Global recovery will be slow and painful

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By Ricardo Hausmann

The world now would be better served by a more efficient and expedited mechanism, such as the Sovereign Debt Restructuring Mechanism.

Suppose you knew that a hurricane was coming, but meteorologists were uncertain if it would make landfall as a Category 2 or a Category 5 storm. Which scenario should you prepare for?

The problem you face reflects the costs of assuming that it is a Category 5 when it is only a Category 2 and vice versa. The latter scenario implies deaths and destruction that could have been avoided through evacuations, well-supplied shelters, and precautionary shutdowns. The first scenario implies unnecessary preventive costs. In the case of hurricanes, we all agree that it makes sense to err on the side of caution for the same reason that it is better to be five minutes early when catching a train than five minutes late.

In most emerging and developing countries, Covid-19 is causing an economic hurricane. It looks increasingly like a Category 5, but the international community and many national governments prepared for a tropical storm. To marry my metaphors, this is a recipe for a train wreck.

It did not start that way. Arguably, on the epidemiological front, the world acted quickly: more than 80 countries imposed lockdown between March 9 and April 2 – some, like El Salvador, before they had their first confirmed case. The strategy, in Tomas Pueyo’s evocative terms, was to hit the coronavirus with a “hammer” (the lockdown) and then to “dance” with it by adopting much less stringent policies that can contain its spread while permitting a return to a semblance of normality.

Beyond their varying epidemiological effectiveness, lockdowns have been economically devastating. The wreckage in advanced economies is bad enough: the UK is facing its worst recession since 1706, and 36 million Americans have claimed unemployment compensation since March. Now add to that the fact that 25 per cent of workers in Lima, Peru, have lost their jobs, but cannot rely on their government for help because it cannot borrow at the scale of the US and the UK. Emerging and developing economies around the world will shrink by 20-40 per cent in the second quarter, with double-digit contractions for the year. They and the international organisations fear announcing such projections because they may spook markets and make matters worse.

More bad news: the post-lockdown period will not be one of strong recovery, because economic activity will remain severely constrained by the need to contain Covid-19. For example, truck drivers coming from neighbouring countries caused outbreaks in countries like Jordan and Namibia, which had been highly successful at suppressing Covid-19. Travel and tourism will not recover at least until a vaccine is widely available. Capital has been flowing out of emerging markets, and credit rating agencies are on an unprecedented downward spree. As a result, most emerging and developing economies will have financial needs that will be hard to meet. First and foremost, they need money just to fund huge collapses in tax revenues caused by the shrinking economy. In addition, they will be asked to help hospitals, households, and firms, just as in advanced countries.

They will not find the needed finance domestically, because everybody at home is hurting. It must come from abroad. In the past, smaller shocks have led to triple whammies: currency, debt, and banking crises. Recovery has taken not a year but a decade.

All this adds up to the worst financial crisis that the Bretton Woods institutions have ever experienced in their 76-year history.

Moreover, this crisis is bound to require many countries to restructure their pre-pandemic debt to bring claims on future income in line with unexpectedly worsened expectations.

The world now would be better served by a more efficient and expedited mechanism, such as the Sovereign Debt Restructuring Mechanism that Anne O. Krueger, then the IMF’s first deputy managing director, proposed in the early 2000s. For humanity, this is a “whatever it takes” moment. To treat it as a “whatever makes us look good enough” moment would be a Category 5 mistake. —Khaleej Times

{Ricardo Hausmann, a former minister of planning of Venezuela, is a professor at Harvard’s John F. Kennedy School of Government. -Project Syndicate}

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