Cash will soon be obsolete. Will America be ready?
By Erik CarterWhen was the last time you made a payment with dollar bills?Some people still prefer to use cash, perhaps because they like the tactile nature of physical currency or because it provides confidentiality in transactions. But digital payments, made with the swipe of a card or a few taps on a cellphone, are fast becoming the norm.To keep their money relevant, many central banks are experimenting with digital versions of their currencies. These currencies are virtual, like Bitcoin; but unlike Bitcoin, which is a private enterprise, they are issued by the state and function much like traditional currencies. The idea is for central banks to introduce these digital currencies in limited circulation — to exist alongside cash as just another monetary option — and then to broaden their circulation over time, as they gain in popularity and cash fades away.China, Japan and Sweden have begun trials of central bank digital currency. The Bank of England and the European Central Bank are preparing their own trials. The Bahamas has already rolled out the world’s first official digital currency.The U.S. Federal Reserve, by contrast, has largely stayed on the sidelines. This could be a lost opportunity. The United States should develop a digital dollar, not because of what other countries are doing, but because the benefits of a digital currency far outweigh the costs.One benefit is security. Cash is vulnerable to loss and theft, a problem for both individuals and businesses, whereas digital currencies are relatively secure. Electronic hacking does pose a risk, but one that can be managed with new technologies. (As it happens, offshoots of Bitcoin’s technology could prove helpful in increasing security.)Digital currencies also benefit the poor and the “unbanked.” It is hard to get a credit card if you don’t have much money, and banks charge fees for low-balance accounts that can make them prohibitively expensive. But a digital dollar would give everyone, including the poor, access to a digital payment system and a portal for basic banking services. Each individual or household could have a fee-free, noninterest-bearing account with the Federal Reserve, linked to a cellphone app for making payments. (About 97 percent of American adults have a cellphone or a smartphone.)To see how this might help, consider the payments that the U.S. government made to households as part of the coronavirus stimulus packages. Millions of low-income households without bank accounts or direct deposit information on file with the Internal Revenue Service experienced complications or delays in getting those payments. Checks and debit cards mailed to many of them were delayed or lost, and scammers found ways to intercept payments. Central-bank accounts could have reduced fraud and made administering stimulus payments easier, faster and more secure.A central-bank digital currency can also be a useful policy tool. Typically, if the Federal Reserve wants to stimulate consumption and investment, it can cut interest rates and make cheap credit available. But if the economy is cratering and the Fed has already cut the short-term interest rate it controls to near zero, its options are limited. If cash were replaced with a digital dollar, however, the Fed could impose a negative interest rate by gradually shrinking the electronic balances in everyone’s digital currency accounts, creating an incentive for consumers to spend and for companies to invest.A digital dollar would also hinder illegal activities that rely on anonymous cash transactions, such as drug dealing, money laundering and terrorism financing. It would bring “off the books” economic activity out of the shadows and into the formal economy, increasing tax revenues. Small businesses would benefit from lower transaction costs, since people would use credit cards less often, and they would avoid the hassles of handling cash.To be sure, there are potential risks to central-bank digital currencies, and any responsible plan should prepare for them. For example, a digital dollar would pose a danger to the banking system. What if households were to move their money out of regular bank accounts and into central-bank accounts, perceiving them as safer, even if they pay no interest? The central bank could find itself in the undesirable position of having to allocate credit, deciding which sectors and businesses deserve loans.But this risk can be managed. Commercial banks could vet customers and maintain the central-bank digital currency accounts along with their own interest-bearing deposit accounts. The digital currency accounts might not directly help banks earn profits, but they would attract customers who could then be offered savings or loan products. (To help protect commercial banks, limits can also be placed on the amount of money stored in central-bank accounts, as the Bahamas has done.) A central-bank digital currency could be designed for use across different payment platforms, promoting private sector competition and encouraging innovations that make electronic payments cheaper, quicker and more secure.Another concern is the loss of privacy that central-bank digital currencies entail. Even with protections in place to ensure confidentiality, no central bank would forgo the ability to audit and trace transactions. A digital dollar could threaten what remains of anonymity and privacy in commercial transactions — a reminder that adopting a digital dollar is not just an economic but also a social decision.The end of cash is on the horizon, and it will have far-reaching effects on the economy, finance and society more broadly. With proper preparation and open discussion, we should embrace the advent of a digital dollar.Eswar Prasad (@EswarSPrasad) is a professor of trade policy at Cornell University, a senior fellow at the Brookings Institution and the author of the forthcoming book “The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance.”The Times is committed to publishing a diversity of letters to the editor. We’d like to hear what you think about this or any of our articles. Here are some tips. And here’s our email: letters@nytimes.com.Follow The New York Times Opinion section on Facebook, Twitter (@NYTopinion) and Instagram.
