Emerging-market Debt in the COVID-19 Pandemic

The COVID-19 pandemic has raised concern about the risk of sovereign debt crises in emerging economies. Although most concern has centred on foreign-exchange-denominated debt, governments could also encounter financing difficulties when seeking to borrow externally in their own currencies. To reduce the risks around foreign-currency debt, policymakers and regulators should increase their focus on emerging economies’ external balance sheets. In particular, the IMF’s metric for assessing reserve adequacy (ARA) should play a bigger role in determining whether countries can take on additional liabilities. A number of emerging economies also face a more challenging international market for their local-currency debt. If external demand for such bonds remains weak, this could push up local-currency bond yields and increase the risk of these countries accumulating more foreign-currency debt to finance their spending needs. One way to address this would be to promote the issuance of GDP-linked bonds. This would boost investor returns in periods of higher economic growth, while reducing issuers’ debt servicing costs in periods of lower growth. Emerging economies can’t launch such a market on their own, however: developed countries will first need to establish the viability of such instruments by issuing GDP-linked bonds themselves, or provide high-level sponsorship of the idea.