The crisis unleashed by Covid in 2020 has been novel. It has brought with it a collapse in GDP and tax revenues, an increase in international reserves by an average of 3.8% (excluding Ecuador), and a rise in commodity prices. It is an unprecedented crisis in which there is not an external denouement but a fiscal crisis, of internal debt at the same time as a generous provision of foreign currency to meet international commitments.
What has led to the misunderstanding of the problem is that the debt-to-GDP ratio jumped between 2019 and 2020 as a result of the contraction of the denominator. Accompanying this was an increase in fiscal deficits that have generally been financed domestically as a result of a healthy external sector and a complicated domestic problem. This is not to say that there were no external problems before the crisis, and some of them are difficult to solve, such as Argentina, but they have nothing to do with COVID. The external component related to COVID is the limited availability of bilateral credit and the politicisation of ODA for the purchase of vaccines in Europe and the United States.
As can be seen in the table, the changes in reserves are positive and the IMF credits do not explain all of the increase in reserves. In sum, central banks borrowed from the Fund in case of an external shock, but the availability of foreign exchange was liquid and only Ecuador, Costa Rica and El Salvador were in a critical situation of international reserves. Mexico's reserve position improved 2.1% in the year between April 2020 and March 2021 without using the available flexible credit line.
The problem is fiscal and western rather than universal, and it is worse for the G7 than for the emerging countries. All of them maintained the public spending programmed before the pandemic and injected more resources to contain the economic downturn, with the exception of Argentina, for lack of fiscal space, and Mexico, which did not consider it necessary. In order to maintain such meagre deficit levels (1.5 per cent), public spending had to be contracted as much as the economic downturn.
The novelty of this crisis situation is that it removes the possibility of a balance of payments denouement. On the other hand, unless central banks lend money to treasuries, which would contradict the autonomy of central banks, there is no way treasuries can service external services without making additional adjustments. Isabel Ortiz and Mathew Cummins1 warn that governments are entering another period of fiscal austerity, which is expected to continue until at least 2025. It appears that the IMF promoted counter-cyclical policies only in 2020 and returned to normal very quickly with the predictable result of lower than projected economic growth. Yellen has proposed a 21% corporate sales tax, payable within each country. This is institutionally constrained by free trade and investment agreements with the United States that prevent tax increases.
If the economy is to be revived, more taxes will be indispensable to prevent inflation from paying off the debt. New taxes on digital activities and the wealth tax, as well as a tax on stock market and financial transactions are still to be discussed. Yellen will have to talk about how to overcome institutional constraints. The outlook for recovery in this framework points to 2025 as the year when everyone will have recovered what was lost in 2020. In the cases of Brazil, Argentina, Chile and Mexico, the loss started earlier and may even take longer.
1 Working paper “Alerta de austeridad global los recortes presupuestarios que se avecinan en 2021-25 y vías alternativas” (Initiative for Policy Dialogue (IPD) / Global Social Justice (GSJ), International Confederation of Trade Unions (ITUC), Public Services International (PSI) / Arab Watch Coalition (AWC), The Bretton Woods Project (BWP) / Third World Network (TNW))