The brutal truth about Bitcoin
Bitcoin, the original cryptocurrency, has been on a wild ride since its creation in 2009. Earlier this year, the price of one Bitcoin surged to over $60,000, an eightfold increase in 12 months. Then it fell to half that value in just a few weeks. Values of other cryptocurrencies such as Dogecoin have risen and fallen even more sharply, often based just on Elon Musk’s tweets. Even after the recent fall in their prices, the total market value of all cryptocurrencies now exceeds $1.5 trillion, a staggering amount for virtual objects that are nothing more than computer code.
Are cryptocurrencies the wave of the future and should you be using and investing in them? And do the massive swings in their prices—nearly $1 trillion was wiped off their total value in May—portend trouble for the financial system?
Bitcoin was created (by a person or group that remains unidentified to this day) as a way to conduct transactions without the intervention of a trusted third party, such as a central bank or financial institution. Its emergence amid the global financial crisis, which shook trust in banks and even governments, was perfectly timed. Bitcoin enabled transactions using only digital identities, granting users some degree of anonymity. This made Bitcoin the preferred currency for illicit activities, including recent ransomware attacks. It powered the shadowy darknet of illegal online commerce much like PayPal helped the rise of eBay by making payments easier.
While Bitcoin’s roller-coaster prices garner attention, of far more consequence is the revolution in money and finance it has set off that will ultimately affect every one of us, for better and worse.
As it grew in popularity, Bitcoin became cumbersome, slow, and expensive to use. It takes about 10 minutes to validate most transactions using the cryptocurrency and the transaction fee has been at a median of about $20 this year. Bitcoin’s unstable value has also made it an unviable medium of exchange. It is as though your $10 bill could buy you a beer on one day and a bottle of fine wine on another.
Moreover, it has become clear that Bitcoin does not offer true anonymity. The government’s success in tracking and retrieving part of the Bitcoin ransom paid to the hacking collective DarkSide in the Colonial Pipeline ransomware attack has heightened doubts about the security and nontraceability of Bitcoin transactions.
While Bitcoin has failed in its stated objectives, it has become a speculative investment. This is puzzling. It has no intrinsic value and is not backed by anything. Bitcoin devotees will tell you that, like gold, its value comes from its scarcity—Bitcoin’s computer algorithm mandates a fixed cap of 21 million digital coins (nearly 19 million have been created so far). But scarcity by itself can hardly be a source of value. Bitcoin investors seem to be relying on the greater fool theory—all you need to profit from an investment is to find someone willing to buy the asset at an even higher price.
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Despite their high valuations on paper, a collapse of Bitcoin and other cryptocurrencies is unlikely to rattle the financial system. Banks have mostly stayed on the sidelines. As with any speculative bubble, naive investors who come to the party late are at greatest risk of losses. The government should certainly caution retail investors that, much like in the GameStop saga, they act at their own peril. Securities that enable speculation on Bitcoin prices are already regulated, but there is not much more the government can or ought to do.
Bitcoin is not innocuous. Transactions are processed by “miners” using massive amounts of computing power in return for rewards in the form of Bitcoin. By some estimates, the Bitcoin network consumes as much energy as entire countries like Argentina and Norway, not to mention the mountains of electronic waste from specialized machines used for such mining operations that burn out rapidly.
Whatever Bitcoin’s eventual fate, its blockchain technology is truly ingenious and groundbreaking. Bitcoin has shown how programs running on networks of computers can be harnessed to securely conduct payments, within and between countries, without relying on avaricious financial institutions that charge high fees. For migrant workers sending remittances back to their home countries, for instance, such fees are a major burden. Technologies that make payments cheaper, quicker and easier to track would benefit consumers and businesses, facilitating both domestic and international commerce.
