Omicron Risks Debt Crisis in Developing World

The arrival of the omicron variant generated a collective gasp from investors in developed economies, followed by a sigh of relief as early reports suggested that current vaccines – if boosted – would provide at least some semblance of protection. Yet, despite the resultant euphoria in equity markets over the past few days, omicron has already produced a slew of negative impacts such as renewed travel bans, testing regimes, and a reversal in the tentative normalization of the tourism industry. Moreover, as the variant continues to spread, so too does the risk of overburdened healthcare systems and additional lockdowns (several European countries were under severe strain even before omicron appeared).

The above risks are especially pronounced for low-income countries, many of which were already straining under the weight of onerous debt burdens. For them, omicron represents an existential threat in new borrowing needs, depressed commodity prices, and further pushing back the horizon for economic normalization. Absent new efforts from G20 countries to streamline debt relief, a cascading debt crisis in the developing world remains a real possibility.

Debt distress in the developing world is hardly a new phenomenon, and much was written about the risks it represents even before COVID-19 appeared. In 2015, some 30 percent of low-income countries were designated as high risk of debt distress by the IMF. Now that number is 60 percent.

Take Sierra Leone for example. The economy of the West African country was hit hard by COVID, particularly through 2020, which saw a contraction in real GDP of 2.7% (following 5.4% growth the previous year). The economy has fared much better in 2021, with a projected expansion of real GDP of 3%, though certain sectors – namely services – have remained in contraction. Government finances have also been relatively stable through the crisis, with a fiscal balance of -5.4 in 2020 and -4.2 in 2021, and a relatively stable accumulation of overall public debt at 71.6% debt-to-GDP (which actually fell slightly in 2020).

Thus we have a country that did an admirable job of maintaining its fiscal outlook despite a collapse in  exports and certain domestic industries. Yet Sierra Leone still faces major risks should COVID drag on via omicron or any future variant. For one, the government remains at the mercy of global financial markets due to its relatively high level of external debt (which the IMF flagged as a risk in its latest sustainability report). And two, as the IMF has also pointed out, the country’s current account deficit, which is both a long-term weakness and one that’s further compounded by COVID-related drops in exports, creates lingering currency risks, especially in the event of a sudden collapse in investor confidence.

Sierra Leone is an indicative case in the developing world: a country that faces existential financial risks, risks that at this point can only be contained rather than completely eliminated due to the nature of the country’s debt obligations.

Thus, the focus should shift to international efforts to reduce these debt obligations and make them more manageable. And if there’s one thing that most stakeholders can agree on, it’s that the current model of debt relief is not fit for purpose; should omicron extend the duration of the global economy’s current upheavals, a new approach will be necessary to forestall a debt crisis in the developing world.

The original COVID-era approach to debt relief came in the form of the G20 Debt Service Suspension Initiative (DSSI), which has to date enacted some $10.3 billion in debt relief to over 40 low-income countries. Yet there was one glaring problem with the DSSI approach: it was built around the previous paradigm of public Paris Club lenders even though non-Paris Club members like India and China account for an ever-growing proportion of global lending. The G20 Common Framework came into being in November 2020 to address this problem, incorporating non-Paris Club and private lenders into  an overarching debt restructuring framework. Yet results have not been overly positive for the three countries that have engaged with the framework thus far – Zambia, Chad, and and Ethiopia – all of which have encountered major delays in securing significant debt relief. Some of these delays stem from the fact that, although the Common Framework brought private creditors to the table, it did not make them particularly pliant with regard to arriving at joint terms with other creditors, perpetuating delays. Put another way, the divergent fundamental interests at work – fiduciary for private creditors, and public/diplomatic interest for public ones – are still thwarting a streamlined approach to debt relief.

These issues will need to be rectified to avoid a solvency crisis in the developing world, particularly if the pandemic gains steam on the spread of the omicron variant. The IMF has laid out three steps to achieving such an objective: 1) streamlining debt reporting procedures and communication among creditors in order to increase engagement in the Common Framework; 2) a debt payment freeze to provide debtor relief and incentivize creditors reaching a deal; and 3) boosting and clarifying enforcement measures to alleviate the concerns of both debtors and creditors. Only when these steps are enacted can the finances of low-income countries be considered to be on the road to stability.