For Indonesia this time last year, things looked shaky. The exchange rate dropped 20 percent from February to April.
As the currency declined, its foreign debt of $ 410 billion increased. The collapse in tourism and the drop in commodity prices meant that the currency they normally used to finance these debts evaporated. The sudden stop in capital flows meant that the $ 44 billion of debt that had to be paid in the coming months would not be able to be refinanced.
Indonesia needed international assistance. Where they sought help was typical of many developing countries, but it also reveals why linking debt forgiveness with investments in Sustainable Development Goals (SDGs) projects may not be as effective as some think. Fortunately, there is a better way to use debt markets to support SDGs.
Indonesia’s first stopover was to seek bilateral support from friends: a pending loan from Australia, a repo facility with the Federal Reserve of New York, and the expansion (or approval) of existing bilateral currency clearing lines with Australia, China, Japan, Korea, Malaysia and Thailand.
Regionally, Indonesia went to the Asian Development Bank (ADB) and the Asian Infrastructure Investment Bank (AIIB). Globally, it went to the World Bank and the United Nations COVID-19 Response and Recovery Fund. With these supports in place, the government termed-out its debt by switching short-term debt for longer-term debt and bolstered its foreign exchange reserves by selling long-term U.S.-dollar denominated bonds.
These supports helped stabilize the Indonesian currency and financial system by increasing investor confidence in Indonesia’s ability to finance its debt. But what is more interesting is where Indonesia is not going to help. It did not go to the International Monetary Fund, claiming that the IMF stigma is alive and well in Asia, and the Chiang Mai Initiative did not go to Multilateralization (CMIM), and the so-called regional alternative IMF remains everything else.
Indonesia’s approach is not out of the ordinary, according to the latest data from ADB. More than a third of the external support received by Asia’s developing countries during COVID-19 came from ADB. More than 20 percent came from bilateral loans and foreign aid. About 18 percent came from the World Bank, while only 9 percent of international support came from the IMF, slightly more than the AIIB (6 percent) dominated by China.
First, they show how important these international institutions were during the epidemic. Funds sought from global, regional and bilateral institutions amount to 40 percent of the amount developing countries spent through fiscal and monetary policies during COVID-19. Less funding from these institutions would mean weaker responses to COVID-19.
Second, the findings suggest that developing countries will prefer incoming international finance without being tied to mandatory financing. Developing countries have options. Facilities with little or no conditionality, such as bilateral loans and development bank subsidies, were strongly favored over those with more conditionality during COVID-19. For example, the IMF and CMIM and its affiliated institutions and mechanisms, such as the G-20’s Debt Service Suspension Initiative or DSSI, require countries to at least request IMF assistance.
For some, the choice of funding with less tethering may be obvious, but this highlights a critical problem in the idea of linking debt forgiveness to investments that help achieve SDGs: Developing countries with other options available to conditional debt forgiveness agreements if they can make a better deal elsewhere will. This is particularly the case in Asia where the painful memories of the IMF’s conditionality during the Asian financial crisis – defined by the IMF’s Independent Assessment Office as failure – can make conditional international support politically untenable even when these conditions are in line with Asia’s sustainability goals. rule makers.
After all, debt forgiveness is not the only way to increase fiscal space. If an economy’s stock of debt is reaching its limit, that economy could seek to reduce its stock of debt through debt forgiveness or seek to increase their debt limit by bolstering market confidence in their ability to finance their debts. Bilateral currency swap lines, access to low-conditionality financing facilities with regional and global financial institutions, terming-out debt, and swapping foreign-denominated debt for local currency debt all act to boost that confidence and increase fiscal space.
It is not risk-free debt forgiveness either. Many developing countries avoided DSSI, fearing that debt forgiveness could jeopardize their access to financial markets and damage capital flows through negative backlash from private sector creditors. Bond spreads widening in the early days after DSSI member states did little to alleviate these fears. Making debt forgiveness linked to SDG spending can make participation in these programs even less attractive.
Of course, alternatives to debt forgiveness vary widely from country to country. Some have many options, while others have few options depending on which international organizations a country is a member of, how much that country can borrow from those institutions, and how far that country has access to bilateral clearing lines. Countries with fewer alternatives may have no choice but to participate in debt forgiveness programs, while countries with many options are more likely to shop.
There is a better way to use global debt markets to support an environmental and inclusive recovery after COVID-19: supporting sustainable finance. Studies show that borrowers who perform well in environmental, social and governance indicators are 50 percent less likely to fail to pay their loans. Offering these borrowers lower interest rates means lower and better priced risks on bank balance sheets and means achieving twin goals such as financial stability and sustainability.
However, global and local regulatory and supervisory frameworks restrict this credit. These frameworks, including global capital rules, do not distinguish between sustainable and unsustainable lending in regulations on the quality of bank capital, despite its lower risk profile. If green loans (and securities backed by green loans) are more secure than other loans, this should be reflected in global capital rules and local regulatory frameworks. Failure to do so undermines banks’ incentives to include sustainability in their loans and hinders proper pricing of risk.
The world’s health and economic recovery from COVID-19 will depend significantly on the fiscal space of developing countries. While debt forgiveness is necessary for some, tying this forgiveness to SDG investments risks reaching less of both.