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Debt dilemma: how to avoid a crisis in emerging nations

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Global institutions, creditors and lobby groups are scrambling to come up with ways of tackling what many fear will be a wave of sovereign debt crises in emerging economies in the coming year.

The economic and financial consequences of the pandemic threaten to tip dozens of nations into a fiscal crisis and to leave many others weighed down with debt and struggling to grow. 

These countries need trillions of dollars of additional public spending to help them recover from the crisis, according to the IMF, which has warned that their national resources will fall far short.

Kristalina Georgieva, the IMF’s managing director, warned this month that about half of low income countries were already in high debt distress.

“We know we must act quickly to restructure their debts . . . so there is no spillover to the rest of the world,” she said.

Not only the poorest countries are at risk. Debt burdens among the 30 biggest emerging economies rose by 30 percentage points of gross domestic product between January and September to almost 250 per cent according to the Institute of International Finance.

Line chart of Total debt as share of GDP in 30 emerging economies (%) showing Emerging market debt has soared in the pandemic

So far the global response has been piecemeal, with little of the co-ordinated action that followed the financial crisis a decade ago. But Joe Biden’s victory in the US presidential election has raised hopes that multilateral action could revive next year.

A range of options have been championed by debt relief advocates.

Extend debt suspension

The debt service suspension initiative (DSSI) announced by the G20 in April has so far delivered about $5bn relief to 46 of the world’s poorest countries, of 73 that are eligible. It has since been extended to mid-2021, and could be expanded further.

Pros: Immediately eases public finances, though debts must eventually be paid.

Cons: Lack of uptake: so far, agreed relief is less than a tenth of this year’s increase in external borrowing needs, according to the IMF. Critics say it fails to take account of debtor countries’ and private lenders’ concerns. Its scope is limited to loans by G20 governments and their policy banks — about 35 per cent of eligible public debt, according to the World Bank.

Level the playing field

The G20’s recently launched framework for how debt relief is implemented beyond the DSSI could be expanded to cover middle-income nations.

Pros: Equal treatment for official bilateral and commercial creditors, including Chinese lenders, banks and bondholders. Would address concerns about potential defaults and fears that they will be hard to handle on an ad hoc basis. 

Cons: Lacks enforceability. “The language is good but there are major questions on implementation,” said Mark Sobel, US chair of Omfif, a central banking think-tank, and former US Treasury official. “Until they are resolved, we won’t believe we are on the right path.”

Covid-19 reverses the profile of systemic risk in emerging markets. Chart showing the number of emerging market economies at each level of risk of fiscal crisis

Rally the IMF

Early in the crisis the IMF suggested allocating more of its special drawing rights, which countries may sell for cash.

The World Bank, the UN and governments across the world supported the call but it was vetoed by the Trump administration. As the IMF’s biggest shareholder, the US has the power to block such a move.

The IMF allocates SDRs to its 190 members broadly in line with their share of the global economy. It last allocated $250bn in 2009, in response to the global financial crisis.

Advocates of SDRs hope the Biden administration will look at this afresh.

Pros: Does not involve policy conditions, so palatable for debtor nations’ domestic politics. An immediate promise of liquidity which has in the past calmed financial markets.

Cons: Benefit wealthy countries more, under existing distribution rules, though advocates say there are ways round this. Would benefit countries that have resisted reforms. 

Relief from multilaterals

Multilateral institutions such as the IMF and World Bank are the biggest lenders to poor countries. They were owed $243bn by DSSI countries at the end of 2019 — 46 per cent of their total public debts, according to the World Bank. Of the $42.7bn those countries owed in repayments in 2020, $13.8bn is to multilaterals.

The UN, China, former and serving world leaders, NGOs and debt campaigners have all called for multilateral lenders to join the moratorium on repayments or even to cancel outstanding loans.

Pros: Equal treatment of all creditors avoids any relief granted by one set being spent on payments to another.

