With Covid 19 triggering the most encompassing economic crisis in almost a century, the World Bank in its latest World Development Report’ focusses on how to reduce the financial risks stemming from the extraordinary policies adopted in response to the COVID-19 crisis while supporting an equitable recovery.
The new World Development Report focuses on the interrelated economic risks that households, businesses, financial institutions, and governments worldwide are facing as a consequence of the COVID-19 crisis.
“The unfolding COVID-19 pandemic has already led to millions of deaths, job losses, business failures, and school closings, triggering the most encompassing economic crisis in almost a century. Poverty rates have soared and inequality has widened both across and within countries. Disadvantaged groups that had limited financial resilience to begin with and workers with lower levels of education-especially younger ones and women–have been disproportionately affected,” World Bank Group President David Malpass said in the forward to the report.
PRIORITY AREAS FOR ACTION
Firstly, the report highlights the need for early detection of significant financial risks. The share of nonperforming loans has generally remained below. But this could be due to forbearance policies that delayed debt repayments and relaxed accounting standards. Firm surveys in emerging economies reveal that many businesses expect to be in payment arrears in the coming months, and so private debt could suddenly become public debt, as in many past crises, the report said.
The report also highlights that interdependence of economic policies across countries are of much importance. With public debt reaching unprecedented levels and monetary policy tightening in advanced economies, the report states that interest rates need to increase in emerging economies as well, and their currencies will likely depreciate. Higher interest rates make debt service more expensive, reinforcing the trend of recent years, and weaker currencies make debt service more burdensome relative to the size of the economy. Liquidity problems could suddenly morph into solvency problems, the World Bank said.
Stating that corporate-government nexus is another potential source of contingent liabilities and hidden debt, the Report said that concessions and public-private partnerships have faced dramatic declines in revenue. Sooner or later, the losses could end up on the budget. Meanwhile, borrowing from foreign state-owned enterprises often escapes the surveillance of debt management agencies. These contingent liabilities and loans can raise significant financial risks in low-income and some emerging market countries.
In the second instance, the World Bank Report mentions the need for proactive management of distressed assets. In the absence of effective resolution mechanisms for private sector debt, balance sheet problems last much longer than they should, with loan ever greening keeping “zombie” firms alive and undermining the strength of the recovery. Formal insolvency mechanisms need to be strengthened and alternative dispute resolution systems facilitated. Revamped legal mechanisms can promote debt forgiveness and help protect the long-term reputation of former debtors, the report said.
Early detection of risks and proactive management may also reduce the risks associated with the servicing of sovereign debt. The report states that the biggest challenge is sovereign debt restructuring. The absence of a predictable, orderly, and rapid process for sovereign debt restructuring is costly, dampening recovery prospects and creating uncertainty it said. The historical track record shows that the longer the debt restructuring process takes, the larger the “haircut” creditors experience. For debtor countries, delay presents major setbacks to growth, poverty alleviation, and development, the report added.
Unfortunately, negotiations on debt restructuring for the poorest countries under the G20 Common Framework are currently stalled. Finally, it is critical to work toward broad-based access to finance. Low-income households are more likely to smooth out their consumption if they can save and borrow. Small businesses are better able to invest and create jobs if they have access to credit. Digital finance can play a critical role in enabling access to finance and fostering new economic opportunities.
The World Bank report has all praise for India for handling the crisis. “To limit the impact of the crisis on households and businesses, the governments enacted a swift and encompassing policy response that used a combination of fiscal, monetary, and financial sector policies. The case of India, which like many other countries enacted a large emergency response to the first wave of the pandemic, offers an example of a decisive policy response that used a wide range of policy instruments to mitigate the worst immediate effects of the crisis. When the pandemic first erupted in India in March 2020, the government declared a two-month national lockdown that closed businesses and sent workers home. The lockdown halted all manner of economic activity, and incomes fell in tandem,” the report said.
” The first measure adopted by the Indian government was a fiscal stimulus package that amounted to nearly 10 percent of the gross domestic product (GDP) and included direct support for poor households. Monetary policy reduced interest rates and eased lending conditions for banks and non-bank financial institutions. Financial sector policies were also part of the support plan, India instituted a debt repayment moratorium for households and firms that ultimately lasted six months. In addition, the Indian government introduced a large credit guarantee scheme aimed at ensuring that small and micro enterprises would continue to have access to credit,” the World Bank said.
“It is critical to work toward broad-based access to finance. Low-income households are more likely to smooth out their consumption if they can save and borrow. Small businesses are better able to invest and create jobs if they have access to credit. Digital finance can play a critical role in enabling access to finance and fostering new economic opportunities,” David Malpas said.
He also mentioned that emerging economies need to rebuild their buffers and avoid sacrificing the accumulation of capital-both physical and human-along the way. “As for advanced economies, they should carefully unwind the extraordinary stimulus policies and avoid creating global turbulence,” he said. Stressing that COVID-19 pandemic is possibly the largest shock to the global economy in over a century, the Report said “as fiscal, monetary, and financial stimulus programs are withdrawn, new policy challenges will emerge at both the domestic and global levels. Early diagnosis of the economic effects of the crisis and decisive policy action to remedy these fault lines are needed to sustain an equitable recovery. There is no room for policy complacency.”