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Podcast May 20, 2021

Tell Me How: Debt, Restructuring, and Recovery in the Post-Pandemic Era

View all episodes on our Tell Me How: The Infrastructure Podcast Series homepage

Firms, governments and people have racked up debt in the pandemic — and many infrastructure sectors are hard hit, too. Debt needs to be well-managed for a solid recovery supported by private financing. In this episode, World Bank Group Chief Economist Carmen Reinhart joins Roumeen Islam to shares insights on how to go forward. 

This podcast series is produced by Fernando Di Laudo and Jonathan Davidar.

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Roumeen Islam: This is the World Bank’s infrastructure podcast. In today's episode, we discuss how to manage debt and how to restart investment such as in infrastructure for a post-pandemic recovery. Recessions are bad for debt. When income and wealth fall, everyone has a hard time paying back what they owe. Yet, a solid and stable recovery relies on firms and governments investing and households earning income, and also investing in their future. How will people and the economy deal with all the payments they missed?

And all the additional borrowing they had to do just to stay afloat. Just think of the travel industry, airplanes and hotels, or think of restaurants and public transport. To give you an example, the international air transport association, estimated that airline debt would be higher by almost 30 percent by the end of last year. And we are now in 2021. Let's find out how to think about the recovery.

Good morning and welcome. I am Roumeen Islam, host of Tell Me How. And today I have with me, Carmen Reinhart, our Chief Economist, and expert on all thing’s debt. Carmen, welcome to our podcast. 

Carmen Reinhart: Thank you, Roumeen. A pleasure to be here. 

Roumeen Islam: Well, we're really excited to have you with us because what we're looking for is some wisdom on how countries should be thinking of the recovery from the debt pile-up during this recession. We also want to hear about what this means, what your wisdom looks like, applied to the infrastructure sectors which have been hit particularly hard. In this recession, what do you think is similar to other such periods in terms of, say, the macroeconomic environment for developing countries, which would affect their potential recovery paths? And what you think is different?

Carmen Reinhart: The impact of the pandemic or the fact that it's so synchronous globally. You really have to go back to the 1930s Great Depression to see shock hit this many economies at the same time. You know, in the 1980s, the developing countries had a crisis, but the advanced economies were doing fine. In the 2008-2009 crisis, it was primarily a dozen advanced economies, the emerging markets and developing countries — pretty much, you know, after a period of turbulence in late 2000, they recover.

So, the global nature of it makes it particularly singular. I think also the fact that it's been brutally severe, so that, you know, for example, this is highlighted in the Poverty and Shared Prosperity report. You've seen a spike in global poverty rates for the first time, since the late 1990s.

So, severity, synchronicity, and also that it's lasting. The duration is not as quickly overcome as it had been hoped for, you know, when it all got started. I'll just leave it there because you really asked a question that I could go on and on, you know, about differences and similarities. 

Roumeen Islam: No, good. I wanted the main ones, thank you. So, when you're talking about duration, I guess another aspect is that it's still sort of uncertain how fast countries will recover, because they're all at different stages in terms of the pandemic and the recovery. 

Carmen Reinhart: Indeed, the degree of uncertainty about the path of recovery. You're never certain about the future, but there are certain situations that you could say, well, within a reasonable degree of confidence, you know, we can expect X. At the moment, I think a very troubling thing is recovery for whom? But who has the fire power to do the kind of fiscal stimulus and monetary policy that the U.S. has done, not many countries, right? Vincent Reinhard, my husband, and I wrote a piece called The Pandemic Depression last summer — basically it said don't confuse rebound with recovery, okay. You know, rebound, we're going to see comebacks in GDP and employment. You know, it's to be expected after the very dramatic contraction we saw in 2020. But that doesn't mean it's recovery in the sense that on a per capita income basis, we are back to where we were pre COVID.

I think to highlight how regressive the crisis is, I think of the low-income countries, and many of the emerging markets, certainly many of the emerging markets in Latin America. This is going to be a very long haul back to get to the pre-crisis per capita income levels to get back to pre COVID employment. Some of the economies that depend on tourism; there you're really seeing very large sectors of the economy that will be still seeing a big period of paralysis or, or very exceptionally low volumes. 

Roumeen Islam: What about global financial markets? How do you think conditions in these markets will affect capital flows in the near term, and in particular, private investment in emerging and development countries? And, if you could speak particularly about infrastructure, that would be good. Thank you. 

Carmen Reinhart: So, look just by way of brief background to where we are and where we may be going, the implosion. There's no other word for it in capital flows to emerging markets between late March, April, early May of 2020, it’s on a league of its own.

