In 2020, as communities around the world struggled to contain the spread of COVID-19 and manage the health and human costs of the pandemic, governments launched significant and unprecedented emergency support measures to mitigate the worst impacts. immediate from the pandemic. These measures included shutdowns that closed businesses, fiscal stimulus packages that included direct cash support to households and businesses, monetary policies that lowered interest rates and eased lending conditions for financial institutions, and financial sector policies such as debt repayment moratoriums for households and businesses, as well as credit guarantee schemes. These crisis policies have helped limit the worst economic outcomes of the pandemic in the short term. However, they have also revealed and aggravated a number of economic fragilities that could threaten a sustainable and equitable economic recovery. This is a real concern given that the economic effects of the pandemic are proving more persistent and severe for low- and middle-income countries.
Our new World Development Report 2022: Financing a just recovery examines the central role finance plays in economic recovery from the pandemic, so that everyone, including vulnerable groups such as poor adults, women and small businesses, can recover.
A global view of the economic risks linked to the pandemic
Although households and businesses have been most directly affected, the consequences of the COVID-19 crisis are reverberating throughout the economy through many mutually reinforcing channels that link the financial health of households and businesses, financial institutions and governments. Because of these interconnections, high financial risks in one sector can easily spill over and destabilize the wider economy, if left unchecked. When households and businesses experience financial stress, the financial sector faces a higher risk of default and is less able to provide credit. Similarly, when the financial situation of the public sector deteriorates, for example due to higher debt and debt service, its ability to support households and businesses may weaken. This relationship is not predetermined. Well-designed fiscal, monetary and financial policies can counteract and reduce these interrelated risks, and they can help transform the linkages between sectors of the economy from a vicious “catastrophic loop” into a virtuous circle.
Managing and reducing interconnected financial risks for households, businesses, banks and governments is key to economic recovery in developing countries
Resolving financial risks through effective policies for an equitable recovery
This World Development Report focuses on solutions for four main areas of risk: weakening bank balance sheets, delayed redeployment of productive assets taken from failing companies, difficulties for lenders in identifying strong borrowers in times of economic disruption and rising sovereign debt. In an ideal situation, governments would implement relevant policies in parallel in each of the four areas. However, since few, if any, governments have the resources and policy space to tackle all at once, countries will need to prioritize the most important policy actions needed.
Policy Area 1: Managing and Reducing Loan Difficulties
Governments and financial institutions could mitigate this risk by emphasizing transparency, the management of distressed loans, and proactive interventions for troubled banks. Debt moratoriums, lending forbearance and relaxed reporting rules implemented to relieve pressure on borrowers and lenders during the pandemic have created a lack of transparency about the health of bank balance sheets, especially in the accounting for non-performing loans (NPL), which affect the lending capacity of the financial sector.
Policy area 2: Improving the legal framework for insolvency
Effective bankruptcy systems, emphasizing out-of-court arrangements, including simplified and faster frameworks for small businesses, can help avoid the risk of long-term and intractable over-indebtedness. Creditors currently cannot rely on traditional credit risk analysis to determine whether distressed borrowers face short-term illiquidity or long-term insolvency. Borrowers also cannot declare themselves insolvent in countries where insolvency mechanisms are non-existent or limited.
Policy area 3: Ensuring continued access to finance
Innovations in digital financial tools and lending models, including alternative data sources, product design, and lending context, can help keep credit flowing in regulatory environments that support and enforce it. mechanisms to ensure consumer and market protection. The continued impact of the crisis on business performance and household incomes could hamper lending due to increased credit risk, reduced visibility on borrower viability and reduced ability to realize the value of collateral.
Action area 4: Manage high levels of public debt
Countries that have debts they are unable to repay risk a prolonged recession. Avoiding this requires active debt management through debt reprofiling or restructuring, and longer-term reforms to debt transparency and fiscal policy. Many governments borrowed to pay for the massive economic support programs, which increased the total debt burden of low- and middle-income countries by about nine percentage points.
Conclusion: setting policy priorities for a fair recovery
Countries will need to consider their specific combination of internal and external risk exposures when developing their precise policy priorities to achieve an equitable recovery. For many low-income countries, tackling unsustainable public debt will be the top priority. Middle-income countries, whose financial sectors are more exposed to corporate and household debt, may need to focus on policies to support financial stability.
Finally, while the World Development Report 2022 focuses on key national financial and economic risks produced by the pandemic, a country’s prospects for recovery will also be shaped by events in the global economy. For example, exchange rate and interest rate risks, which could emerge as economic activity in advanced economies recovers and stimulus programs are withdrawn, causing banks to tighten global liquidity. power plants and an increase in interest rates.
Addressing the financial risks that have emerged during the pandemic is important to ensure that governments and financial institutions can support the recovery, including through investments in services such as healthcare and education. It is also essential that households and businesses do not lose access to financial services that underpin the recovery of economic growth and resilience to economic shocks. Success in addressing risk will help limit damage to development outcomes and maintain momentum to “green” the global economy to tackle the climate crisis.