Tag Archives sovereign debt crisis

Reforming the international financial system is no act of charity

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Rolph van der Hoeven and Rob Vos are the authors of a chapter* of the recently published book ‘COVID-19 and International Development’. In this blog, they elaborate on their chapter, which is about the international financial system. They urge governments worldwide to implement four reforms, necessary to create more fiscal space and access to adequate external finance for developing countries.

Deep inequalities in pandemic response capacity

The global economic crisis provoked by the COVID-19 pandemic has painfully revealed the fundamental flaws in the international financial and fiscal system (IFFS). While advanced countries could engage in massive fiscal and monetary support measures, low- and middle-income countries lacked such capacities and were hit disproportionally. During the first year of the pandemic (2020), advanced countries provided fiscal stimuli to the tune of 12.5 percent of Gross Domestic Product (GDP) on average. This was three times more in relative terms than the stimulus in emerging and other middle-income countries, and almost 10 times more than governments in low-income countries could provide (Figure 1). This divergence in government support mimicked the inequality in vaccine roll-out.

Figure 1. Fiscal and monetary support in response to COVID-19, as of January 2021

Source: Van der Hoeven and Vos (2022), based on data from IMF (2021), Fiscal Monitor, Database of Country Fiscal Measures in Response to the COVID-19 Pandemic.

Four reforms to overcome financing flaws

As with past crises, a lack of adequate contingency financing forced poorer nations to take a big hit with lasting consequences. While high-income countries could engage in massive, and almost costless fiscal and monetary expansion, low-income countries saw their external debts increase to severe distress levels. In addition, they were forced to devalue their currencies, and curtail economic and social support programs. Consequently, an estimated 100 million to 150 million more people faced hunger during 2020, lifting the total number of people with not enough to eat to 810 million.[1]

The lack of fiscal space and access to adequate external finance for developing countries has its origins in the weaknesses of the International Financial and Fiscal System (IFFS). These structural weaknesses demand four urgent reforms, outlined below:

  1. Establish credible mechanisms for international tax coordination.

Such mechanisms would include, among other things, an internationally agreed, uniform corporate tax rate of approximately 25% to stop tax base erosion. This tax rate would hinder multinational companies shifting their profits to tax havens. Improved tax coordination should further include mandated publication of data on offshore wealth holdings. This would enable all jurisdictions to adopt effective progressive wealth taxes and facilitate the monitoring of income taxes effectively paid by the super wealthy. After years of deliberations, the G20 indeed agreed to a proposal for uniform corporate tax treatment in 2021. Unfortunately, at 15%, the rate is still significantly lower than we proposed, thereby falling short of making a more significant impact on boosting tax revenues and on limiting profit-shifting behaviour.[2]

  1. Establish a multilaterally backed sovereign debt workout mechanism.

Although existing mechanisms to renegotiate sovereign debts with private creditors have improved over the years, they are still far from adequate. This is due to the multiplicity of debt contracts, some of which are not subject to collective action clauses. These collective action clauses are perceived as preventing more drastic action in cases of crises; without them bonds could potentially lose a great amount of their value. A global institutional mechanism to renegotiate sovereign debts should, therefore, be put in place as soon as possible. To this day, sovereign debt solvency problems continue to be solved in an ad-hoc fashion, at little favourable terms to debt-distressed countries. Moreover, they are accompanied by policy conditionality. This leads to unnecessary hardship in affected countries.[3]

  1. Reform of policy conditionality attached to International Monetary Fund (IMF) contingency financing.

While the IMF has recognized the need for enhanced public spending by developing country governments, including those facing debt distress, in practice, however, it continues providing pro-cyclical policy advice. This means that the IMF asks for fiscal restraint, rather than deficit spending when economies are in recession.

  1. Increasing the availability of truly international liquidity by increasing Special Drawing Rights (SDRs) and making these available to developing countries.

As an important step in this direction, the IMF approved the issuance of US $650 billion in new SDRs in June 2021. However, no agreement has yet been reached regarding how these additional SDRs should be allocated to developing countries, and how they can leverage additional investment to foster sustainable development. Had such reforms been in place already, the pandemic response would have provided a fairer level playing field for emerging and developing countries. This would have mitigated the pandemic’s worst economic consequences.


Conclusion

None of these reforms should be seen as acts of charity. They are necessary to facilitate a global economic recovery that is both sustainable and equitable. As in past crises, government leaders have acted with a ‘me first’ attitude, as has been blatantly clear in the roll-out of vaccination programs. Some countries perceived this as a return to protectionism. This form of protectionism was evident in the unprecedented fiscal responses of high-income countries to protect the livelihoods of their own citizens, but which woefully disregarded the fate of people in low-income countries. The governments of those countries did not have the means to protect the livelihoods of their citizens to the same extent. Beggar-thy-neighbour policy responses, however, will affect global prosperity in the long term, and will make the Sustainable Development Goals elusive.

