Creating Fiscal Space in the Covid-19 Era
CSIS Commission on Strengthening America's Health Security
Global health challenges threaten the United States’ health and economic security, a reality made painfully clear over the past 14 months. Many low- and middle-income countries lack adequate domestic resources to invest in public health and, at the same time, face mounting debt burdens that impede their ability to raise new funding for essential investments. The Covid-19 pandemic is a call to action to rethink how the United States prioritizes pandemic preparedness and investments in public health. U.S. leadership will be essential to mobilizing investment from the official sector and private investors.
Even after the Covid-19 pandemic is contained, the United States will remain vulnerable to global health security threats unless and until it prioritizes domestic and international investments in public health. Many low- and middle-income countries (LMICs) lack adequate domestic resources to invest in public health and, at the same time, face mounting debt levels that challenge their ability to raise new funding. While the Covid-19 pandemic represents a human tragedy on a global scale, it also is a call to action to rethink the roles of official and private sectors in financing global public health. At this moment of acute health and economic crises, the United States needs to think boldly about new approaches that will compel higher investment in essential areas, more aggressively leverage existing institutions, and mobilize additional resources to sustain investment in public health and pandemic preparedness.
Policy Space and Debt Sustainability
The Covid-19 pandemic and economic fallout are by definition global, but country responses have been anything but universal. LMICs are confronting dual health and economic crises but with considerably less space to apply countercyclical fiscal and monetary policies than most advanced economies. The International Monetary Fund (IMF) estimates that, in 2020, advanced economies provided fiscal policy support equivalent to about 24 percent of their gross domestic product (GDP), compared to just 6 percent of GDP in emerging markets (EMs) and 2 percent in low-income countries.
Such differences in individual countries’ capacity to respond to a global health emergency reflect the reality that most advanced economies can rely on deficit spending—expenditures financed with borrowing—to a degree unimaginable for LMICs. While advanced economies’ sovereign issuers have been able to borrow at near-zero interest rates, many LMICs face the most restrictive financing environment in over a decade, as demonstrated by the limited external bond issuance by sub-Saharan sovereigns since the World Health Organization’s (WHO) pandemic declaration in March 2020. In another indication of the financial strain, over 100 countries, or just over half of the total IMF membership, have requested IMF assistance in the form of emergency financing, precautionary arrangements, or formal program engagement since the pandemic began.
Along with the IMF, the other international financial institutions (IFIs) have stepped in to provide assistance. The CSIS Economics Program estimates that IFIs approved nearly $240 billion in Covid-19–related support in 2020, with the IMF and the multilateral development banks (MDBs) accounting for 43 and 56 percent, respectively, of the total approved. The amounts represent a massive amount from the IFIs in terms of headline approvals in less than a year; however, a significant portion comes in the form of IMF precautionary support to shore-up market confidence in a few emerging market economies, including Chile ($24.8 billion), Colombia ($17.5 billion), and Peru ($11.4 billion), while low-income countries account for only $11.6 billion (5 percent) of total approved funding. CSIS estimates only about $16.4 billion (7.7 percent) of the total explicitly supports health-related expenditures. And while the IFIs place social spending—health, education, and social protection—at the forefront of country work, they must also take into account a country’s fiscal sustainability, limiting debt financing to those countries at high risk of debt distress to avoid jeopardizing the creditworthiness of the IFIs themselves.
Debt Sustainability, DSSI, and the Common Framework
Many countries entered the crisis with debt already at record levels; the pandemic and its economic fallout have pushed even more countries toward unsustainable fiscal positions. The latest publicly available Debt Sustainability Analyses under the World Bank and IMF’s joint Debt Sustainability Framework for Low Income Countries (LIC-DSF) assess 38 of 67 low-income countries to be at “high risk” of external and/or overall debt distress, including seven countries (Republic of Congo, Grenada, Mozambique, São Tomé and Príncipe, Somalia, Sudan, and Zimbabwe) already classified as “in distress.” Beyond limiting resources available for health-related expenditure, high levels of debt can result in lower overall investment and weaker growth, jeopardizing the sustainability of any health-related investments over the medium term.
