Mitigating the pandemic debt crisis

Mitigating the pandemic debt crisis

Akilah Rahman

The global economy has experienced its biggest crisis in more than a century due to the pandemic.

Poverty rates have soared and economic activity has shrunk in 90% of countries, more than during the Great Depression of the 1930s and the global financial crisis of 2007 to 2009, according to a World Bank report.

As a result, households and businesses could struggle to repay their loans, end up insolvent, or find it difficult to access credit to support themselves during the pandemic.

Excessive debt levels are a problem that the World Development Report 2022 identifies as an economic risk.

He also discussed areas where policy makers, especially those in developing countries, should be looking to try to mitigate its effects.

One area the report suggested addressing is what would happen when pandemic debt relief
measures expire. For example, many countries have sought to ease the debt burden by offering loan repayment terms.

However, the report says non-performing loans (NPLs) – the failure to pay debt as expected for a period of time – are expected to increase in all countries as governments end their support policies for borrowers.

Loans to zombie companies – companies that have little chance of recovering and repaying their debts – are also expected to increase.

To effectively manage NPLs, the report suggests improving transparency and supervision, resolving troubled loans through regulatory interventions, and deploying early intervention measures to turn around troubled banks and resolve failing ones. .

The report also notes that many households and businesses are struggling with unsustainable debt due to the pandemic.

Insolvency proceedings – a process initiated when businesses or individuals are no longer able to meet their financial obligations and pay their debt – can help reduce excessive levels of debt.

However, a sudden increase in delinquencies – failure to pay debt for an extended period – and bankruptcies makes it difficult to resolve bankruptcies in a timely manner.

In order to alleviate over-indebtedness and facilitate economic recovery, the report proposes the following reforms: strengthen formal insolvency mechanisms, facilitate alternative dispute resolution systems, establish judicial and extrajudicial procedures accessible to small businesses and promote the cancellation of debt and long-term protection of the reputation of former debtors.

Many households and small businesses risk losing access to formal credit due to the pandemic. Uncertainty about the economic recovery and the financial health of applicants makes it difficult for financial institutions to assess risk and determine an applicant’s suitability for a loan.

While deferring debt payment and freezing credit reports are important in managing the impacts of COVID-19, it is also more difficult for banks to distinguish applicants with temporary cash flow problems from those who are genuinely. insolvent.

Meanwhile, the credit risk of low-income households and small businesses is difficult to assess because they typically lack credit histories and audited financial statements.

The difficulty of valuation is further amplified by the disruption of business activity and livelihoods.

With the pandemic making it difficult for potential borrowers to access credit risk, the report suggests mitigating PNP risk with improvised visibility.

This includes using new data and technology to update existing risk models and increase visibility into a borrower’s ability to repay.

Other strategies include temporarily reducing loan terms and leveraging digital channels to collect current transactional data.

In addition to the three areas highlighted above, the pandemic has also led to a sharp increase in sovereign debt.

For low- and middle-income countries, the average total debt burden increased by about nine percentage points of GDP in the first year of the pandemic, compared to an average increase of 1.9 percentage points during of the previous decade.

Over-indebtedness, defined as the inability of a country to meet its financial obligations, entails significant social costs.

As governments accumulated debt to fund current expenditures, spending on public goods such as education and public health was limited.

With governments often being the lender of last resort, the report points out that private sector debt can quickly become public debt in the event of an economic crisis and the need for public assistance.

The government’s investment in public assets, as well as its role as lender of last resort, are crucial in the management of sovereign debt.

Countries will need to prioritize the most important policy actions needed to address the
aforementioned areas.

Low-income countries can prioritize tackling unsustainable sovereign debt, while middle-income countries with indebted businesses and households can focus on supporting financial stability.

Countries also need to consider factors such as fluctuating commodity prices, exchange rate and interest rate risks for an equitable economic recovery.

Robert P. Matthews