[1]  Laborde, D., Martin, W. and Vos, R. (2021) Impacts of COVID-19 on Global Poverty, Food Security and Diets, Agricultural Economics 52(3) https://doi.org/10.1111/agec.12624, and FAO, IFAD, UNICEF, WFP and WHO. 2021. The State of Food Security and Nutrition in the World 2021.  Transforming food systems for food security, improved nutrition and affordable healthy diets for all.  Rome: FAO. https://doi.org/10.4060/cb4474en

[2] A. Cobham, 2021 Is today a turning point against corporate tax abuse? Tax Justice Network, 4 June 2022

[3] INET. (2021). The pandemic and the economic crisis: A global agenda for urgent action (Interim report of the commission for global economic transformation). Institute for New Economic Thinking. https://www.ineteconomics.org/research/research-papers/the-pandemic-and-the-economic-crisis-a-global-agenda-for-urgent-action

Note

*This blog is based on: Rolph van der Hoeven and Rob Vos (2022), ‘Reforming the International Financial and Fiscal System for better COVID-19 and Post-Pandemic Crisis Responsiveness’, Chapter 2 in Papyrakis, E.(ed.). COVID19 and International Development, Springer

Opinions expressed in Bliss posts reflect solely the views of the author of the post in question.

About the authors:

Rolph van der Hoeven is Professor of Employment and Development Economics at the Institute of Social Studies (ISS)

Rob Vos is Director of Markets, Trade and Institutions Division at the International Food Policy Research Institute.

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Haemorrhaging Zambia: Underlying sources of the current sovereign debt crisis

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Following a stand-off with commercial creditors and protracted but unresolved negotiations with the IMF, Zambia defaulted on its external sovereign debt on 13 November this year. While most commentary has focused exclusively on the government’s sovereign borrowing, our own research has detected massive outflows of private wealth over the past 15 years, hidden away in an obscure part of the country’s financial account. The outflows are most likely related to the large mining companies that dominate the country’s international trade. With many other African countries also facing debt distress, this huge siphoning of wealth from Zambia provides crucial lessons that need to be central in discussions about debt justice in the current crisis. We explain here what we’ve found.

Zambia was already debt-stressed going into the COVID-19 pandemic. The economy was hard hit following the sharp fall in international copper prices from 2013 to 2016, especially given that copper made up about 72% of its exports in 2018 (including unrefined, cathodes and alloys). Following a severe currency crisis in 2015, the government entered into negotiations with the IMF for a balance of payments support loan, but until now they have failed to reach an agreement on the conditions and accompanying programme. There was some improvement in its macroeconomic outlook in 2017 due to rising copper prices, which sent international investors throttling back into optimism.

However, international investors again turned against the country in 2018 in the midst of the global emerging market bond sell-off, which compounded the effects of severe droughts in 2018-19. As a result, the government was already teetering on the edge of default on the eve of the COVID-19 pandemic. The economic fall-out of the pandemic has since pushed the country over the edge (see an excellent analysis here).

Inductive quantitative balance of payments analysis

Most of the commentary on Zambia’s default focuses exclusively on the government’s sovereign borrowing. Our own analysis peers behind this headline focus into the intricacies of financial flows into and out of the economy.

This is part of our ERC-funded project on the political economy of externally financing social policy in developing countries. As the principal investigator, I have focused on researching aid and financial flows related to social protection programmes and their place within broader macroeconomic and political economy dynamics. The rest of the research team (three PhDs: Ana Badillo Salgado, Emma Dadap-Cantal, Benedict Yiyugsah, and one postdoc, Dr Charmaine G. Ramos) have been focusing on how these external dynamics influence the adoption and implementation of social protection programmes.

As one of my main methods, I have been conducting historical-structural inductive analysis of balance of payments and related macroeconomic data. This might be best described as a form of investigative or forensic analysis of the external accounts of the respective case countries, of which Zambia happened to be one.

Financial account anomalies in the post debt-relief period

It is through this analysis that I identified a difficult-to-explain data anomaly on the financial accounts of the Zambian balance of payments that started with the debt relief of the Multilateral Debt Relief Initiative (MDRI) in 2005. The anomaly is a sharp rise in net acquisitions of debt instruments by resident non-financial ‘other sectors’ on the ‘other investment’ account. In other words, Zambian residents – which include the local subsidiaries or affiliates of transnational corporations – were massively increasing their holdings of debt assets abroad even in the midst of debt distress at home.

The magnitude of these acquisitions of debt assets far exceeded the amount of Eurobonds that are now in default (worth $3 billion USD). They started at the same time as the MDRI debt relief, when this category jumped from non-existence in 2003 to over $600 million in 2005 and over $900 million in 2006, more than counteracting the gains of debt relief.[1] These obscure debt asset acquisitions then jumped to almost $1.5 billion in 2007 and peaked at over $5 billion in 2012, over $3 billion in 2015, and over $1.8 billion in 2017. While they subsided in 2018 and 2019, they had already reached over $1.3 billion in the first half of 2020 (based on the latest quarterly reporting).