You know, basically in a period of about six, seven weeks, we saw a contraction in capital flows to emerging markets that it had taken about a year and a half to unfold during the 2008-2009 crisis. That's how compressed it was. Then, you know, the big, of course, federal reserve easing, the decline in global interest rates, the huge injection of liquidity, has helped stabilize, renewed the search for yield.

Definitely. There's an appetite for EM debt that in connection with, you know, the extremely low interest rates, right? So, there's an appetite by investors for high yield debt. Whether it's high yield corporate debt in the United States or emerging market sovereign debt, I think the outlook for equity flows and FDI flows, I am more worried about, okay.

Because equity flows and FDI flows, sure, you know, the, the, the low interest rate environment and high liquidity environment help, but they also depend importantly, on the kind of growth prospects that you see in the place where you're directing your investment. 

Roumeen Islam: Yes. That's a bit concerning given that infrastructure investment fell already during the pandemic, because, you know, there was more attention towards other sectors in any case, and these are longer term investments.

Carmen Reinhart: Right, but, but look, each episode is extremely distinct, okay. But, if you look at not on the global scale that we've been talking about, but if you look at, for example: the aftermath of the 1980s debt crisis, the aftermath of the Asian 97- 98 crisis. the aftermath of the so-called globally, even though it was in 2008-2009 crisis. All those three crisis episodes are marked by a declining fixed investment, initially.

Well, first of all, in budgets, often you cut what's most discretionary as well. So,  many governments in which interest expense is soaking up, a larger share of revenues and social needs are soaking up a larger share of revenues, will do what I mentioned in the past, which is, often a disproportionate amount of the adjustment falls on fixed investment, which of course has, you know, obvious implications since  non-trivial, parts of it are infrastructure driven. 

Roumeen Islam: So Carmen, what I wanted to talk about a bit is whether you think this recovery might be different because in terms of the employment impact, because there's a renewed interest or an acceleration in digitization and automation, we might expect to see more of a jobless recovery because of that. On the other hand, you've got a renewed interest in green investments in which in the short term might be quite labor intensive. So how do you see this in the next year or so? 

Carmen Reinhart: Look, I think it’s complicated. I'm not dodging your question Roumeen, but it is complicated because it's not just those two. So yes, I do think that the digital economy has been given a huge push by COVID. So, I do think that trend is definitely part of the post COVID landscape. However, I think, developments on climate, I'm not sure how speedy it's all going to happen. I think we would like it to happen very quickly whether on the ground it happens at the speed we would like to see, remains to be seen. I do think however that there are important employment consequences that need to be considered. I mentioned that this has been, you know, a regressive crisis that the vulnerable groups, have been hit the hardest. One dimension of that, that I don't think is in many people's radar screen, but it people who are on the ground and talking, you know, see this happening already is — financial institutions have also lent the big hand in supporting the economy during this crisis, by offering forbearance, you know, all kinds of facilities to restructure repayment, indefinite suspension, in some cases. Which also means that at the end of this financial, I am concerned. One of the concerns I have is about the health of financial institutions as many households and firms cannot repay existing debts. And what do financial institutions do when their asset quality worsens? They lend less and who gets less credit? Typically, you know, the bottom of the totem pole are households and small and medium businesses.

I bring this up in connection with your employment question because small, medium businesses are a big, big story when it comes to employment. And so, I do have concerns connected to what we were discussing earlier, that true recovery will take more time. The rebound in employment, I think will face, you know, headwinds from the difficulties of small and medium businesses, which are so labor-intensive.

Roumeen Islam: All right, but let's move away from small and medium labor-intensive businesses and go to the infrastructure sector. How do you think that's going to be affected about the condition of financial markets?

Carmen Reinhart: This goes back to your earlier question, right? I mean, it really does because, you know, I think to the extent that many countries rely on foreign saving. Okay. On the domestic side, a lot of governments, I think, find it more expedient to cut back on fixed investment. They certainly can't do a lot or as much as quickly on salaries, government salaries or on transfers that are needed during the pandemic or on interest payment. So, investment domestically takes a hit. And the question is, does foreign private capital flows rush in to fill in that gap? I'm not saying there won't be a recovery in that dimension, but how robust? I will reiterate that I think FDI investment with it's more medium term, infrastructure investment and FDI investment more broadly, will be held in check by concerns about , the medium term economic viability of the situation, which is suspect for a number of countries. 

Roumeen Islam: Yes, as well, domestic private investment as well, not just public investment. Yes. So, could we talk a bit about what's happening to SOEs and contingent liabilities?

