It is becoming increasingly clear that Brazil’s government is using the Covid-19 pandemic as cover to allow the conversion of yet more untouched rainforest into agricultural land. Last month, a group of global institutional investors warned that they would sell Brazilian assets including sovereign bonds if the situation worsened. The investment community can and should do more.
On a recent call with the country’s agriculture ministry, investors were astounded to hear a senior official argue that the sector was responsible for “only” 12 per cent of Brazil’s deforestation. The government, under President Jair Bolsonaro, points to strong demand from China as it seeks to farm more virgin land. Ricardo Salles, the environment minister, recently proposed that Brazil should weaken environmental rules while media outlets were distracted by the pandemic.
As stewards of savers’ money, we have a fiduciary duty to generate returns. We also have a moral responsibility to do so in a sustainable way. The two are inextricably linked. We want sustainable growth that produces sustainable returns, rather than the boom and bust that depletes our planet’s resources. Just as Brazil has tried to leverage the Covid crisis, investors should do the same.
There should be opportunities to apply pressure. Brazil may yet need to restructure its debt pile. We have seen significant sales of emerging market debt in recent months as nations bolster their firepower to fight the pandemic, locking in lower interest rates after an extraordinary bout of monetary policy easing by the world’s central banks.
Brazil’s debt is expected to reach 90 per cent of its gross domestic product by the end of this year. Investors may not fret about the scale of its borrowing now, but next year could be different. Other nations, including Argentina and Ecuador, are already in negotiations to repair their balance sheets,
Investors should attach strings to any refinancing, by insisting on environmental, social and governance-related commitments in return for favourable repayment terms. These conditions could include anti-deforestation measures, phasing out fossil fuel subsidies, increasing renewable energy in the national mix, or spending more on health and education. Investors might even urge countries to commit to greater transparency on infrastructure debt, which is often associated with opaque projects that can deplete treasury coffers.
As it is not possible to skip paying coupons without triggering default, a new type of contract will be needed.
One option, as part of the restructured debt, is to issue bonds tied to the UN’s sustainable development goals. That so-called SDG framework addresses poverty, equality issues and climate change, and many countries, investors and institutions have already signed up to them. No one can argue against wanting cleaner air, more hospitals and better schools.
Money from an SDG bond could be restricted to financing green projects that address concerns over climate change, for example by promoting clean energy or investing in flood defences. Or they could be limited to promoting social goals such as more investment in education and healthcare, in order to address spending gaps that will only get worse as the Covid crisis continues. The coupon on the SDG bonds would be variable, depending on compliance with the sustainability commitments. That would encourage countries to stick to their promises in order to lower their cost of funding.
Such an approach poses tricky questions about sovereignty: should investors be telling governments how to run their country? We need to be realistic about what is politically possible. For example, ending fossil fuel subsidies overnight can trigger serious civil unrest, as we saw in Ecuador last year.
So a gradual plan that phases out incentives over the period of the bond — to 2040, say — is needed. Investors need to be flexible and patient on the timing of implementation for such measures. Variable coupons are among many sacrifices perhaps required of the investor. Another would be a haircut, or a reduction in the value of existing debt, that is contingent on SDG conditions.
At the end of the day, this is a negotiation and we cannot force change on governments. Investors can, however, encourage leaders to make the right choices.
How do we ensure that countries keep to their side of the bargain? Independent oversight is crucial, through regular, third-party inspections. We would also need alignment between the IMF, the World Bank, the UN Development Programme and other public and private stakeholders. A joined-up position agreed between creditors will prevent borrowers from playing one off against another.
Win-win situations are rare, but the Covid crisis presents a clear opportunity for nations and investors to achieve goals that are mutually beneficial: sustainable growth and sustainable debt. That would not only make countries more investable, but improve the lives of their citizens.
The writer is global head of emerging markets at Amundi