Responding to Global Economic Vulnerability
Responding to Global Economic Vulnerability
Commentary / Global 12 minutes

Responding to Global Economic Vulnerability

Overlapping crises have added to the economic burdens of many countries, particularly those already in debt. In this excerpt from the Watch List 2023, Crisis Group lays out steps the EU and its member states can take to reduce vulnerability and risks of unrest.

Growing economic vulnerability – caused by the cost-of-living crisis, financial instability and debt burdens that countries are facing – has potentially serious consequences for global peace and security. Though COVID-19 rates have dropped, and food and fuel commodity prices have fallen from their post-Ukraine invasion highs, these compounding crises nevertheless exposed longstanding weaknesses in the international financial system, which, in previous decades, was better able to buffer at least some shocks. Poorer countries, especially those with weak governance and a high debt burden, are most at risk, but some middle-income countries face crises, too. The protest wave that engulfed Sri Lanka and led to the resignation of President Gotabaya Rajapaksa in 2022 exemplifies the sort of tumult that could occur elsewhere – especially in countries already suffering instability – if supply chain disruptions, the financial system’s fragility and states’ inability to provide for their people remain unaddressed. 

The global system is ill equipped to deal with a situation in which a fifth of all countries, by Crisis Group’s count, have experienced some level of food and fuel-related protests since the start of the full-scale Ukraine invasion, and the major rating agencies consider 26 countries at risk of default on their debt. It is daunting to imagine the sort of international mobilisation that would be required to pull all these countries onto a sound financial footing – especially when many wealthy countries, including some in the European Union (EU), are suffering their own economic strains. 

Yet short of a full global economic rescue, there are steps the EU and at least some member states could take to mitigate crisis conditions, help protect vulnerable nations’ finances and ameliorate the looming wave of sovereign debt defaults. 

  • To address vulnerable conflict countries’ financial and fiscal instability, EU member states should follow through on their commitment to recycle their allotment of Special Drawing Rights (SDRs) and consider pushing for a new allocation. 

  • To prevent the severe economic deterioration that accompanies default, the EU should encourage, and coordinate among, its member states to lengthen the repayment period for sovereign borrowers and to introduce broadly framed contingency measures and concessional financing to respond to extreme shocks.

  • To address the cost-of-living crisis and food insecurity, the EU and member states should maintain high levels of humanitarian aid funding, and where possible increase it, recognising the difficulty of doing so amid the weakening European economy, while also ensuring that their sanctions regimes include wide-ranging, predictable and consistent humanitarian exemptions, starting with the robust incorporation of the provisions recently adopted in UN Security Council Resolution 2664.

A shopkeeper in Beirut, Lebanon. CRISIS GROUP/Michelle Malaney

Assessing the Risk

Expert opinions differ widely on the 2023 economic outlook, though there is precious little by way of optimism. Some economists warn of a deep recession, despite recent improvements, while others foresee a milder dip. The World Bank has warned of a “sharp, long-lasting slowdown” that could see high unemployment, rising prices, low growth and stringent debt burdens, all of which will take a toll on humanitarian assistance. 

This situation is at least partly the result of overlapping systemic shocks – including COVID-19, Russia’s all-out invasion of Ukraine, tight anti-inflation policies and climate distress – in a deeply interconnected world of just-in-time supply chains, which means that a problem in one place can cause catastrophe in another. Countries dependent on external sources of energy, fertilisers, food and key natural resources are particularly vulnerable; low-income countries without financial resources to buffer economic shocks tend to be even more at risk; and states with deep political polarisation or those already suffering from deadly conflict, where economic distress is often exploited for political gain, may be the most precarious of all.

Managing the effects of volatile energy and food markets, as well as government policies to control inflation, will prove especially challenging over the coming year. EU and U.S. sanctions on Russia will continue to unsettle global markets, even as supply chains readjust to political realities, and it will continue to be important that Western powers take steps to ameliorate their impact. In 2022, 93 per cent of lower- and middle-income countries and 89 per cent of upper-income countries experienced average domestic food price inflation of above 5 per cent, with the majority facing double-digit increases. Malnourishment is rising markedly, with women particularly at risk of food insecurity. The gendered impact already seen in the wake of the economic upheaval – including increases in unpaid care work by women, domestic violence, sexual exploitation, underage and forced marriage, and the number of children pulled out of school – is expected to become more marked as a result of the cost-of-living crisis.

Not surprisingly, humanitarian aid organisations have reported an increased need in conflict arenas, particularly to combat food security and malnutrition, but also because operating expenses have gone up. In South Sudan, for example, the World Food Programme has projected the need for an additional $1 million per month to maintain its operations, largely due to high fuel prices, which have been affected by both the war and the imposition of sanctions by outside actors. As costs increase, organisations face the difficult decision to reduce beneficiaries or cut benefits. 