Recognizing the magnitude of the Covid-19 shock—and shortly after the WHO’s pandemic declaration on March 11, 2020—the heads of the World Bank and IMF called for debt relief for the poorest countries through a temporary suspension of debt service to official bilateral creditors. Their call resulted in the Debt Service Suspension Initiative (DSSI), which was formally adopted by the Group of 20 (G20) finance ministers in April 2020; in April 2021, it was extended a “final” six months through the end of December 2021. As of mid-March, 46 low-income countries have requested to participate in the DSSI, resulting in the deferral of about $5 billion in debt service payments, which are to be directed to priority social spending including health. Participating countries also agree to publicly disclose all public debts and debt-like instruments.
While helpful in allowing countries to immediately direct additional funding to health, the DSSI is quite limited in its scope and coverage. Advocates of a more ambitious approach called for applying like terms to a wider set of creditors, and private sector creditors in particular, extending relief to a larger number of countries, and offering more significant relief in the form of debt rescheduling and write-downs. Importantly, China has asserted that the China Development Bank (CDB), the largest official bilateral creditor to low-income countries, should be treated as a private creditor, such that debt-service obligations to the CDB fall outside the scope of the DSSI.
Building on the DSSI, G20 leaders agreed in November 2020 to a Common Framework for Debt Treatments beyond the DSSI. The Common Framework represents a further advance in the sovereign-debt architecture by bringing in non-traditional official bilateral creditors such as China, India, and Turkey to a common set of agreed terms on restructured debts. Treatment under the Common Framework goes beyond debt service suspension to debt rescheduling—that is, providing indebted countries more time to repay their obligations—and, in the most extreme cases, face value debt reduction. Importantly, the Common Framework, like the Paris Club, calls for “comparability of treatment,” meaning that a country receiving debt relief “will be required to seek from all its other official bilateral creditors and private creditors a treatment at least as favorable.” Comparability of treatment effectively protects participating creditors from “bailing out” non-participating creditors, since the debtor is obligated to offer all participating creditors the same terms. In January, Chad became the first country to formally seek debt relief under the Common Framework, followed by Zambia and Ethiopia.
The Common Framework is an important step forward in the international response by extending a coordinated approach to the largest group of official bilateral creditors. However, it still falls short of what is required. Many at-risk countries remain reluctant to request help for fear of jeopardizing future market access.1 Instead, many will opt for tightening policies in the hopes that short-term savings can bridge to an improved outlook. Regrettably, history shows such an approach often only delays the eventual need to restructure debt. In the meantime, attempts to muddle through can prolong the economic pain if a country’s creditors remain unconvinced of its creditworthiness. In the current context, delays can be especially damaging given the need to invest immediately in health, while other spending cuts—for instance in education and infrastructure—will lower countries’ growth potential over the medium term, worsening global inequality.
Skeptics of debt relief as the answer to the current crisis correctly note that debt reduction alone would fail to address domestic structural issues that have challenged the sustainability of past efforts. They cite the need for improved public financial management, better domestic resource mobilization, enhanced transparency, and greater priority placed on social expenditures.
Rather than view the solution to current fiscal challenges facing many LMICs as a choice between treating existing debt stocks or relying on domestic efforts to increase revenue and reprioritize spending, these efforts can be complementary and mutually reinforcing. In fact, treatment of debt under the Common Framework occurs in the context of an “upper credit tranche IMF-supported program,” which entails conditionality to address macro-relevant vulnerabilities. Therefore, debt treatment under the Common Framework will occur in the context of a country’s IMF program, which would include macro-critical reforms. Moreover, the official sector can support these efforts with instruments such as guarantees on sovereign debt and by facilitating greater standardization in measuring and reporting progress toward the Sustainable Development Goals (SDGs), as detailed below.
Proposals to Create Fiscal Space
Absent efforts to create fiscal space through additional donor support, many LMICs will be forced to scale back pandemic response and recovery efforts in the short term, as well as investments in health, education, infrastructure, and future pandemic preparedness in the medium term. Such an outcome would fail to address the current health emergency and would undermine economic recovery, leaving countries vulnerable to future health crises and the rest of the world more vulnerable to a future pandemic. Today, the United States has an opportunity to think strategically about the challenges facing LMICs and their potential solutions, including how efforts to boost investment in public health and pandemic preparedness can be made self-reinforcing.