Cons: Multilaterals borrow cheaply in the capital markets because they are first in the queue ahead of other creditors and have the highest possible credit ratings. This lets them lend at ultra-low rates and finance grants. David Malpass, World Bank president, has said that a moratorium would “undercut” its “dependable access to global capital markets”.

They have also done more to help than any other organisation so far: the IMF has lent $102bn to 82 countries and effectively cancelled repayments from the poorest. The World Bank has set aside $160bn to lend over 15 months, with a further $80bn allocated by other development banks.

Tackle private investors

Commercial lenders, which hold about 19 per cent of the DSSI countries’ debt stock and are owed repayments of $11.5bn this year, have been encouraged to take part in the DSSI but have not done so.

Pros: Debt campaigners and others say private creditors should share the burden.

Cons: Debtor countries fear damaging their creditworthiness and losing capital market access. To address this, some argue that credit rating agencies could not regard a debt relief request as a default. But the agencies argue that would go against their duty to clients.

Change sovereign debt rules

The IMF has been trying for at least two decades to redesign the international architecture for resolving sovereign debts to private creditors. In September it launched its latest proposals.

It has also been suggested that the US and UK, the legal jurisdictions of most foreign currency sovereign bonds, could pass legislation to prevent bondholders from taking legal action. 

Pros: Reduce the disruption and stagnation inherent in lengthy disputes. 

Cons: Hard to design, with great legal, policy and enforcement difficulties.



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Emerging Markets

Coronavirus latest: Boris Johnson extends lockdown restrictions in England to July 19

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New York state has the lowest seven-day average Covid-19 positivity rate at 0.44 per cent, governor Andrew Cuomo said, citing Johns Hopkins University data.

On Sunday, the state health department said 383 new positive cases were identified from 110,437 tests – a rate of just 0.35 per cent.

“We’re beating back Covid-19 across the state and New York has the nation’s lowest seven-day average positivity rate, but it’s going to take more vaccinations to get us across the finish line,” Cuomo said.

The state plans to offer “exciting incentives” for vaccinations, he added.

Cuomo said more than two-thirds of New York adults – 67.2 per cent – now had at least one vaccine dose, and 60 per cent were fully vaccinated.

“I encourage everyone eligible who hasn’t yet been vaccinated to take advantage of a free $20 lottery ticket.”

Scholarships in the State University of New York system and City University of New York were also being offered.

The number of new coronavirus cases tallied in the US has remained near levels not seen since the early days of the pandemic, an encouraging decline that has prompted some states to scale back their daily reporting of Covid-19 trends.

Infections, hospitalisations and deaths related to Covid-19 have dropped sharply since a winter surge, brought down by a vaccination rollout that kicked off in December. 

Overall about 64 per cent of American adults have now received at least one shot, according to the Centers for Disease Control and Prevention.

The US has reported 15,928 infections per day in the week ending June 10, which is down about half in the span of one month and 94 per cent from a January peak of nearly 251,085, based on a Financial Times analysis of figures from Johns Hopkins University.



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Hong Kong-Taiwan spat threatens cross-Strait business

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Official representation between Hong Kong and Taiwan is set to end this year as mounting political tensions threaten one of the region’s most important trade and investment relationships.

The number of staff in Taiwan’s representative office in Hong Kong has dwindled over the past two years as the territory has stopped issuing visas, with the documents of those who remain due to expire by the end of November.

Hong Kong also abruptly suspended operations of its representative office in Taipei two weeks ago, ending its official presence there. The stand-off has grown so severe that Taipei has begun making contingency plans for a situation without on-the-ground representation in Hong Kong, two senior Taiwanese government officials said.

The breakdown in relations follows rising military tensions between Taiwan and China and a crackdown by Beijing on pro-democracy groups in Hong Kong that has led some activists in the territory to seek refuge in Taipei.

China claims Taiwan as part of its territory and has threatened to annex it if the island fails to submit to its control indefinitely.