The technology is not without risks. Facebook plans to issue its own cryptocurrency called Diem intended to make digital payments easier. Unlike Bitcoin, Diem would be fully backed by reserves of U.S. dollars or other major currencies, ensuring stable value. But, as with its other ostensibly high-minded initiatives, Facebook can hardly be trusted to put the public’s welfare above its own. The prospect of multinational corporations one day issuing their own unbacked cryptocurrencies worldwide is deeply disquieting. Such currencies won’t threaten the U.S. dollar, but could wipe out the currencies of smaller and less developed countries.
Variants of Bitcoin’s technology are also making many financial products and services available to the masses at low cost, directly connecting savers and borrowers. These developments and the possibilities created by the new technologies have spurred central banks to consider issuing digital versions of their own currencies. China, Japan, and Sweden are already conducting trials of their digital currencies.
Ironically, rather than truly democratizing finance, some of these innovations may exacerbate inequality. Unequal financial literacy and digital access might result in sophisticated investors garnering the benefits while the less well off, dazzled by new technologies, take on risks they do not fully comprehend. Computer algorithms could worsen entrenched racial and other biases in credit scoring and financial decisions, rather than reducing them. The ubiquity of digital payments could also destroy any remaining vestiges of privacy in our day-to-day lives.
While Bitcoin’s roller-coaster prices garner attention, of far more consequence is the revolution in money and finance it has set off that will ultimately affect every one of us, for better and worse.
The key to global climate success
Recent advances in green technologies have made reaching net-zero greenhouse-gas emissions by 2050 not only technically feasible but also economically worthwhile. Meeting this goal—which has started to anchor expectations now that an increasing number of countries have adopted it—is necessary to keep global warming well below 2 degrees Celsius relative to pre-industrial levels. But countries must start rapidly reducing emissions now.
Climate change affects different parts of the world differently, and not all countries are equally responsible—both now and historically—for carbon dioxide emissions. These disparities have so far prevented the emergence of an international consensus on how to share mitigation costs fairly. But in the run-up to the United Nations climate-change summit (COP26) in Glasgow in November, recognition of the severity of the global warming threat, coupled with a dramatic reduction in the cost of renewables, is making rapid progress easier. In fact, the emphasis in the climate debate has shifted from the costs of mitigation to the opportunities provided by new technologies.
The race to realize a net-zero world by 2050 remains tight, with different groups of countries moving at varying speeds. But it is becoming increasingly clear that the performance of emerging markets and developing economies (EMDEs) other than China is likely to hold the key to success.
The race to realize a net-zero world by 2050 remains tight … . But it is becoming increasingly clear that the performance of emerging markets and developing economies (EMDEs) other than China is likely to hold the key to success.
Among advanced economies, Europe is at the forefront of green transformation efforts. The United States under President Joe Biden now seems determined to raise its climate ambitions, and its technological capacity makes it likely to perform well, despite continued domestic political obstacles. The same can be said for other rich countries such as Japan and Canada, which also have the resources and technology to be in the net-zero vanguard.
The poorest countries already suffer the most from ongoing climate change and are the least able to afford mitigation and adaptation measures. On ethical grounds, they deserve a lot of assistance to help them adapt and leapfrog to green technologies, but their total CO2 emissions will be too small to affect the global aggregate significantly between now and 2050.
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This is not the case for EMDEs, whose level of climate ambition and capabilities will be a major determinant of global success. While emissions in most advanced economies are declining, they are still increasing in most EMDEs, which, including China, now account for about two-thirds of global emissions. (China by itself generates about 30 percent of the global total.)
But, because China differs in some important ways from most other EMDEs, lumping it together with these countries is not the best way to assess their prospects for further decarbonization. For starters, China has both the desire and the capacity to be a global export leader in green technologies, and pursuing this ambition will also boost China’s efforts to tout the attractiveness of its sociopolitical system.
Moreover, China has the financial resources to meet the often-large upfront costs of the green transition, and the country’s semi-public firms may be willing to take the long view needed for many of these investments to prove profitable. Finally, China’s sheer size means that it will benefit substantially from its own emission cuts, diminishing the free-rider problem—a point that many overlook.
There are thus good reasons to believe that China will soon scale up its climate policies and embark on a growth path that reduces emissions much more rapidly than now. In contrast, the other EMDEs, while a diverse group, are almost all still on carbon-intensive growth paths.