Over the medium term, fiscal space depends on domestic resource mobilization and sound public financial management, but given current crisis circumstances, domestic revenues will not fill the gap. Immediate efforts should focus on providing additional support through grant and other concessional assistance and on addressing the debt overhang in many LMICs. The former can build upon current efforts to raise resources for concessional financing at the IFIs, while the latter can be achieved through expanding the Common Framework, linking debt treatment to commitments on priority reforms, and offering incentives to participate in voluntary exchanges. These efforts can leverage existing tools, including MDB guarantees on sovereign debt, and boost transparency and greater harmonization, which in turn can mobilize market-based financing for social expenditures at scale. U.S. leadership, working with partners and through the IFIs, will be essential to making concrete and timely progress.
Increase Resources for Concessional Financing at the IFIs. The February 2021 statement by the Group of Seven (G7) leaders reaffirmed financial support to the most vulnerable countries and to meeting the SDGs, including by working through the G20 and the IFIs. For their part, G20 Finance Ministers similarly reaffirmed support for these countries, especially those facing an unsustainable debt burden, and called on the IFIs to explore additional tools to meet financing needs. Additional support for concessional instruments—such as the Poverty Reduction and Growth Trust (PRGT) and the Catastrophe Containment and Relief Trust (CCRT) at the IMF—and an accelerated timeline for replenishing the International Development Association (IDA), the World Bank’s fund for the poorest economies, are consistent with these goals and will be essential to delivering much-needed financing.
(Re-)Allocate SDRs. Recent endorsement for a new allocation of Special Drawing Rights (SDRs)—provided the allocation is approved by the IMF Board and Board of Governors—will provide additional SDR resources to all IMF members. However, an SDR allocation on its own will not be sufficient to meet the magnitude of financing needs in many LMICs. Therefore, action on proposals to re-allocate SDRs, for instance from countries that have ample foreign reserves to new or existing facilities at the IFIs, can provide targeted assistance to LMICs. Re-allocations typically require legislative approval, but given the extremely low budgetary impact, these proposals represent an efficient mechanism for leveraging the IFIs and providing needed support to LMICs. Some IMF members have lent their surplus SDRs in support of low-income country facilities in the past. Such precedent, combined with the favorable treatment of an SDR re-allocation from a budgetary perspective, would allow the United States and others to move quickly, working through the IFIs, to provide urgent support to LMICs.
Expand the Common Framework for Debt Treatments beyond the DSSI. The DSSI and the Common Framework are examples of multilateral cooperation facilitated by the G20 to respond to the pandemic. The Common Framework’s main innovation is in extending the coordinated approach to include non-traditional official bilateral creditors such as China. This more comprehensive coverage reflects the importance of such creditors in the international financial system and constitutes an essential upgrade to the sovereign debt architecture that should be commended and sustained beyond the end of the Covid-19 pandemic. The G20 should build upon this success and extend treatment of debt under the Common Framework to include middle-income countries facing insolvency, not just the 73 low- and lower-middle-income countries that are eligible under the DSSI.
Link Treatment of Debt under the Common Framework to Foundational Reforms. Building on the history of the Highly Indebted Poor Countries (HIPC) initiative,2 launched in 1996 by the IMF and World Bank to provide debt relief in exchange for commitments to poverty reduction through policy adjustment, official debt treated under the Common Framework could be swapped for instruments that explicitly support transparency, health-related investments, domestic resource mobilization, and other priority reforms. In terms of linking donor support to priority areas and outcomes, specific targets in health can be informed by the Joint External Evaluation (JEE), which represents an independent assessment of a country’s health security preparedness. Similarly, IMF and World Bank assessments can guide priorities to boost transparency, improve budget classification to allow better expenditure tracking, and promote domestic resource mobilization, which together allow for sustainable domestic investments in health.