Analysts said that cutting official channels would undermine Hong Kong’s traditional role as a conduit for business and financial exchanges between Taiwan and China. Despite the dispute with Beijing over sovereignty, Taiwanese companies are among the largest foreign investors, employers and exporters in mainland China.

Taiwan air force personnel during the visit by President Tsai Ing-Wen
Military tensions between China and Taiwan have escalated, but investment and trade across the Taiwan Strait remains important to both countries © Ritchie B Tongo/EPA-EFE/Shutterstock

A significant part of trade across the Taiwan Strait trade goes through Hong Kong, and many Taiwanese investors in China also use Hong Kong for financial, taxation and legal purposes. Last year, Taiwan was Hong Kong’s second-largest trading partner, while Hong Kong was Taiwan’s fifth-largest, with HK$504bn (US$65bn) in total bilateral trade. Taiwanese companies invested US$912m in Hong Kong in 2020, while Hong Kong-registered companies invested US$555m in Taiwan.

“Hong Kong has been a springboard for Taiwanese companies into mainland China and it has also been a springboard for Chinese [companies] into Taiwan,” said Liu Meng-chun, a research section director at the Chung-Hua Institution for Economic Research, a Taiwanese government-backed think-tank.

Tensions between Hong Kong and Taipei have escalated over the past two years after the territory started demanding Taiwanese diplomats sign documents declaring their country part of China as a precondition for being issued a visa.

After Taipei refused, the number of staff at its office in Hong Kong began to dwindle, from 20 to eight today, according to the Mainland Affairs Council, Taiwan’s cabinet level China policy body.

Hong Kong, meanwhile, said it was temporarily closing its Taipei office because “Taiwan’s series of actions in recent years has severely damaged Hong Kong-Taiwan relations”.

A Hong Kong government official suggested the suspension came on instructions from Beijing.

“I think Beijing is of the opinion that [Taiwan’s representative office] affects national security,” said Sung Yun-wing, an economics professor at the Chinese University of Hong Kong, who is also a member of a semi-official think-tank, the Chinese Association of Hong Kong and Macao Studies, in Beijing.

“There have been reports that Taiwan has been encouraging the protest movement in Hong Kong, which has turned violent, so the protest movement is not only against the Hong Kong government but also Beijing,” said Sung. He added China was also concerned Taiwan was “sheltering” Hong Kong protesters.

While Taipei has been careful to avoid being seen as making it too easy for Hong Kong dissidents to flee to Taiwan, civil society groups in the country have supported the protest movement with advice, money and logistics. “This is something we cannot interfere with as they have done nothing illegal,” said a senior Taiwanese China policy official.

Historically, Hong Kong’s most important economic role in the Taiwan-China trade has been as a sea and air trans-shipment hub for Taiwanese companies to supply their factories in southern China with components.

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While analysts suggested that much of this commerce could continue even if official ties between Taiwan and Hong Kong were severed, they foresaw a sizeable impact on financial services, tourism and education.

“Hong Kong plays a very important role for Taiwanese private wealth management,” said Patrick Chen, head of Taiwan research at CLSA, the brokerage.

He said many Taiwanese individuals had accounts in Hong Kong, where the local units of Taiwan’s banks offered them offshore investment products not accessible under the island’s stricter regulations.

Liu of the Chung-Hua Institution for Economic Research said many Taiwanese enterprises kept profits from their China operations with their Hong Kong affiliates for tax purposes.

“These things would become a lot more cumbersome without official representation because you would have to start sending documents back and forth for notarisation,” Liu said.



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Nato leaders fret China’s Atlantic ambitions

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China’s growing military and economic presence in the Atlantic region is expected to trigger a rare warning from Nato leaders about the potential security threat when they meet on Monday, diplomats said. 

From joint Chinese drills with Russia to western worries that China wants to set up military bases in Africa, the Nato focus reflects China’s primacy among western foreign policy concerns, in particular those of US president Joe Biden.

