G-20 debt freeze won’t fix eligible sovereigns’ liquidity pressures or medium-term debt challenges: Moody’s

  • Most frontier market sovereigns are experiencing acute foreign-exchange liquidity shortages
  • Liquidity relief from bilateral creditors will only partially offset the immediate shock
The G-20 debt suspension initiative is unlikely to ease the significant credit challenges that the coronavirus pandemic has amplified in some frontier market sovereigns,  Moody’s Investors Service said in a report yesterday ( 18). “By lowering debt-service payments at a time when government resources are limited and access to market financing is considerably constrained, the initiative will help to ease short-term liquidity pressures,” it said. Moody’s estimates that the suspension of debt-service payments could reduce the funding needs of eligible Moody’s-rated sovereigns by about $10 billion over the next eight months. This would only cover a fraction of the external gap, leaving an outstanding shortage of around $40 billion. New official sector disbursements are expected to help fill the gap, including emergency financing from the IMF. The size of the potential liquidity relief offered by this initiative varies between sovereigns, in proportion to their level of debt owed to official creditors. Each eligible sovereign’s decision to seek debt forbearance is likely to be in part a function of the immediate need for liquidity relief and the magnitude of potential relief on offer. Moody’s estimates that Angola, Vietnam, Pakistan (B3 RUR-), Bangladesh (Ba3 stable), Sri Lanka (B2 RUR-) and Kenya have the highest debt-service payments to official creditors as a share of GDP, at between 1% and 4%. Significant external financing gaps would remain in Mozambique, Mongolia (B3 negative) and Cambodia, even if they participate in the initiative. There remains significant uncertainty over the scope and conditionality associated with the G-20 Debt Service Suspension Initiative (DSSI). On scope, it is not clear whether the inclusion of external debt from state-owned enterprises will be systematic or if this will be on a case-by-case basis. With regard to conditionality, how the three conditions will be monitored remains unclear. “However, debt-service relief won’t have a significant impact on medium-term debt trends that have worsened during the crisis. Bilateral relief would only cover a fraction of the increased external funding gap resulting from the shock,” it said. “While debt-service relief will allow some governments to reallocate scarce resources toward health and social spending, it will not have a significant impact on weaker medium-term debt trends,” said Lucie Villa, a Moody’s Vice President – Senior Credit Officer and the report’s co-author. “The coronavirus shock will lead to sharply lower growth this year, wider budget deficits and higher debt burdens for at least the next few years, as well as higher borrowing costs, at least for debt contracted on commercial terms.” “The prospect of significantly diminished revenue constraining debt-service capacity poses longer-term solvency challenges.” Government debt levels for Moody’s rated DSSI-eligible sovereigns have been continuously rising since the start of the decade, from relatively low levels following the debt-relief initiatives in the 2000s. Rising government debt is not a unique feature of DSSI-eligible countries but the trend has been particularly pronounced in this group. The rating agency expects that the median debt burden of DSSI-eligible countries will be on par with high income economies, rising by 6 percentage points of GDP this year alone. A combination of lower growth, and in many countries recession, widening fiscal deficits, and strong currency-depreciation pressures, which raise the value of foreign-currency denominated debt, will push government debt burden for DSSI-eligible countries further up in 2020-21. The related pressure on credit profiles is reflected in our ratings that range from Ba3 to Ca among DSSI-eligible sovereigns Future rating migration depends not only on the extent to which debt levels will rise and debt affordability weaken as a result of the crisis, but also on the governments’ financial-management capacity and ease of access to funding. For certain sovereigns, negative debt dynamics may continue well after the global economy recovers from the coronavirus shock, amplifying credit challenges. Some low-income sovereigns may face difficulties in restoring growth to pre-crisis levels after measures to contain the spread of the virus are removed. Households incomes are being hit in countries with limited or minimal welfare systems, potentially precipitating widespread financial stress. Weak institutional capacity, economic rigidities and limited fiscal scope to implement stimulus policies in support of the economy are key constraints. For instance, Moody’s forecasts that Cambodia, Maldives (B2 negative) and Ethiopia, will record the lowest growth rates in 2020-2021 compared to their five-year pre-crisis levels. Moreover, reducing fiscal deficits will take time. The economic downturn will significantly constrain government tax receipts, while health and social spending pressures will persist, constraining debt-service capacity. Moody’s expects that some countries such as the Maldives, Kenya, Mongolia, Pakistan, Sri Lanka will continue to register large fiscal deficits in 2021 and beyond.    

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