National Council of Applied Economic Research
Opinion: Poonam Gupta.
For developing countries, global finance has virtually disappeared when they need to spend more on education, health and food security. As a result, climate financing has become an unaffordable luxury.
In the last three years, developing countries faced unprecedented challenges, a combination of external shocks: Covid-19, the Russia Ukraine war, food and energy security risks, and the four-decade-high global inflation. None of these shocks is of their making, yet they impact developing countries the most.
These shocks have amplified the development needs of the developing world and pushed their public finances into unsustainable zones. Meanwhile, global finance has virtually disappeared when developing countries need to spend more on education, health and food security. As a result, climate financing has become an unaffordable luxury. The forthcoming Summit for a New Global Financing Pact, starting June 22 in Paris, will discuss the financing required to address these interlinked crises.
Developing countries rely on three kinds of external financing:
All three sources of funding have dried up. The monetary policy tightening of advanced economies has led to a reversal of private capital flows from developing economies. Multilateral development banks (MDBs) can extend new financing only if they receive fresh equity capital injections. Developing countries battling debt distress cannot access additional bilateral funding to restore economic dynamism and growth. There is an urgent need to unclog each source of global finance.
Private capital flows are fickle. They are quick to pull out from developing economies for higher yields. Derisking such capital flows can help fill an important gap in the global financial order. The following measures can do so.
The spillovers of the monetary policy actions of advanced economies need to be diluted. This necessitates fresh thinking on the frameworks that have characterised monetary policy decisions in advanced economies in the last quarter-century.
Developing countries should be given prompt and effective access to bilateral swap lines and International Monetary Fund (IMF) contingency lines to handle the liquidity crunch caused by the frequent reversals of capital flows. There is a distinct North-North concentration in the swap lines offered by the issuers of hard currencies. The North-South component needs to be strengthened equally. Advanced economies, led by the US, ought to be more inclusive in offering swap lines to developing countries, particularly those impacted by the spillovers of their monetary policies.
IMF offers an alternative to bilateral swap lines through its three contingency credit lines. These facilities have been under-utilised since their inception a decade and a half ago. It is incumbent upon IMF to expand their use by de-stigmatising them, widening access and streamlining costs.
Credit rating agencies need to be better regulated and made more accountable for the ratings assigned to emerging market economies. The ‘pro-advanced country bias’ of credit rating agencies has been well- documented. While the average rating they assign to an advanced economy is the highest possible, the rating they assign to an emerging market is close to junk status. This differential cannot be explained by their respective levels of economic growth rates, debts, fiscal deficits, inflation or current account deficits.
At the minimum, there needs to be an open dialogue on the frameworks adopted by credit rating agencies. This assumes great importance and urgency since countries are being called upon to attract foreign capital (and expand their current account deficits in the process) to invest in global public goods, including reducing global warming.
As for multilateral financing, the balance sheets of MDBs, such as the World Bank, are stretched to their limits. The operational model of MDBs involves leveraging their equity capital and near-perfect credit rating to raise low-cost funds from the capital market up to a multiple of their equity capital. They on-lend these resources to developing economies. While balance-sheet optimisation is essential and desirable, they need a fresh injection of equity capital to expand their lending.
Yet, the largest shareholders of MDBs are neither willing to recapitalise nor do they agree to dilute their shares to allow other countries to contribute more equity. This stalemate is hurting the developing world and humanity.
Since we need all hands on the deck to address global challenges, advanced economies should be forthcoming in their support to inject more equity into MDBs. The amounts involved are small, no matter which metric one considers. If they prefer, they may earmark the new funding for climate financing. Getting the buy-in of their citizens should be easy. It may entail appealing to their innate sense of fairness, being the early contributors to climate risks, and their concerns regarding this looming threat.
Most low-income countries are either already in a debt crisis or close to it. It is important to reduce the current debt stock through debt relief and to raise future debt in transparent, responsible and sustainable ways. Exchange rate risk is not just a concern of investors. For developing countries, a currency collapse makes debt relief meaningless. Collective efforts to develop relevant and affordable hedging instruments would help to mitigate these risks.
The crises facing developing countries can only be addressed if global finance is reset, especially in revisiting past practices that are ill-suited for emerging challenges.
Global leadership and legitimacy can only be preserved when incumbents respond purposefully to contemporary challenges. Else, competing choices will evolve and present themselves as the only rational alternatives for developing countries in the foreseeable future – business as usual risks irrelevance for the incumbent leadership of the world.
The writer is director-general, National Council of Applied Economic Research