In proportional terms, these outflows reached peaks of almost 20% of GDP in 2012, 15% of GDP in 2015, and over 7% of GDP as recently as 2017. They thereby siphoned off most of the gains from both the commodity boom of the early 2010s and the government’s borrowing, undermining any hope for achieving external financial stability.

What could such debt assets represent? Local subsidiaries of transnational corporations have been known to borrow heavily offshore, as is commonly discussed in the financialization literature.[2] However, such financial operations would appear as debt liabilities, not as debt assets, so this explanation does not make sense.

In exploring this puzzle during fieldwork in Zambia in 2017,[3] we came to understand that the debt assets in question represent an accounting discrepancy that is mostly likely explained by unreported profit remittances by large mining companies in Zambia. Other corporates might have also been involved, although given the conventional wisdom that most things occurring on the external accounts of Zambia are somehow related to the mining majors, it follows that so too were the discrepancies.

The monetary authorities in Zambia have been aware of this anomaly.[4] They admitted to us that they had been trying to figure it out with the help of the IMF. It was not related to private capital flight through banks given that the banking sector is well regulated by the central bank (the Bank of Zambia or BoZ). In contrast, mining companies are not required to report to the BoZ given that they are non-financial firms and hence are not covered by banking regulations, even though they dominate much of the financial activity in the economy, especially on the external accounts.

Indeed, the anomaly itself was a creation of the BoZ based on their observation of discrepancies between their own data versus the reporting of assets held by Zambian residents by the Bank of International Settlements, to which international banks are required to report even when they fall outside Zambian jurisdiction. This led the BoZ to believe that the discrepancies belonged in this category of international debt assets. Technically, however, they should have been reported in the category of errors and omissions or even as profit remittances, although this would have of course raised alarm bells given the magnitude of these flows.

More than just debt relief is needed

The enormous sums involved provide a vital counterperspective to the rise of sovereign borrowing by Zambia. In effect, sovereign borrowing has helped sustain these private outflows, especially once the commodity boom came to an end. Foreigners have profited, much of the wealth of Zambia is now offshore, and yet the Government of Zambia has continued borrowing in a desperate attempt to keep the financial ship afloat despite these massive holes in its hull. Regular Zambians are now paying the price.

The argument for this economic model since the beginning of the century has been, to put it crudely, that Africans are better off being exploited than not being exploited at all, in terms of the extra jobs, investment, demand, and revenue that transnational corporations bring. With governments returning to the spectres of hard adjustment and deep recession, so soon after debt relief and commodity boom were squandered by massive outflows of wealth that open capital accounts facilitated, it is hard to see how this logic retains any credibility. More than just debt relief, a complete rethink of the model is required.

[1] Cancelled multilateral debt was close to $2 billion in both 2005 and 2006 although the actual gains from this were only accrued through reduced interest payments on debt, which only fell by $73 million USD in 2016 and $37 million USD in 2017.

[2] For instance, see Serena JM, Moreno R. 2016. ‘Domestic financial markets and offshore bond financing’. BIS Quarterly Review, September: 81-97. For more critical discussions, see Bortz PG, Kaltenbrunner A. 2018. ‘The International Dimension of Financialization in Developing and Emerging Economies’. Development and Change. 49(2): 375-393; or Kaltenbrunner A, Painceira JP. 2015. ‘Developing countries’ changing nature of financial integration and new forms of external vulnerability: the Brazilian experience’. Cambridge Journal of Economics. 39(5): 1281-1306.

[3] While the PhDs in the project spent four to six months in each of the case study countries conducting political economy process tracing of social protection agendas and programmes, I joined them in each of the countries for a shorter period of time and focused specifically on conducting elite interviews with a range of specialized actors that had technical knowledge and experience over the external financing of domestic spending. These actors included staff from major donors, international organisations, central banks, finance ministries, and other government departments, especially those involved in social protection programmes.

[4] These must remain anonymised given the political sensitivity of these issues.

This article is an abridged and slightly modified version of the full analysis, including detailed data analysis, posted on the Developing Economics blog, which can be found here.

About the author:

 

Andrew Fischer

Andrew M. Fischer is Associate Professor of Social Policy and Development Studies at the ISS and the Scientific Director of CERES, the Dutch Research School for International Development. His latest book, Poverty as Ideology (Zed, 2018), was awarded the International Studies in Poverty Prize by the Comparative Research Programme on Poverty (CROP) and Zed Books and, as part of the award, is now fully open access (http://bora.uib.no/handle/1956/20614). Since 2015, he has been leading a European Research Council Starting Grant on the political economy of externally financing social policy in developing countries. He has been known to tweet @AndrewM_Fischer

 

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