“This is not about ‘Nato going to China’,” said Claudia Major, a defence analyst at the German Institute for International and Security Affairs. “It’s about ‘China is coming to Europe and we have to do something about it’.”

In 2015, joint military drills with Russia brought the Chinese navy into the Mediterranean and the heart of Europe for the first time. Since then, China has built up the largest naval fleet in the world and invested in critical European infrastructure, including ports and telecoms networks.

“China [through its navy] has come through the Indian Ocean, into the Gulf, up to the Red Sea and they’ve been in the Mediterranean,” according to one British military official, who said China had not yet deployed submarines in the north Atlantic but could do so in future.

“You build nuclear submarines for range and stealth. And China does like to test the boundaries.”

The planned joint statement by the transatlantic security alliance, which diplomats said was still under discussion and subject to change, would be only the second time that Nato leaders have addressed the subject of China head-on. The first was in December 2019, at the insistence of the administration of Donald Trump.

But Biden is understood to be pushing for tougher language than the bland “opportunities and challenges” terminology used that time.

Nonetheless, how to deal with the issue represents a dilemma for the 30-member group, which was originally set up in 1949 to deal with cold war-era threats.

Internally, Nato countries are divided over how to treat China: member Hungary, for one, has good political relations with Beijing.

In addition, there is reluctance to confront Beijing in its own Pacific region — although the UK and France have followed the US in deploying ships to carry out freedom of navigation exercises in the South China Sea.

Chinese and Russian marines take part in joint exercises in China’s Guangdong province
Chinese and Russian marines take part in joint exercises in China’s Guangdong province © Li Jin/Getty

China’s joint military operations with Russia are viewed as a particularly unwelcome development by some Nato members. As well as their annual military exercises, Beijing and Moscow have recently added joint missile defence drills and training for internal security forces.

“Their [the Chinese/Russian] relationship is transactional and pragmatic rather than ideological,” the UK military official said. “But working together in any form provides confidence. And confidence is something we should be wary of.”

As the Center for a New American Security, a bipartisan US think-tank, warned in a January report: “Where Russian and Chinese interests align, Moscow and Beijing could eventually co-ordinate their combined capabilities to challenge US foreign policy.”

Another Nato anxiety is Africa, which China could use to expand its military presence in the Atlantic as part of its long-term goal to become a truly global armed force.

Gen Stephen Townsend, head of US Africa Command, told the US Senate in April that his “number-one global power competition concern” was what he described as Chinese efforts to establish a militarily useful naval facility on Africa’s west coast. “I am talking about a port where they can rearm with munitions and repair naval vessels,” he said.

Experts on the Chinese military said there was no evidence that Beijing was trying to establish such a west African base, yet. However, China has a base in Djibouti and has already used international anti-piracy missions in the Gulf of Aden to train thousands of military personnel and to build military relations with countries outside its usual neighbourhood.

Each time a naval contingent finishes deployment, for example, it typically takes a detour on the way home. Some have visited the Mediterranean and the east and west coasts of Africa.

Another trend vexing Nato allies is the growing involvement of Chinese companies in critical infrastructure in Europe, such as through telecommunications company Huawei.

Chinese state shipping company Cosco also owns a controlling stake in Piraeus, Greece’s largest port, and is reportedly in talks to invest in a Hamburg port terminal.

Such economic ties complicate Nato’s efforts to create a unified approach on China — as do the political relationships between Beijing and friendly European leaders.

That creates the potential for clashes, with the tougher stance of Washington and Jens Stoltenberg, Nato’s secretary-general, who last month warned that China was “coming to us” in areas including cyber space, Africa and the Arctic.

“There is a risk that having this discussion within Nato surfaces very uncomfortable differences between allies on how much China is actually perceived as a threat,” said Sarah Raine, an expert in geopolitics and strategy at the International Institute for Strategic Studies.

“The fact is that there are countries which are seen by hawks as making very pro-China arguments within Nato, at least with regards to being robust but not confrontational.”

Additional reporting by Katrina Manson in Washington



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