Governments’ budget constraints are too tight

In November in Bali, the heads of state and government from the world’s leading economies met for the G20 summit. They faced a daunting agenda, and negotiations were made even more difficult by the fact that Russia is a member of the G20 and its invasion of Ukraine has worsened many global challenges. Iwan J. Azis, an economics professor from Indonesia, told me in an interview that the summit actually delivered a stronger declaration than he had expected.

Inflation, so far, is a particularly intractable problem. Central banks focus on the countries they are responsible for, but do not pay much attention to what impacts their decisions have beyond their borders. As André de Mello e Souza, a Brazilian economist, elaborated on our website, however, the strong dollar exacerbates difficulties governments are facing internationally.

Paradigm shift

An obvious way to increase fiscal space is to raise more taxes. That is easier said than done of course. Even high-income countries, which actually collect large shares of GDP as governments revenues, need more money. In less fortunate places, the situation is even more difficult. In the eyes of Praveen Jha from Jawaharlal Nehru University in New Delhi, an international paradigm shift would help. He wants incomes and wealth to be taxed and spelled out on our platform why the small-state ideology has failed.

The paradigm shift may actually be underway already. High-income nations have been coordinating efforts to prevent tax avoidance and tax evasion in recent years in the context of the OECD (Organisation for Economic Co-operation and Development), a group of prosperous nations. Moreover, they have been demanding for many years that developing countries generate more domestic resources, which basically means increasing state revenues. According to Nairobi-based journalist Alphonce Shiundu, William Ruto, Kenya’s new president, has heard the message. He has indeed adopted policies to improve the efficiency and the reach of the tax system.

Sovereign debt problems

Where a government cannot service its country’s sovereign debt any more, better tax policies alone do not suffice. Some kind of relief is needed, and multilateral action becomes indispensable. Germany’s Federal Government is in favour of establishing an international mechanism for dealing with sovereign insolvency. In March, Kathrin Berensmann of the German Institute of Development and Sustainability (IDOS) wrote a comment for us in which she discussed why it would be useful.

It must never be forgotten that excessive sovereign debt can cause or worsen an economic crisis and thus exacerbate severe hardship. The most vulnerable people are affected most, including in particular women and girls. Sundus Saleemi, a post-doc scholar at Bonn University’s Center for Development studies, assessed how things play out in Pakistan, a country that has a fragile government, needed a new loan from the International Monetary Fund (IMF) last summer and was hit by devastating flooding.

So far, however, an international mechanism for dealing with every insolvent sovereign government does not exist. In situations where debts overburden an economy, political stability may suffer, exacerbating the crisis. A prominent recent example is Sri Lanka, as journalist Arjuna Ranawana reported.

Part of Sri Lanka’s problem is that a large share of the debt is owed by Chinese institutions. So far, they have been generous in regard to postponing payments, but very strict in regard to debt restructuring and debt relief. Zambia is another country that needs debt restructuring, and negotiations that include China have begun on the matter. The IMF was therefore able to grant the government a fresh loan. Without some kind of debt relief on the horizon that would have been impossible because the IMF is only allowed to lend money if the debtor country can realistically be expected to repay. Peter Mulenga, Chibvalo Zombe and Charles Chinanda from Copperbelt University assessed the Zambian scenario on www.dandc.eu.

How international financial institutions see things

For pragmatic reasons, our small team has largely focused on Sri Lanka, but many others are in trouble too. Indeed, the topic of the World Bank’s World Development Report 2022 was how the situation worsened in the course of the Covid-19 pandemic. Our Indian colleague Roli Mahajan read the report and summed up its messages in April.

The IMF has made similar statements too, and whether a country belongs in the low-income category or not, it always has an important role to play. Kristina Rehbein and Malina Stutz find fault with its approach. They work for erlassjahr.de, a German civil-society organisation engaged in debt issue. They pointed out on our platform that IMF rhetoric tends to be more progressive than the institution’s actual stance towards individual countries.

Where governments’ fiscal space is insufficient, central banks and financial regulators can contribute to making indispensable investments in climate mitigation or adaptation, for example, possible nonetheless. Indeed, institutions from Asia and Latin America have taken the lead in regard to efforts to gear the financial sector towards making more contributions to achieving sustainability. Ulrich Volz of the University of London spelled out what central banks and financial regulators can – and indeed should – do.

The challenges are daunting. We are indeed living in a polycrisis, and governments urgently need more fiscal space. If you are interested in a brief summary of the issues, I think, I provided one in the editorial I wrote for the December 2022 issue of our digital monthly.

Hans Dembowski is the editor in chief of D+C/E+Z.
euz.editor@dandc.eu