The risk of deadly violence stemming from economic vulnerability depends greatly on pre-existing conditions. In some places, even plummeting indicators might not contribute to violence, whereas in others, an objectively smaller deterioration might; in still others the causal links between economic hardship and violence are unclear, but the two work together to compound immiseration. To offer just a handful of examples, in Pakistan, political turmoil and the risk of instability is increasing partly as a result of the rising cost of living; in Sudan, the transition to civilian rule will be in serious jeopardy – with another coup in the offing – if the future transitional government fails to bolster the country’s cratering economy; and, of course, in war-torn countries like Afghanistan, Ethiopia, Syria and Yemen, cost rises and competition for donor dollars are exacerbating suffering. 

Promoting a More Stable Economic Environment

The EU and member states can take several kinds of actions to help buffer crisis conditions and promote an economic environment that is more conducive to peace and security. 

Use of SDRs to protect finances. The EU and member states should also make better use of mechanisms that can help protect the finances of affected countries, including SDRs. 

The need for additional protection is clear. In reaction to the price hikes accompanying Russia’s all-out invasion of Ukraine, governments worldwide have raised fuel and food subsidies, cut taxes, expanded social programs, augmented food reserves and diversified commodity import sources. These measures not surprisingly have strained national budgets, especially since they came on top of the already substantial COVID-19 monetary stimulus. By the end of 2022, 60 per cent of low-income countries were in debt distress and 26 countries faced a significant risk of default on their sovereign debts. Most governments today have few financial and fiscal tools left. Against this backdrop, the European Commission encouraged its member states to expand macro-economic support to economically vulnerable countries, particularly those affected by rising food prices. 

To this end, SDRs, an asset created by the International Monetary Fund (IMF) to boost the national reserves of its member countries, can be useful for addressing the financial limitations of conflict-torn countries. In August 2021, the IMF allocated $650 billion globally to help confront COVID-19 challenges. Each member country was allocated a percentage of the total roughly in proportion to the size of its economy, though crucially, a country can only convert its SDRs into usable currency if another state is willing to swap hard currency for the SDR. So far, 98 low and middle-income countries have used SDRs for economic stability, including direct pandemic relief, fiscal purposes, debt relief and other social needs. For 23 of these countries, more than half of which suffer from conflict, SDRs were a lifeline that prevented debt default.

With allocation proportional to economic standing, the wealthy countries of the world received the lion’s share of the [Special Drawing Rights].

With allocation proportional to economic standing, the wealthy countries of the world received the lion’s share of the SDRs. In October 2021, the G20 promised to “recycle” – transfer – $100 billion in SDRs to poorer countries, but the commitment has not been met, despite the additional problems caused by the war in Ukraine, rising inflation and counter-inflationary measures. Autocratic nations have recycled a greater portion of their SDRs; Saudi Arabia has used its SDRs to extend financing to Egypt and Pakistan, and China committed to recycling 25 per cent of its SDR allocation to Africa alone. By contrast, EU member states have made a less than robust showing, having promised to recycle fewer SDRs than other states. 

The EU and its member states should fulfil their commitments to recycle funds and advocate for the distribution of new SDRs in order to stabilise the finances and economies of vulnerable countries experiencing conflict. A frequent justification among wealthy governments for refusing to support a new SDR allocation is the felt need to deny resources to sanctioned countries like Belarus, Iran, Russia and Sudan. This logic is not convincing. Although these states indeed received an allocation in 2021, they have not been able to use it for anything because no state or multilateral body has agreed to exchange a sanctioned state’s SDRs for one of the world’s five hard currencies (the dollar, the euro, the pound, the renminbi and the yen), which as noted is necessary to use funds that can be spent either domestically or externally. Any country that swapped its own hard currency reserves for the SDRs of a sanctioned entity would be subject to reputational damage and, theoretically, to secondary sanctions. 

Some states also worry that a new SDR allocation runs the risk of worsening inflation by increasing countries’ liquidity. That is indeed a risk. But for places that are facing desperate need, the trade-off may be worth it.

Reconfiguring debt relief. While most global attention has been focused on inflation and the cost-of-living crisis, sovereign debt default can be even more disruptive to markets and livelihoods through its effects on capital flows, currency depreciation, balance of payments crises and subsequent unemployment, with those in informal and precarious jobs – in many countries, disproportionately women – hardest hit. The number of countries potentially defaulting has increased dramatically, rising from 30 per cent of low-income countries in 2015 to more than 60 per cent in 2022. 

The priority right now is to avoid default. There are several ways to do that, chiefly forgiving debt, extending the repayment period, renegotiating interest rates and reducing principal obligations. Each has benefits and drawbacks. For instance, a write-down would provide some relief, but with interest rates sky-high, even a considerable reduction in principal owed might not reduce payments to a manageable level in the short run. No less important, international financial institutions, as well as banks and hedge funds, tend to strongly oppose write-downs. 

