What just happened?

As the COVID-19 pandemic wreaks havoc on the global economy, public debt in emerging markets has surged to levels not seen in the last 50 years.[1] As a result, the developing world is facing a wave of government bankruptcies.[2]

What does this mean?

The virus has demolished global tourism and has significantly devastated the world economy. A rapid increase in unemployment, a decrease in cross-border trade, and tourism have caused the developing countries to face high debt burdens. Emerging markets and developing countries have about $11 trillion in external debt and about $3.9 trillion in debt service due in 2020.[3] The debt crisis in developing countries will lead to losses for banks, both domestic and international, undermining the stability of financial systems in both the developing and developed countries.[4]

Zambia, Ecuador, and Rwanda have all announced in recent weeks that they are struggling to repay the debts.[5] The brutal and abrupt recession could translate into the Maldives becoming the latest country to sink into sovereign bankruptcy to which the IMF has already lent $29m.[6] More than 100 countries have already appealed to the IMF for help, and the IMF has already cancelled six months of debt payments due from 25 countries.[7] Moreover, the G20 has agreed to temporarily freeze about $20bn worth of bilateral loan repayments for 76 poorer countries and has urged the private sectors to do the same.[8] The World Bank will deploy as much as $160 billion over the next 15 months, of which $50 billion will be in either grants or highly concessional terms from IDA, the World Bank's fund for the poorest.[9] Such economic climate can prove to be advantageous for some countries. For instance, China is the global lender and has extended loans to developing countries than any other country[10], which means that Beijing could either take control of other countries' assets or forgive debt to boost its soft power.[11] It is predicted that China would go beyond a freeze on repayments and offer something closer to a debt write-off.[12]

How does this affect the legal industry?

The debt crisis affects all the sectors of society, particularly the legal industry. A debt crisis would result in reduced profits and low growth for law firms. The firms will have to enter talks with its lenders to extend the credit facility and relax certain covenants.[13] Net debts will likely be higher with lower profits.[14] The debt crisis has resulted in a decline in bond yields and borrowing costs, which has resulted in tightened financial conditions for weaker corporate borrowers.[15] To manage debt, law firms will have to cut wages and reduce partner profits. Furthermore, the debt crisis will have an impact in the non-bank corporate sector, where the current disruption to supply chains and reduced global growth imply lower earnings and greater difficulty in servicing debt.[16]

There is a risk of businesses going bust due to such a crisis, which increases the workload of insolvency lawyers. In response to this thought, the UK government is aiming to bring the measures at the earliest opportunity. To achieve this, the government plans to amend the current UK insolvency law to give the firms extra time and space to ensure that the creditors can get the best return possible. However, these measures will have an impact on creditors' position and their existing rights to seek repayment of overdue indebtedness.[17] It follows a temporary suspension to UK's wrongful trading provisions will be implemented to prevent the directors from facing liability if they allow the company to continue to trade when there is no reasonable prospect that the company would avoid liquidation.[18]

Written by Samriti Rudhra

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References:

[1] ‘Debt Service Suspension and COVID-19’ (The World Bank, 11 May 2020).

[2] Robin Wigglesworth, ‘A Solution to the looming debt crisis in emerging markets’ (The Financial Times, 4th May 2020).

[3] Homi Kharas, ‘What to do about the coming debt crisis in developing countries’ (Brookings, 13th April 2020).

[4] ‘How a country’s debt crisis can affect economies around the world’ (Investopedia, 18th February 2020).

[5] Colby Smith and Robin Wigglesworth, ‘Why the coming emergency markets debt crisis will be messy’ (The Financial Times, 12th May 2020).

[6] Colby Smith and Robin Wigglesworth, ‘Why the coming emergency markets debt crisis will be messy’ (The Financial Times, 12th May 2020).

[7] Colby Smith and Robin Wigglesworth, ‘Why the coming emergency markets debt crisis will be messy’ (The Financial Times, 12th May 2020).

[8] Robin Wigglesworth, ‘A Solution to the looming debt crisis in emerging markets’ (The Financial Times, 4th May 2020).

[9] ‘Debt Service Suspension and COVID-19’ (The World Bank, 11th May 2020).

[10] Sebastian Horn, Carmen M. Reinhart and Christoph Trebesch, ‘How much money does the world owe China?’ (Harvard Business Review, 26th February 2020).

[11] Helen Davidson, ‘Coronavirus chaos could strengthen China’s debt hold on struggling nations’ (The Guardian, 12th April 2020).

[12] Lauren Johnston, ‘How COVID-19 will change China and Africa’s economic relationship’ (World Economic Forum, 12th May 2020).

[13] Hamish McNicol, ‘DWF FLAGS covid-19’s ‘material impact’ on profit and increased debt as Keystone declines dividend’ (Legal Business, 27th March 2020).

[14] Hamish McNicol, ‘DWF FLAGS covid-19’s ‘material impact’ on profit and increased debt as Keystone declines dividend’ (Legal Business, 27th March 2020).

[15] John Plender, ‘The seeds of the next debt crisis’ (The Financial Times, 4th March 2020).

[16] John Plender, ‘The seeds of the next debt crisis’ (The Financial Times, 4th March 2020).

[17] Iain Goalen and others, ‘COVID-19 Changes announced to UK Insolvency Law and for AGMS’ (Shearman & Sterling, 31st March 2020).

[18] Iain Goalen and others, ‘COVID-19 Changes announced to UK Insolvency Law and for AGMS’ (Shearman & Sterling, 31st March 2020).

Disclaimer: This article (and any information accessed through links in this article) is provided for information purposes only and does not constitute legal advice.