Debt-for-Health Swaps. Whereas treatment of debt under the Common Framework entails a non-voluntary restructuring of a country’s obligations, voluntary debt-for-health swaps could provide an option for countries with high but sustainable debt burdens that are seeking a cooperative approach to creditors. Building on the long history of targeted debt-for-policy swaps, a sponsor could buy outstanding sovereign debt (potentially at a discount to face value) and direct debt service on the bonds to spending that would allow countries to meet priority targets based on their individual needs. Using the precedent of debt-for-nature swaps,3 the United States and other official donors could scale up financing for purchases, thereby increasing resources available for spending on health.4
New Instruments as Catalysts
Debt treated under the Common Framework and any debt-for-health swaps would create new securities, which could both improve the debtor country’s economic sustainability and catalyze broader systemic reforms.
Greater Harmonization. The issuance of new securities can advance the goal of greater harmonization of measurement and reporting related to the SDGs.5 Such harmonization—supported by the United States with IFI involvement—would help attract “socially responsible investors” whose investment mandates include Environmental, Social, Governance (ESG) objectives in addition to pure investment returns. The attractiveness of bonds considered ESG-compliant, in turn, catalyze reform in the issuing country. The link to ESG can serve dual purposes of boosting the market for such offerings and building a common approach to ESG compliance linked to the SDGs, and could lower countries’ borrowing costs given a potentially expanded investor base. Along these lines, the G20 Finance Track’s Development Working Group recently recognized the importance of promoting SDG finance mobilization and alignment of standards through “SDG bonds” in developing countries. In the United States, the Securities and Exchange Commission’s (SEC) Asset Management Advisory Committee found that consistent issuer disclosure would make performance attribution to ESG factors more consistent and reliable.
Sovereign Guarantees. New securities could also include credit enhancements, which lower the risk to lenders and the cost of borrowing for debtor countries, further improving debt sustainability. The provider of the guarantee could be an individual donor, such as a national government’s development finance institution, or an MDB, wherein the sovereign issuer would require specific policy commitments, for instance on transparency, public accounting, and use of proceeds—which would, in turn, be consistent with meeting ESG outcomes. There are recent precedents for such guarantees, including the World Bank’s partial guarantee on Ghana’s 2015 $1 billion bond issuance. Such guarantees can improve issuer ratings and widen the investor base, lowering borrowing costs and extending maturities, thus improving overall sustainability. In the case of the Ghana guarantee, Fitch Ratings attributed a two-notch difference between Ghana’s guaranteed security rating and its long-term foreign currency rating to the higher recovery and liquidity protection offered by the partial credit guarantee. While current practice calls on MDBs to treat such precautionary instruments as loans, modifying such treatment—or employing treatment akin to countercyclical capital buffers—could enable the IFIs to ramp up support precisely when private credit conditions are most restrictive.
State-Contingent Features. New instruments could also include “state-contingent” features—for instance, extending debt-service obligations when national disasters hit—to effectively create future fiscal space when countries need it to finance essential spending. According to the IMF, more widespread issuance of debt with state-contingent features would deepen the market and increase demand, thereby lowering borrowing costs to issuers.
The various proposals to create fiscal space present an ambitious set of options to meet the urgent needs facing many LMICs. Heightened U.S. leadership, in partnership with the international community, will significantly raise the prospects for durable solutions, benefiting both LMICs and the United States’ own health security. Additional consultation with stakeholders, from LMIC authorities to donors and market participants, is needed. There is a compelling case for extending additional concessional resources, especially to meet immediate needs to end the pandemic and support economic recovery. Such resources will also be essential for future pandemic preparedness to avoid a repeat of the health and economic devastation of Covid-19.
Efforts to improve debt dynamics in many LMICs—whether through treatment of debt under the Common Framework, voluntary exchanges, or greater use of sovereign guarantees—should support priority domestic reforms as well as greater harmonization and endorsement of ESG disclosures, thereby attracting socially responsible investors. Linking official sector support to domestic reform and promotion of market-based finance can lead to the long-term sustainability of investments in health, without open-ended donor commitments, to the benefit of all.
Stephanie Segal is a senior fellow of the Economics Program at the Center for Strategic and International Studies in Washington, D.C.
This brief is a product of the CSIS Commission on Strengthening America’s Health Security, generously supported by the Bill & Melinda Gates Foundation.
CSIS Briefs are produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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