This paper, which is published under the Global Economy and Finance Programme’s ‘Rebuilding International Economic Cooperation’ project, offers two proposals to help prevent sovereign debt crises in emerging markets.
COVID-19 has raised concern about the risks of such crises, given fiscal pressures, structural factors directing capital flows to emerging markets, and the prospect of tighter constraints on domestic-currency borrowing for governments in those markets.
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.
At the same time, one way to support borrowing in local currency 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. Advanced economies will have an important role to play in launching such an initiative.
