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The COVID-19 Default Time Bomb

The world is facing a potential flood of disorderly sovereign defaults at a time when developing-country governments need to be spending huge sums on keeping their citizens healthy. To avoid a catastrophic outcome, the International Monetary Fund should coordinate a broad debt moratorium.

BERKELEY/CHICAGO – Without a comprehensive debt moratorium, the COVID-19 pandemic will lead to a wave of uncontrolled sovereign defaults, especially among emerging and developing economies. Should that happen, global efforts to contain the public-health crisis will fail, and the current economic collapse may well turn into a permanent decline.

Rich and poor countries alike are facing an unprecedented economic crisis as businesses close and workers lose their income. A downturn of this magnitude can cause tremendous long-term damage, as critical economic linkages vanish. Scores of firms will close permanently unless urgent action is taken. To this end, the United States Congress recently passed a $2 trillion rescue package, while the Danish and Canadian governments, for example, are subsidizing 75% of the payroll of their countries’ small and medium-size enterprises (SMEs). China, meanwhile, has expanded credit and eliminated payroll taxes, and just announced a rescue package worth almost $1 trillion.

But COVID-19 poses even greater problems for emerging economies such as India and Mexico. There, the economic costs of social distancing are even higher than in the US and Europe, and vulnerable SMEs, with low cash reserves, account for a much larger share of the economy. Such countries also have far more precarious health-care systems. The funds required to support vulnerable workers and businesses, as well as to treat COVID-19 patients, could be as much as 10% of their GDP.