Growth models in emerging markets and developing economies (EMDEs) need to be remastered in the long term towards more reliance on sustainable domestic sources of finance as a response to the ongoing COVID-19 crisis, found a new research by Egypt’s Economic Research Forum.
The research was conducted by the UN Special Envoy for Financing Sustainable Development 2030 Agenda Mahmoud Mohieldin and the Assistant Professor in Economics at the British University in Egypt Sarah El-Khishin.
EMDEs, which have relatively young populations and potential demographic dividends, need to adopt inclusive growth policies and develop their domestic financial markets to channel dividends, leverage domestic savings and fill financing gaps, said the study.
Sustainable domestic sources of finance are key to decreasing reliance on short-term external finance, widening fiscal space, overcoming debt maturity mismatches and hence decreasing external vulnerability, the research added.
Current debt threats in EMDEs arise mainly from debt architecture and the dominance of volatile debt forms, primarily bonds denominated in foreign currencies, according to the study.
The combined debt of households and non-financial corporations constitutes more than 60 percent of the total debt, while corporate bonds constitute the largest share of foreign currency bond issuance in emerging markets, reported the Institute of International Finance.
EMDEs need to set a balance between temporary accommodative measures and the post-shock monetary-fiscal policy mix that will prevent a deflationary spiral, without worsening indebtedness and financial fragility, according to the research.
Although global initiatives to support the debt sustainability of EMDEs are advancing, measures are needed to reform international debt architecture, capital flows management, and exchange rate misalignments, read the research.
The Covid-19 crisis initially resulted in a liquidity shock that largely stemmed from capital outflows from EMDEs, exchange rate shocks, and rising credit spreads with the onset of the crisis. Nonetheless, financial markets overcame early losses, reflecting either investors’ denial of the severity of the crisis or a response to stimulus packages and debt restructuring plans.
The study added that "increased low cost finance, large monetary expansion, and injected liquidity led to a surge in corporate bonds and speculative activities, disturbing the connection between financial markets and real sector performance during the crisis."
It stated that EMDEs are in dire need of global and country-level actions to improve their resilience during the Covid-19 shock and to achieve better debt sustainability outcomes after the crisis.