“APRIL is the cruellest month”, so said the poet T.S. Eliot in his 1920s poem, the Wasteland. The April Spring meetings of the International Monetary Fund (IMF)/World Bank will be held virtually this year, locked down by the pandemic that is raging into its third wave worldwide.
The world is in a cruel situation, because the uneven arrival of vaccines demonstrate that a few rich countries get them first, whereas the health and economic condition for the many are dire. The latest available OECD Economic Outlook suggested that the recovery in 2021 will be divergent, meaning that certain countries will do better, but others will continue to struggle. That is polite officialese for devastation.
When the pandemic hit, the rich countries spent roughly three times the stimulus package that applied for the last financial crisis in 2008/2009. The poorer emerging market economies (EMEs) could not afford to print money to the same extent, but they witnessed considerable capital outflows.
According to the Institute of International Finance, emerging markets attracted US$313bil (RM1.28 trillion) in portfolio flows in 2020, US$48bil less than the previous year. Furthermore, foreign direct investments (FDIs) fell 42% from US$1.5 trillion in 2019 to an estimated US$859bil, per UNCTAD Investment Trends Monitor.
With lower export income as commodity prices tumbled, many developing countries are facing debt distress. In the last decade, the external debt of developing countries doubled from US$4.5 trillion in 2009 to US$10 trillion or 29% of GDP in 2019. In 2020 and 2021, developing countries face repayments on their public external debt amounting to an estimated US$700bil to US$1.1 trillion for low-income countries and middle-income countries.
Thus, when official forecasts preach recovery on an “average basis”, we should have no illusions that from Mexico to South Africa, the decline in GDP last year was over 7%-9%, so the situation for the bottom half of society in many EMEs are deadly serious. The rich do not fear inflation, but when food and energy prices rise once again with massive monetary creation, the poor will be the major victims.
In the 1930s, the English economist John Maynard Keynes identified the liquidity trap where aggregate demand lagged aggregate supply. Put simply, too much savings were stuck in short-term liquid assets, and not enough money put into long-term investments to get jobs going again. Funding is available, but since no one is investing for the long term and improving productivity, you get “secular stagnation”, sliding into slow-growth depression.
We have a similar situation today.
Since the 2008 global financial crisis, the invention of quantitative easing (QE or increase central bank balance sheets and reduce interest rates) used painless short-term monetary policy to avoid painful fixing of long-term structural deficiencies. Since Wall Street controls Main Street through money politics, no one was willing to tax the rich to deal with the widening inequalities.
At the end of the Second World War, the US emerged as the strongest and richest country, and therefore acted as the world’s banker, lending US dollars to those who need them to recover, including creating multilateral development banks (MDBs) like World Bank to provide long-term development funds.
Today’s situation has reversed. The US has become the world’s largest borrower, with net foreign liability of US$14 trillion as of September 2020 or over 60% of US GDP. The rest of the world is in effect funding their banker, who is not investing long term in its own home market, let alone the rest of the world.
Here’s how the global balance sheet looks like. The EMEs (including China) hold roughly US$10 trillion out of total US$12 trillion of global foreign exchange reserves, of which 60% is in US dollars. At the same time, the emerging markets owe roughly US$10 trillion in foreign debt, mostly in US dollars. And since they pay a 4% margin (2% higher borrowing costs and 2% lower return on short-term investments and deposits), they provide global bankers and asset managers US$400bil revenue for not lending them money for long-term investments.
Here’s the irony. Since the global rating agencies define credit risks to rich countries as low and emerging risks as high, the EMEs are being starved out of their own money. There is no shortage of short-term money, since the top four reserve currency central bank balance sheets increased by US$9 trillion in 2020 alone.
The MDBs have total assets of US$1.6 trillion, when the UN Sustainable Development Goals investments have a financing gap of US$2.5 trillion annually. The rich countries, which have majority control of the MDBs, refused to increase their capital to help meet this gap, asking the EMEs to resort to market funding. But the financial markets are only funding the rich. Indeed, stock markets fund have only 41,000 listed companies, whereas there are millions of small and medium enterprises which cannot access public capital.
The present global financial system is designed for the few and not the many. If the world’s bankers refuse to think for their clients, it is time for the emerging markets to think for themselves.
The recent US and European support for US$500bil increase in Special Drawing Rights issue by the IMF is a step in the right direction but does not address the structural liquidity trap of who will lead the investment in long-term green and inclusive infrastructure for the developing world?
The first thing to address is the massive implementation capacity gap. Too much short-term thinking has depleted almost all governments’ operational capacity to design, execute and operate long-term infrastructure, with the exception of China. Many private-public partnerships have turned out to be opportunities for corruption or weak project designs. The MDBs complain but they lack today the effective advisory and implementation experience that used to exist before the 1980s, when project engineers dominated operations, rather than present-day macro-economists and MBAs who talk more theory than hard project skills.
Democracy is about the many for the many. Time for the many in EMEs to think and act for themselves.
Andrew Sheng worked in the World Bank in the 1990s on development finance. Views expressed here are the writer’s own.