The road to recovery: How emerging markets can find their way out of a crisis

Karby Leggett Global Head of Public Sector and Development Organisations

13 Oct 2020

As governments in emerging markets come out of ‘emergency mode’, they need to put in place the policies and funding necessary to get back onto a long-term growth path. How can they ensure they set the right priorities?

The World Bank expects economies in emerging markets to decline by 2.5 per cent in 2020. This may look like a small drop compared to the eight per cent dip in the industrialised nations, but for emerging markets, this is the worst downturn since the 1960s, and for many a recession is looming.¹

Karby Leggett, Global Head of Public Sector and Development Organisations, tells us what this decline means for governments and public sector organisations in emerging markets, and how they can put their economies onto a path of long-term, sustainable growth.

What are the challenges emerging market governments face as they embark on their recovery plans?

In the first three months of the pandemic, governments were in crisis mode, often forming emergency fiscal policy responses from their dining tables as part of the work-from-home reality they faced.

We are now seeing a gradual resumption of normal activity. As governments look at how they can claw back growth, they must make longer-term policy decisions and secure funding to get their countries back on track.

That is a tall order. Deficits are continuing to widen because of shrinking economic activity and measures taken to shore up economies against the impact of COVID-19. Even after the pandemic abates, it will likely take years for governments to normalise public finances and unwind the elevated debt stock.  Unemployment will probably continue to be an intractable problem for years to come as economies adapt to changing industry patterns.

Adding to this are continued subdued external demand, reduced export receipts, low commodities prices and lower remittance inflows over a prolonged period².

Many governments also have to defend their sovereign credit ratings at a time when investors are nervous: the IMF estimates³ that more than USD100 billion in foreign capital was withdrawn from emerging markets in the early phase of the pandemic. While there has been some recovery, it has been uneven and will likely stay that way as investors form their views on which countries will recover the fastest.

Understandably, countries who entered the crisis with questions around the sustainability of their public finances or with high external vulnerabilities have been among the worst affected by this investor pull-back.

What type of projects should emerging markets focus on to help ensure future growth?

Governments are juggling a lot of priorities right now.

Naturally, healthcare was the critical starting point for public spending at the onset of the crisis, as the inadequacy of healthcare supplies and infrastructure to address the pandemic became clear. There was a scramble to put supplementary budgets in place to address the shock.

But these rapid-fire decisions also point to one of the most forward-looking investments that emerging market governments can now make: they need to refocus on building out their countries’ infrastructure.

Infrastructure deficits can put the brakes on economic growth. An economy’s ability to grow is constrained by how many trucks can travel down a highway and how many ships can enter a port on any given day.

Hospitals, power, roads, schools and safe water supplies are among the projects that will lay the foundations for long-term growth. And alongside that, they are creating employment, raising tax revenues, driving demand and delivering many other beneficial by-products.

There are other focus areas, too, including education and training. China has set a very positive example here by earmarking the special purpose bond receipts for spending on projects with enduring benefits. This includes funding new infrastructure, reskilling migrant workers who have lost their jobs, new university graduates and, most recently, a commitment to reach carbon neutrality by 2060⁴.

Which funding vehicles work best in the current context?

Specific COVID-19 bonds are an immediate option for countries seeking support with their short- and long-term recovery.

A good example is a new USD1.5 billion three-year COVID Response Bond issued by the New Development Bank⁵. It will be available to NDB member countries – China, India, Russia, Brazil and South Africa – to combat the pandemic and support the economic build-back.

That said, some of our most successful projects in recent months have involved working with Export Credit Agencies, providing structured export finance.

For instance, we recently collaborated with a Scandinavian ECA to provide a loan to Côte d’Ivoire for the purchase of buses that would form the public transport backbone in the city of Abidjan. We also arranged a loan to the Government of Ghana to build the new Eastern Regional Hospital at Koforidua, backed by support from UK Export Finance.

Blended finance jointly with global and regional multilaterals is also an option, as it means that risk participation is shared between a bank or an investor and a multilateral. This is particularly important in high-risk times like these.

In South Asia, we are partnering with multilateral development banks (MDBs) to provide credit support and enhancement to help microfinance institutions make small-sized loans to individuals and businesses in need.

Another source of funding that is growing in importance is Islamic Finance. While investors at large have become very cautious, we do see a lot of Sharia-compliant liquidity available. With its developmental and social goals and ethos of profit-and-loss sharing, Islamic Finance offers an alternative to traditional approaches to lending.

Though it still has a small share in global finance, the total volume of Islamic financial assets is reported to exceed USD2 trillion⁶, and we see significant opportunities in this space.