For decades the Paris Club was the primary forum for debt renegotiation as most international debt was held by the Western countries that formed its membership. But now, with non-Western powers like China, India and members of the Organization of the Petroleum Exporting Countries holding the majority of the debt of low- and middle-income countries, the pressure to include them in international forums has escalated. In November 2020, G20 countries created what is referred to as the Common Framework to unite major debt holders in a single forum and replace the Paris Club. The Common Framework has been ineffective, however, with only one country (Chad) receiving relief through it. 

Other solutions are needed, and here the EU could play a useful role. True, EU member states have decreased the proportion of their debt holdings from low-income countries from 65 per cent in 2008 to 30 per cent in 2020. But 30 per cent is still a significant number and affords the bloc considerable influence. One option for the EU would be to encourage and coordinate among its member states to extend the repayment period for sovereign borrowers in lower-income countries (and possibly middle-income countries depending on how one defines income and assesses the severity of need). It could also develop contingency measures in the event of shocks generating extreme economic distress. Such a crisis response would include concessional financing instruments and contemplate partial interest forgiveness and interest renegotiation. Experts and multilateral groups including the Group of Thirty, comprising renowned economists and financial leaders, have recommended just such a course. Though some people fear this move might raise interest rates and thus borrower payments, IMF analysis suggests this concern is overblown. Creditors overwhelmingly prefer restructuring and easing payments over the complications of default – particularly when the prospect of cascading defaults looms over the global economy. 

In parallel, the broader reform of the international financial architecture should accelerate. Many of today’s debt-burdened countries may not be able to repay their loans no matter what allowances are made. But with, for instance, Pakistan down to a single month of import reserves, the need for immediate measures is becoming acute.

The EU and member states should maintain high levels of humanitarian aid funding, and where possible increase it.

Humanitarian aid and sanctions carveouts. With aid agencies facing rising needs and costs, the bloc will need to try to mobilise more humanitarian funding for those it serves if it is to merely tread water. The EU and member states should maintain high levels of humanitarian aid funding, and where possible increase it, recognising how challenging this task will be amid the projected decline in Europe’s economic strength between 2023 and 2024 due to rising energy costs, inflation and the economic strains of the war in Ukraine. 

At the same time, Brussels and member states can usefully take measures to avoid encumbering their own assistance. Humanitarian providers must wrestle with EU sanctions regimes in places like Syria, Myanmar or Iran and more broadly with the EU’s Russia sanctions. In theory, providers may benefit from two kinds of exceptions for humanitarian activity: 1) exemptions, which are broad carveouts from EU sanctions for specific types of goods or activities; and 2) derogations, which are explicit authorisations for specific types of goods or activities that would otherwise be prohibited by EU sanctions, and which humanitarian operators have to apply for – on a case-by-case basis – prior to conducting their activities. 

Despite the preferences of humanitarian organisations, the EU has so far refused to grant general humanitarian exemptions (apart from a very small number for specific types of sanctions) and prefers a system of derogations. Aid groups tend to find derogations inadequate and onerous, resulting often in “over-compliance”, that is, a reduction of operations beyond that which is required in order to avoid legal, financial or reputational risk. The procedures to obtain them are complex, time-consuming, slow and unpredictable, which make them unfit for emergency response; once a derogation is granted to an organisation for a specific activity in a specific country, it cannot be extended to others. Nor is it clear if and when a derogation granted by one country will be respected by others. Even when the EU and its member states endeavour to minimise sanctions’ burdens and secondary costs for humanitarian actors, and have granted limited humanitarian exemptions, such as in the case of Russian sanctions, the exceptions’ patchwork and partial nature mean they often do not achieve their stated objective. 

At the global level, countries increasingly recognise this problem. In December 2022, Ireland and the U.S. sponsored UN Security Council Resolution 2664, which provides for a standing humanitarian carveout to almost all asset freezes implemented under UN sanctions. The resolution (which was adopted) authorises a wide variety of specifically enumerated entities, including those entities’ “grantees” and “implementing partners”, to support the delivery of humanitarian assistance even if it requires transactions with designated entities. The U.S. subsequently made promising changes to its general licences framework to align its humanitarian aid provisions with the resolution. 

At a minimum, all EU member states are obligated to comply with Resolution 2664 in their implementation of Security Council asset freezes. But there are two key further steps the EU can take to maximise the effects of the resolution in removing impediments to humanitarian support.

  • The EU should take Resolution 2664 as a model for creating an identical carveout for its own sanctions regimes – or even, like the U.S., to create a stronger one by extending its provision to certain additional entities and activities. 

  • To the extent possible, the EU should seek to harmonise the European approach to humanitarian carveouts, including by reflecting a robust interpretation of the Security Council resolution in its directives to member states and in other norm-generating outputs. In this regard, the EU should specify well-defined implementation measures for member states, requiring them, for instance, to report annually on how they put into effect the carveout that Brussels develops. The EU also could go further by including carveout provisions for additional activities in its grantmaking.

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