EMDEs must invest heavily in power, transportation, housing, and related sectors to meet the expectations of their still-growing populations, including hundreds of millions of very poor citizens. Despite the justifiably optimistic emissions-reduction scenarios for the advanced economies and China, therefore, it is the other EMDEs’ trajectories that could be the difference between limiting global warming to well below 2°C and significantly exceeding this threshold.
Compared to developed countries and China, EMDEs have limited ability to mobilize the long-term upfront finance needed to put them on green growth trajectories. They lack domestic fiscal space and do not qualify for concessional resources from advanced economies, which are mostly reserved for low-income countries.
Moreover, some important EMDEs such as India, Indonesia, and South Africa still rely heavily on coal. While these countries’ primary challenge is rapid growth of new green capacity, they face the additional difficulty of decommissioning relatively new capital stocks. China also must confront these issues, but has greater leeway to deal with them.
The only viable solution to this challenge is a lot of long-term international financing for EMDEs, mostly from private sources. Multilateral development banks should facilitate this process by offering to blend in some slightly concessional financing of their own and providing risk-reducing facilities to mobilize private resources. That would require the MDBs to obtain additional shareholder capital as well as permission to use their balance sheets less conservatively. Meanwhile, China, rather than being a net recipient of foreign capital, will be a source of long-term private and public finance for the other EMDEs.
As policymakers prepare for COP26, prospects for achieving a carbon-neutral world by 2050 are improving. But it is unrealistic to expect to keep global warming well below 2 degrees Celsius if middle- and lower-middle-income countries do not participate fully in the green transformation.
Will another taper tantrum hit emerging markets?
In early July, the yield on U.S. 10-year Treasury bonds fell to its lowest level in four months, and stock markets dipped on fears that this year’s rosy projections for economic growth will not be borne out. Still, the prevailing view is that the recent spike in inflation will be transitory, allowing the U.S. Federal Reserve to pursue a smooth unwinding of its balance sheet at some point in the future.
This month’s market episode can be partly traced back to February and March of this year, when U.S. long-term rates rose in anticipation that the Fed might soon start tightening its monetary policy. With U.S. President Joe Biden’s large fiscal packages came new fears about inflation and economic overheating. Ten-year Treasury yields duly rose from below 1.2 percent to close to 1.8 percent before stabilizing and falling back to previous levels this month.
Though there were some jitters following the June meeting of the policy-setting Federal Open Market Committee, when some FOMC members assumed a more hawkish attitude, the Fed nonetheless managed to keep markets cool by promising to give plenty of advance notice before beginning to taper its monthly bond purchases. Since then, interest rates have declined at a notable pace.
Rather than worrying about another taper tantrum, we should be more concerned with the slow pace of immunizations leading to an anemic post-pandemic recovery; commodity price hikes generating inflation; and economic strategies that merely restore the low growth rates of the pre-pandemic era.
But uncertainties remain for emerging markets, most of which suffered capital flight as a result of the February-March tantrum and the attendant hike in U.S. market interest rates. Although these outflows have since reversed, there is always a possibility that the Fed will feel obliged to change tack, leaving open the question of whether we are heading for another “taper tantrum” of the kind that shook global markets in 2013.
Recall that in June of that year, then-Fed Chair Ben Bernanke suggested that the FOMC might soon start to slow down its bond purchases. With that one passing statement, Bernanke unwittingly triggered a wave of interest-rate hikes and capital flight from emerging markets.
At the time, the “fragile five”—South Africa, Brazil, India, Indonesia, and Turkey—had high current-account deficits and a strong dependence on inflows of foreign capital. For years, they had experienced the spillover effects of ultra-loose U.S. monetary policies, which sent investors seeking higher yields in emerging markets. When Bernanke raised the possibility of gradual monetary-policy tightening, investors briefly panicked.
Another bout of capital outflows from emerging markets occurred in May 2018, when the Fed really did start to reduce its asset holdings; but this tapering—followed by a sell-off in U.S. bond markets and dollar appreciation—was halted in 2019. This time, the “fragile five” had been reduced to the fragile two of Turkey and Argentina, which both had high current-account deficits and an acute vulnerability to exchange-rate fluctuations, owing to their large volumes of foreign-currency debt.
