AS COVID-19 wreaks havoc upon nations across the globe, the effort to combat the virus is costing billions. By and large, countries have been unprepared for this eventuality and are now being forced to dip into their piggy banks and produce eye-watering stimulus packages in the attempt to mitigate the fallout.
In last week’s article we examined some stimulus packages adopted by various countries and what they entailed, as well as what sectors stood to benefit most. However, with countries such as Trinidad and Tobago proposing packages worth as much as US$1 billion, the question arises: Where are countries getting the money?
In this article we highlight some of the funding options available to governments, as well as the possible implications of each.
An attractive option at first, simply printing the additional money required for spending may seem to be the perfect solution: a government would have instant access to the required funds, and there would be no increase to public debt. However, this is usually avoided because of its inflationary impact. Printing more money does not actually increase economic output; it merely increases the amount of cash in circulation. As a result, if more money is printed, consumers are able to demand more goods in an environment where companies’ supplies of goods are fixed, leading to price increases. An extreme example of this would be Zimbabwe, where in 2008 reckless printing of money for government financing led to a daily inflation rate of 98 per cent.
Government Bonds are issued by a government with the goal of supporting government spending and other state financial obligations. It can be simplistically described as a debt security. This form of funding is fairly common among countries, and can prove to be a useful tool in absorbing excess liquidity which may be present in a given economy. Challenges with borrowing money within your own economy however, arise when bond sales siphon money away from other essential lending markets. If this borrowing is not managed properly it may result in a crowding-out effect that raises interest rates and hinders the private sector’s ability to borrow, inadvertently further slowing economic activity.
Despite the obvious drawback of increased public debt from issuance of government bonds, countries with relatively large volumes of debt can still borrow quite comfortably as long as economic activity is strong, and supporting measures are implemented alongside the loans to minimise the possibility of a crowding-out effect.
For example, the USA, which plans to fund its US$2 trillion stimulus package through government bonds, is expected to reach debt levels of US$25 trillion. In order to support this level of borrowing, the USA’s Federal Reserve was noted to have “vastly expanded its purchases of various bonds…. buying at least $300 billion in corporate bonds and other security tied to assets like real estate and auto loans”. This was done to ensure adequate liquidity to facilitate the additional government borrowing.
Although external borrowing also tends to increase overall public debt, it differs from government bonds, which is oftentimes predominantly purchased by national investors. External borrowing is synonymous with external debt, since it refers to the portion of a country’s debt that accrues as a result of borrowings from foreign lenders, including commercial banks, governments or, in most circumstances, international financial institutions. Some of the more well known of these international financial institutions are the International Monetary Fund (IMF), Inter-American Development Bank (IDB), and CAF—the Development Bank of Latin America.
In its broadest sense, the criteria that countries must follow when applying for a loan from these agencies are not much different from what individuals face with commercial banks. In other words, loans are agreements between the financial institution and the country for a specific purpose. The country agrees to return to the financial institution, within a specified period, the sum of money borrowed plus interest, fees, and other expenses as per the lending conditions.
In some circumstances however, conditions for a loan may include the implementation of macroeconomic and structural adjustment policies. Borrowing countries often consider such conditions to be undesirable as they can be highly restrictive. Take for example Jamaica, which has engaged in IMF-related structural adjustment for over 40 years. In 2018 it was recorded that the country had failed 11 of the 15 IMF agreements put forth, and was assisted to pass two of the remaining four by way of debt forgiveness and waivers, etc. Without this, the country would have failed 13 out of 15 IMF agreements outlined in the terms of its loan.
Sovereign Wealth Funds
Essentially a Sovereign Wealth Fund (SWF) refers to a state-owned investment fund or entity comprising pools of money derived from a country’s reserves, and which is set aside for investment with the goal of benefitting the country’s economy and its citizens.
A country can establish a SWF for many different reasons such as savings and future generations, pensions revenues, or reserve investment. SWFs can also be established for economic stabilisation purposes, which would allow governments to access additional funding with the goal of cushioning the impact of an economic downturn. An example of an SWF fund set up for this purpose would be Trinidad and Tobago’s Heritage and Stabilisation Fund, established in March of 2007.
It should be noted though that not every country may have an SWF, and rules for drawing down differ from country to country. Where it exists, an SWF can prove to be a valuable source of funding, albeit with the downside of a reduction of the country’s savings.
If dealing with the pandemic could be likened to a war, then the resistance battles now being waged call for extraordinary levels of spending, and world governments are being forced to adjust their budgets. While there remains a multitude of available funding options for governments, countries will now have to even more carefully assess each alternative to determine what is the most viable.
Only time will tell how long this COVID-19 pandemic lasts, however the decisions we make today can prove to have a lasting effect on the generations of tomorrow.
This article was developed by Reagon Stroude, Research Officer of the Trade and Business Development Unit of the T&T Chamber.