely more on employment protection legislation, which, however, protects only a fraction of workers – risking a dual labor market of protected formal sector workers and a large unprotected informal sector. This is one of the obstacles to creating jobs in the formal sector. See Duval, R. and P. Loungani (2019), “Designing Labor Markets Institutions in Emerging and Developing Economics: Evidence and Policy Options”, IMF Discussion Note, May 2019, International Monetary Fund.

4. In August 2007, and before the financial crisis hit, the FED’s balance sheet totaled about $870 billion. By January 2015, after the large-scale asset purchases had occurred, its balance sheet swelled to $4.5 trillion. See https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.

5. Prices did rise modestly in the low-interest rate environment that followed the global financial crisis, but not nearly enough to be considered anything close to a hyperinflation.

6. See IMF (2020), “Economic Policy in Latin America and the Caribbean in the Time of COVID-19”, April 16.

7. In 2018 Latin America’s GDP was at $5.5 trillion. Latin America countries considered: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela. GDP data obtained from World Bank.

8. The amount that IMF is able to lend to its member countries, and which comes from three different sources (quotas, multilateral borrowing arrangements, and bilateral borrowing agreements), is $980 billion. See https://www.imf.org/en/About/infographics/imf-firepower-lending.

9. IMF’s lending capacity is based on quotas, which as of January 2020 (Fifteenth General Review of Quotas) have been decided to remain stable. For Latin America countries this means 7.5% of total Special Drawing Rights (SRD), or SRD 35 billion, or $49 billion. This represents 0.89% of Latin America’s GDP.

10. See IMF Fiscal Monitor of April 2020.

11. Data for March and April 2020 have been considered. See: https://www.iif.com/Research/Capital-Flows-and-Debt/Capital-Flows-Tracker.

12. See IMF’s Director, Kristalina Georgieva briefing on March 27, 2020.

13. Social bonds entail three characteristics that make them an attractive solution. They are: i) inclusive; ii) responsive to short and longer-term needs; and iii) flexible and multifaceted.

14. About $25 billion in social ($12 billion) and sustainable ($13 billion) bonds were issued in Q1 2020, according to Moody's (https://www.pionline.com/interactive/covid-19-response-prompts-253-billion-social-sustainable-bonds). Nevertheless, social bonds have been issued at a much lower rate than green bonds. In 2019, social bonds had a total issuance of $17 billion, compared to $259 billion in issuances for green bonds.

15. In January 2020, Ecuador issued the world’s first sovereign social bond of $400 million with guarantee support from the Inter-American Development Bank (IDB), in an effort to support a government housing program.

16. Deficit-financed public investment might lead to some crowding out of private investment during better periods. However, low interest rates – which will stay for longer – suggest that the rate of return on private investment is low, so crowding out is not a major concern. In such a low-rate, low-inflation environment, the risk of piling on debt seems more manageable, at least for countries like the US and Japan that borrow in their own currencies. See Blanchard, O. (2019), “Public Debt and Low Interest Rates”, American Economic Review, 109(4): 1197-1229; and Krugman, P. (2020), “The Case of Permanent Stimulus”, in Baldwin, R. and Weber di Mauro, B. “Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes”, A VoxEU.org Book, CEPR Press.

17. Such a standstill entails an agreement among creditors (officials and private) and the debtor for a temporary pause on debt payments.