Carmen Reinhart: Okay. So, let's take a step back on the SOE question — it's a very important question. Before coming to the Bank, I wrote about the issue of hidden debts, hidden external debts, and especially how even sort of the gold standard of external debt databases like the Bank's IDS data did not fully capture the increasing indebtedness, uh, to China and other non-Paris club creditors, but importantly to China, which is the largest creditor to many developing countries at the moment. And what we found in that study, Roumeen is that we have a much better handle on the indebtedness of the general government than we do have the SOEs. So, what we're saying is what we're still uncovering is that SOEs are a lot more leveraged than our numbers suggest.

When I talk about some of the challenges faced by governments on the debt front, I'm really also speaking broadly about public and publicly guaranteed debt. And in some cases, of course, the guarantee is implicit, and I'll get to that in a second, okay. So, the SOEs also are part of the story of the debt overhang.

And it's difficult to make blanket statements because, you know, the ground we're covering is very broad. But another concern where the health of SOEs is evident is that, you know, a lot of the reports that one hears about banks having difficulty in collecting, dealing with late payments and so on, are SOEs.

So domestic banks are already indicating that, you know, many SOEs are at the moment quite challenged. And finally, one area that is also very much under documented is domestic arrears. We know that domestic arrears of central government have been increasing. This is local suppliers, you know, in some cases, even affecting wage bill. Many SOEs are in that boat, as well to conclude on that, the issue of contingent liabilities.

Now, some of these are explicitly already included within the public sector. Okay, so when the IMF goes on mission and does the consolidated public sector, these are part of the public sector. In our own work, we do joint debt sustainability analysis with the IMF. And part of that, a DSA analysis, short for Debt Sustainability Analysis, involves scenarios for contingent liabilities.

These are risks scenarios that are actively considered in cases where we think that, we're definitely not capturing the full picture. I would know on the contingent liability question.  At the moment, it's not just the SOEs that worry me, but also what kind of support made the, governments end up, giving the financial institutions. Serious problem. 

Roumeen Islam: Yes, and that's absolutely right. They could be in serious problems if you know, things keep getting worse. But if we were to go back to think about infrastructure a bit, do you have any thoughts on what should be prioritized in the recovery because there are all kinds of debts, right? There are debts to domestic suppliers to sovereign creditors to other private financiers, there are all kinds of debt. And I'm just wondering whether you've had any ideas or  any principles that you'd like to propose for dealing with this sector, because you know, they do have to go on and provide basic services if we're taking the electricity sector or the mass transit sector or whatever they do have to go on and provide services. So, what, how should we think about this? 

Carmen Reinhart: So, look, I brought up the issue. By and large, it's an opaque issue, poorly measured, but it's very important. The buildup of domestic arrears is very worrisome, right? You asked me about priorities — the multiplier on the domestic economy — you don't pay the supplier; the supplier has loans; they can't pay their loans; the bank has problems. Now the ripple effect, I think moving on the dimension of really limiting and clearing those domestic arrears is very important because of these internal multiplier effects. That is not to say that, you know, you don't worry about paying external commercial creditors. But my sense is that the pecking order is one in which the external creditors are sort of the very top tier and then you work your way down, suppliers, domestic suppliers that are at the bottom of that tier. I think that needs to be rethought, Roumeen because for reactivating the economy for attracting, uh, more investment, those multiplier effects domestically are part of the story of being able to attract foreign capital. 

Roumeen Islam: Yeah. No, this is a very important point that you just made, Carmen. I'm just wondering; if we start with that, are there any examples from other episodes or any principles that you might want to follow in terms of how to restructure, who should be involved in addressing these problems with arrears? I mean, is it government, is it the utilities themselves that should do it? Do you have any suggestions? 

Carmen Reinhart: Well, look, the problem of clearing arrears is hardly a new one and it, again, it depends on the setup, who has them, and the scale, but under a number of previous crises countries had, say an IMF program. Part of the program was you consolidate the arrears of the public sector, so that central government ends up taking the SOE arrears, consolidating these, and securitizing right. 

Roumeen Islam: That's right. Securitizing them.

Carmen Reinhart: There's also a lot of inter-enterprise arrears. You know that the central government doesn't pay the electricity. And then you sort out the inner governmental or your situation, you consolidate the arrears, and you securitize. None of this is pretty because indeed more often than not what happens is it reveals, there was a lot more debt out there than you knew, right? When you start of digging the skeletons out of the closet, so to speak, consolidation and securitization, are a way forward. In effect, you know, I think, on the securitization front, we are seeing a little bit, depending on the country or a lot of it actually, depending on the country, also trying financial institutions, trying to sell off their bad loan portfolio and other firms coming in.