That brings us back to this year. According to the Institute of International Finance, the February-March market tantrum was enough to generate a significant reduction in non-resident portfolio flows to emerging markets. Although these losses were partly recovered over the following three months, worries of a “taper tantrum 2.0” will remain salient over the next two years, especially if it starts to look like the Fed will tighten faster than it is currently projecting.
But it is important to remember that we are no longer in 2013. Back then, the fragile five’s current-account deficits averaged around 4.4 percent of GDP, compared to just 0.4 percent today. Moreover, the flow of external resources into emerging markets in recent years has been nowhere close to as large as in the years before the 2013 tantrum. Nor are real exchange rates as overvalued as they were then. With the exception of Turkey, the fragile five’s gross external financing needs as a proportion of foreign reserves have fallen substantially.
Two additional mitigating factors are also worth considering. First, if stronger economic growth drives up U.S. interest rates, positive trade linkages for some emerging markets might help to offset any negative financial spillover. Second, it is reasonable to assume that the Fed will offer more appropriate “signaling” this time around, thereby minimizing the risk of another panic episode.
What about the problem of “twin deficits” in many emerging economies? One cannot dismiss the fact that emerging markets suffered large capital outflows last year just as their fiscal deficits were rising in response to the pandemic. But despite the COVID-19 crisis, emerging markets generally have been able to finance their larger fiscal deficits by relying on domestic investors and, in some cases, their central banks. And starting in the second half of 2020, purchases of government securities by non-residents in some emerging markets started to pick up again.
True, because some issuance of foreign-currency-denominated securities may still be necessary, the risks associated with changing foreign-exchange flows have not been eliminated entirely. Countries like Colombia and Chile still have relatively high levels of dollar-denominated debt, and in some emerging markets, portfolio inflows will remain crucial to financing fiscal deficits.
But, ultimately, the bigger risks facing emerging markets lie elsewhere. Rather than worrying about another taper tantrum, we should be more concerned with the slow pace of immunizations leading to an anemic post-pandemic recovery; commodity price hikes generating inflation; and economic strategies that merely restore the low growth rates of the pre-pandemic era.
A golden opportunity to end destructive fishing subsidies
It is not often that trade negotiators get a chance simultaneously to protect vulnerable people and their livelihoods, promote healthier oceans, and fulfill one of the United Nations Sustainable Development Goals. But that is exactly the opportunity awaiting trade ministers as they gather at the World Trade Organization this week to discuss new global rules limiting government support for the fishing industry.
These public subsidies incentivize overfishing, and WTO members have been debating how to limit them for 20 years now. During those long two decades, global fish stocks have decreased sharply, and poor and vulnerable artisanal fishers have suffered along with ocean ecosystems.
In 2017, the U.N. Food and Agriculture Organization (FAO) warned that an estimated one-third of global fish stocks were overfished, an increase from 10 percent in 1970 and 27 percent in 2000. The depletion of fish stocks threatens the food security of low-income coastal communities and the livelihoods of poor and vulnerable fishers, who must travel farther and farther from shore only to bring back smaller and smaller hauls.
In 2017, the U.N. Food and Agriculture Organization (FAO) warned that an estimated one-third of global fish stocks were overfished, an increase from 10 percent in 1970 and 27 percent in 2000.
Despite these disturbing findings, governments continue to disburse around $35 billion in annual fisheries subsidies, two-thirds of which go to commercial fishers. In doing so, they are keeping at sea many commercial vessels that would otherwise be economically unviable.
World leaders recognized the seriousness of the problem back in 2015 when they agreed to forge an agreement on fisheries subsidies by 2020 as part of the Sustainable Development Agenda. But while trade ministers reaffirmed this pledge in 2017, talks at the WTO have repeatedly stalled.
Over the past year, however, things have begun to turn around. Political leaders and trade ministers from around the world tell me they want to get an agreement done this year. In Geneva, the chair of these negotiations, Ambassador Santiago Wills of Colombia, has worked with WTO members to draft a negotiating text that I believe can provide the foundation for final-stage talks. But despite the political support voiced by government leaders, important divisions persist. Indeed, as matters stand, we are in danger of failing to conclude a deal before the WTO’s year-end Ministerial Conference.