Does ESG feature in emerging market recovery plans, and to what extent?

ESG considerations are becoming increasingly important in emerging markets, and this trend will only increase in the context of the COVID recovery. This is because ESG criteria will help ensure that countries don’t focus on a quick economic bounce-back, but instead invest in a sustainable recovery, maintaining long-term reform agendas.

You could say that the pandemic has brought together three parallel priorities in this context: investors’ interests in good returns, governments’ economic growth objectives and ESG targets.

Although education is still needed, investors are becoming increasingly receptive to ESG and financing structures such as green bonds, green loans and even green deposits. There is a realisation that meeting ESG requirements can generate both financial returns and long-term benefits for all parties.

This could be through reducing energy costs or commanding higher rental payments in real estate, or using lower-cost, easier-to-maintain nature-based solutions⁷.

In turn, growing investor interest has increased the appetite from emerging market governments to develop their ESG agendas to attract capital. For example, Indonesia became the first Asian sovereign to issue a green bond in 2018. And the Republic of Seychelles recently launched its first-ever ‘blue bond’ to develop its ocean economy, supported by the World Bank and commercial banks including Standard Chartered⁸.

The example of the Seychelles also points to another trend that will play into the growth of ESG-linked finance for emerging markets: the rise in ESG project financing by multilateral development banks. Climate financing, for example, reached an all-time high in 2019, with commitments amounting to USD61.6 billion.⁹ This area holds a lot of potential, and we expect to see significant growth in the future.

What should emerging market governments and public sector investors do to make the most of the current environment?

Emerging market governments need to be strategic about how they raise capital. There is a lot of competition for the available funds, and investors are – and will continue to be – selective as they are rightly concerned about the economic and financial health of some countries.

Keeping credit ratings stable will be critical in this context. Governments that came into this crisis with a good track record of fiscal prudence and a robust external balance sheet are going to have an easier time maintaining their credit rating. They are going to get more sympathy from the rating agencies compared to those that came into this crisis with less favourable track records in debt and deficit management.

But even those with the best track record cannot rest on their laurels. Staying in rating agencies’ good books will be down to two key criteria: demonstrating future-proof, solid policymaking, and a commitment to reining in debt in the medium term and returning to fiscal balance.

Beyond that, it will be critical to delivering the highest-quality, most risk-appropriate projects. Putting together such a package for investors will be challenging for many emerging markets, especially considering the G20 debt service suspension and the various support measures issued by the likes of the IMF and the World Bank.

Another crucial requirement for emerging markets in search of investment is maintaining lasting reform agendas, showing that their planning extends beyond the immediate crisis.

The Philippines’ Build Build Build programme is a great example of what investors will be looking for. It extends across 20,000 infrastructure projects nationally, from roads to airports to schools, all aimed at decentralising the highly urbanised Philippines. While adjustments had to be made during the pandemic, the programme is generally seen as a reflection of the authorities’ long-term focus and a key driver of the country’s recovery.¹⁰

Finally, governments and public sector organisations should maximise the opportunities to engage with both the private sector and multilateral organisations to focus on growth projects that ensure sustainability and inclusivity don’t get left behind.

¹ https://blogs.worldbank.org/opendata/understanding-depth-2020-global-recession-5-charts
² https://www.worldbank.org/en/news/press-release/2020/04/22/world-bank-predicts-sharpest-decline-of-remittances-in-recent-history
³ https://www.imf.org/en/News/Articles/2020/05/28/sp052820-opening-remarks-at-un-event-on-financing-for-development-in-the-era-of-covid-19
⁴ https://www.theguardian.com/environment/2020/sep/22/china-pledges-to-reach-carbon-neutrality-before-2060
⁵ https://www.ndb.int/press_release/ndb-prices-inaugural-usd-1-5-billion-3-year-covid-response-bond-international-capital-markets
⁶ https://www.ft.com/content/8190401b-8ee0-42a1-89d5-945b7b3fe256
⁷ https://www.undp.org/content/undp/en/home/librarypage/poverty-reduction/private_sector/catalyzing-private-sector-investment-in-climate-smart-cities.html
⁸ http://pubdocs.worldbank.org/en/242151559930961454/Case-study-Blue-Bond-Seychelles-final-6-7-2019.pdf
⁹ https://www.ebrd.com/documents/climate-finance/-2018-joint-report-on-multilateral-development-banks-climate-finance.pdf
¹⁰ https://theaseanpost.com/article/build-build-build-program-amid-pandemic