Roumeen Islam: Okay, good. Let's change tack a bit. Let's talk about fiscal stimulus. We've talked about how some governments have done it and are continuing to do it, but in your talk, you mentioned the U.S. So, if governments are going ahead with doing more fiscal stimulus, what's your view on how they should go about doing it? What should they be spending on, for example?

Carmen Reinhart: This is a huge, huge topic, and I'm not dodging your question in the least. But the amount of fiscal space a country has runs from negative territory to very big, you know, that in our country groups, we also have countries that are past having fiscal space. They're already, you know, by definition in distress.  It's really about prioritizing very scarce resources. I think I've likened COVID to a war and that you first have to win the war and then you start worrying how you're going to pay for the war. Part of winning that war really means the focus has to be on the social, the health, the kinds of social transfers, cash transfers — support for the glaring gaps that COVID has exposed. So social spending, it's a matter of prioritizing in a shrinking pie. This you're going to like. Okay, so I said something you didn't like. 

Now, I'm going to stay something you like, okay. Countries, this is a study from debt crisis of the 1980s that compares a sample of Asian countries and a sample of Latin American countries and looked at the response. Countries that, over the first couple of years, few years of the crisis, balanced, more in favor of keeping public investment did better growth wise than  the ones that basically supported consumption, government consumption and other expenditures at the expense of hacking down public investment.

So, the issue that right now, you prioritize, prioritize on the social issues. We've got a pandemic going, but, but I think once you get past the initial stage, the finding of the study is very suggestive. It basically says countries that were less able or willing to take the hit on government consumption, government wages and therefore concentrated the adjustment disproportionately on public investment did much worse, in terms of magnitude of being recovered. 

Roumeen Islam: I completely agree that public private partnerships will be a key element in this. So if you were to think of a couple of things that governments might do, that countries might do to increase confidence in this kind of venture, do you think that what sort of policies do you think are important? Do you think of first order importance are, you know, things like the regulatory framework? Do you think it's other instruments to reduce risks of investment? What do you think?

Carmen Reinhart: We know this, Roumeen, from the literature on the determinants of investment over the long haul, things like, you know, rule of law and governance issues are important for being able to attract medium and long-term investment. This is not just, you know, a short portfolio strategy chasing a high coupon bond. In terms of the near-term risks, think of the question that you posed to me also about prioritizing: Who do you pay? The same time, I said, look, "You know, there's all these multiplier effects. If you're not paying, if you're not cleaning up domestic arrears, if you don't pay your external creditors, it's not a great signal for attracting capital either." So, it's all fraught with very tough tradeoffs. I think anything that, you know, speaks to more macroeconomic, stability, you know, well-defined government program, not just shooting from the hip: transparency on contracts and so on, are all things that help attract capital. Though, one has to be realistic. You know and I know these things don't change overnight.  

Roumeen Islam: Okay, good. That's good to know. So, Carmen, we have now come to the end of all the questions that I had in mind for you. And we've learned a lot from you in terms of how to approach this problem. 

Carmen Reinhart: You grilled me there, you know, Roumeen, you really grilled me.

Roumeen Islam: I'm glad you thought so, but, but we heard a lot about how to approach all the different aspects of the debt problem, but maybe I've left out something. Is there anything I've left out that you think is critical that I should've mentioned critical to the recovery? 

Carmen Reinhart: I think the issue of financing is still so critical. I mean, you look at country after country, you look at their financing gaps; they have big financing gaps. So, you know, I think, you know what one can do, it's infinitely easier to talk about it than to actually achieve it.  Engage the private sector because the multilaterals have done a great deal of financing during the pandemic — are likely to continue on that path for the near term, with the financing gaps. And that is a big source of worry. How are they going to be filled? 

Roumeen Islam: Very good, yes.  We've been thinking about that for a while, yes. So, thank you Carmen. That was very good. Very illuminating. It was a pleasure to have you with us. Thank you. 

Carmen Reinhart: Likewise. Thank you.

Roumeen Islam: Carmen has provided us with a lot to think about. Firstly, she emphasized how the severity, the synchronicity, and the incredible uncertainty in the current prices, makes it really difficult to estimate the magnitude of the large and rising debt problems.

Secondly, social expenditures are the priority during the health crisis that experience shows that public investment in infrastructure will be key to a sustained and strong recovery. 

Thirdly, the stifling effect of domestic payment arrears will need to be dealt with expeditiously, for economies to recover and for fiscal multipliers to do their work.

Finally, private investment, public-private partnerships, will have to be part of the recovery, made all the more important because of tight fiscal constraints, and for this good governance, good management of external debt and debt transparency of the whole public sector are critical. Bye for now. And until next time. 

This episode was recorded in May 2021. 

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View all episodes on our Tell Me How: The Infrastructure Podcast Series homepage