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This tight timetable is the reason for convening trade ministers this month. While no one expects a miracle, the meeting represents a golden opportunity to bring the negotiations within striking distance of a deal. WTO members need to conclude an agreement in time for the U.N. Biodiversity Conference in October, and no later than the end of November, when the WTO’s own ministerial begins. A failure to do so would jeopardize the ocean’s biodiversity and the sustainability of the fish stocks on which so many depend for food and income.
Yes, the talks are complex, because fish do not inhabit a single national territory or observe maritime boundaries. WTO negotiators must account for both the existing framework of international fisheries rules and the role of the regulatory bodies that govern many aspects of fishing around the world. They also must define how new subsidy rules would apply to far-flung fishing vessels.
By negotiating away harmful fisheries subsidies, WTO members will not just be honoring past commitments. They will also be lending momentum to other international efforts to address problems in the global commons—from climate change to the COVID-19 pandemic.
Compounding the challenge is the fact that the WTO is not a fisheries management organization. Still, the WTO has a longstanding framework of rules that curb trade-distorting subsidies for industrial and agricultural goods. That is why trade ministers agreed back in 2001 to come up with similar measures to protect marine fisheries.
Although there is still work to do, the current draft negotiating text would make an important contribution to the sustainability of our oceans. For starters, it would completely ban government funding for vessels that engage in illegal fishing. According to the FAO, these activities account for 11 million to 26 million tons of fish per year, or roughly 20 percent of the total global catch. The agreement would also rein in other types of subsidies that support increased fishing activity, by requiring that governments prove they have taken steps to ensure such support does not harm fish stocks.
One of the toughest issues in the negotiations is how to define and honor the original negotiating mandate guaranteeing special and differential treatment for developing countries—and especially for least-developed countries. Many of these countries rely on small-scale artisanal fishing, and they are seeking more policy space to develop their industrial fishing capabilities. But, because their fisheries management capacity is weak, they may struggle to implement new subsidy regimes as quickly and effectively as better-off members can.
Another tough issue is to ensure transparency, with requirements that a member offer notification when deploying non-harmful and non-distortionary subsidies to encourage its fishing industry. Tackling these issues will not be easy, but tackle them we must, because WTO members have pledged to protect the fisheries and ocean we all share.
By negotiating away harmful fisheries subsidies, WTO members will not just be honoring past commitments. They will also be lending momentum to other international efforts to address problems in the global commons—from climate change to the COVID-19 pandemic.
Let’s hope that the world’s trade ministers rise to the challenge.
How to balance debt and development
The COVID-19 pandemic is, we hope, only a temporary shock to economies everywhere. The appropriate policy response to such a disruption is to borrow to cushion the impact on consumption and investment. But for many emerging markets and developing countries, borrowing could result in debt-servicing difficulties that require years of austerity to overcome. Yet, if they do not borrow, they will have to cut public spending, which could mean major health crises, children out of school, job losses, and prolonged recession.
What to do? Borrow and risk a debt crisis, or choose austerity and risk a development crisis?
In 2020, countries took very different approaches, largely linked to their income. Governments in advanced economies provided trillions of dollars of direct and indirect fiscal support, equivalent to 24 percent of GDP, while those in emerging and developing economies provided just 6 percent and 2 percent of GDP, respectively.
Because private capital markets are procyclical, the risks of debt distress are large and growing. Global foreign direct investment fell by 40 percent in 2020 and is expected to decline by another $100 billion in 2021. Greenfield investment projects and cross-border mergers and acquisitions were likewise down 50 percent last year.
What to do? Borrow and risk a debt crisis, or choose austerity and risk a development crisis?
Half of all low-income countries were in debt distress or at high risk before the pandemic, according to the International Monetary Fund, and six have defaulted in the past year. In addition, 36 developing countries have had their sovereign credit rating downgraded by one of the three major ratings agencies, and 28 others have had their outlook downgraded. While many middle-income countries have returned to international bond markets since the pandemic began, only two Sub-Saharan African countries (Ivory Coast and Benin) have accessed the market.
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The risks of widespread development distress are also growing. The IMF estimates that low-income countries need $450 billion through 2025 to respond to the pandemic and accelerate sustainable investments. Total investment in developing countries (excluding China) fell by 10 percent in 2020, and is likely to remain below 2019 levels this year and next. And if growth slows, creditworthiness will deteriorate, making debt distress even more likely.
The debt dimension
Preventing this vicious circle will require policymakers to address two collective-action problems that markets cannot resolve on their own. First, they must ensure that private creditors’ procyclical behavior does not trigger liquidity problems and debt crises. Most developing countries, especially middle-income countries, were growing fairly well before the pandemic, with stable long-term debt dynamics. If they can refinance their debt on reasonable terms, they should be able to avoid default. This will require additional financing from official and private creditors.
In May 2020, the G-20 paused bilateral debt-service payments by World Bank International Development Association (IDA) countries under the Debt Service Suspension Initiative (DSSI), which has been extended until the end of 2021. The DSSI has so far deferred $6 billion in debt-service payments—resources that developing countries have used to advance economic recovery and procure COVID-19 vaccines and personal protective equipment.
But given the pandemic’s ongoing nature, and the time needed to roll out mass vaccination campaigns in developing countries, this is not enough. The G-20 should expand DSSI eligibility to all vulnerable countries, including small island developing states and tourism-dependent economies. Middle-income countries account for the bulk of developing-country debt service due in 2021-22, but have had access to only limited fiscal support until now.
Because debt crises typically reflect poor government spending decisions, debt programs are often accompanied by a temporary lending pause. But this time is different, because most countries are suffering from a short-term liquidity squeeze rather than a long-term solvency problem. The World Bank and the IMF need to ensure that the macro framework and their own lending to DSSI countries supports strong increases in public investment in the near term.
Some have called for larger-scale debt restructuring and relief efforts, including swaps of debt for investments related to achieving climate objectives or the Sustainable Development Goals. The G-20 has agreed to a common framework for debt treatment, with three countries (Chad, Ethiopia, and Zambia) requesting relief thus far. Such efforts must transparently link debt relief to incremental investments in health, climate, or SDG projects, in order to connect the debt crisis with larger development financing needs.
Investment imperatives
This points to the second collective-action challenge: providing developing countries with sufficient fiscal space to tackle the pandemic and embark on the sustainable investments needed to build green, resilient, and inclusive economies.
Even before COVID-19, the world was not on track to achieve the SDGs and meet the targets set by the 2015 Paris climate agreement. In 2021, the international community needs to devise a sound program of public investments, based on country-specific needs and current spending levels, in order to jump-start recovery efforts and enable longer-term progress on the 2030 Agenda for Sustainable Development.
Several financing proposals are on the table. Developing countries have received $150 billion in COVID-19-specific funding from the major multilateral development banks (MDBs), and another $100 billion in ongoing project financing. But much more is needed. G-20 finance ministers support an early conclusion of the World Bank’s IDA20 replenishment, as well as a new $650 billion allocation of special drawing rights (SDRs, the IMF’s reserve asset).
Because new SDRs would be distributed based on existing IMF quotas, which reflect countries’ relative economic importance, the bulk of them would go to advanced economies. There are thus concurrent proposals for a reallocation mechanism so that countries with excess SDRs can lend them to others in need of additional liquidity. The IMF’s Poverty Reduction and Growth Trust (PRGT), which has been used for this purpose before, is a potential vehicle. But because only low-income countries are eligible for PRGT funds, there would need to be other efforts to expand lending to middle-income countries.
Beyond one-off proposals designed to address immediate short-term financing difficulties, policymakers need to establish an international financing system that can support much higher levels of public investment in the medium term. MDBs are the natural vehicles for providing this finance, because they can offer better terms with longer maturities than other lenders, and they can combine loans with grants and technical assistance.
Moreover, the MDBs could increase lending by $750 billion to $1.3 trillion by making greater use of callable capital and tolerating more risk. They could also do more to mobilize private capital, both by using their guarantee authority and by developing platforms for blended financing in specific sectors. But these institutions need a strong push from major shareholders to be more ambitious.
Developing countries need financing for public-health spending, vaccine rollouts, and green investments. Much of it (except in the case of the poorest countries) will have to come in the form of debt, but this is getting more expensive for many. Given the need to avoid the debt-development trade-off, mobilizing additional development finance, especially for middle-income economies, and linking it transparently to sustainable investments are thus urgent challenges.
In 2020, policymakers focused on domestic recovery efforts. In 2021, they must invest in global collective action to avert a vicious cycle of debt and development distress.