In March this year, the United Nations Conference on Trade and Development (UNCTAD) and the International Monetary Fund (IMF) called for a US$2.5 trillion coronavirus crisis package for developing countries, arguing that even before the pandemic, many of these countries faced high and rising shares of their government revenues going to debt repayments, squeezing health and social expenditures.
Just before the pandemic hit, the World Bank published Global Waves of Debt, presenting evidence that the past decade has seen the largest, fastest, and most broad-based increase in debt in developing economies in the past 50 years.
Since 2010, their total debt (public plus corporate) rose to a historic peak of more than 170 percent of GDP in 2019 from about 110 percent a decade ago.
The recent debt build-up is particularly concerning because the composition has also become riskier.
The share of private creditors—sovereign bondholders, banks, and commodity traders—in long-term public debt more than doubled during 2009-2018, to reach a high 41 percent. The share of publicly guaranteed private sector external debt of developing and transition governments owed to private creditors reached 62 percent of the total in 2019, compared to around 41 percent in 2000.
The World Bank's new Chief Economist, Carmen Reinhart, warned that "in a crisis, private debts would quickly become public debts", as in the past. In June, she warned of "debt challenges ahead".
The recent accelerated debt build-up has not been entirely due to the faults or mismanagement on the part of developing countries. As UNCTAD highlighted, the global financial system since the 2008-2009 global financial crisis (GFC) created incentives or "push factors" for increasing indebtedness of developing countries.
Excess liquidity due to "unconventional" monetary policies in the United States, the European Union and other developed countries flowed to emerging economies in search of higher returns, increasing their vulnerability with more currency volatility and financial fragility.
The dogmatic pursuit of fiscal austerity and 'unconventional' monetary policies, while failed to achieve robust recovery, simply added to the vulnerabilities of emerging and economies. Slowing global economic growth since the GFC, exacerbated by the rise of trade protectionism, and falling commodity prices have heightened susceptibilities in these economies.
Calls for debt relief
The IMF's First Deputy Managing Director observed, "As the pandemic raged throughout the world, debt turned out to be a very serious pre-existing condition". Thus, in April, UNCTAD warned that the coronavirus pandemic had hit developing countries at a time when they were already struggling with unsustainable debt burdens for many years, as well as with rising health needs. It called for US$1 trillion in debt relief.
Earlier in April, Carmen Reinhart co-authored with Kenneth Rogoff an opinion piece calling for the suspension of debt payments of developing countries, arguing that "it is myopic for creditors, official and private, to expect debt repayments from countries where those resources would have to be diverted from combating Covid-19".
On 15 April 2020, G20 finance ministers agreed to a "time-bound suspension of debt service payments" for 76 low-income developing countries eligible for World Bank International Development Association consideration, while the IMF has offered debt service relief to 25 of the poorest countries.
Nevertheless, the UN believes these actions will not be enough to avoid defaults as the G20 move does not cover private lenders. In July, the UN Secretary-General warned that "series of countries in insolvency might trigger a global depression, with very dramatic circumstances".
Developing countries' public debt is likely to worsen further with the pandemic induced recessions, and accumulated debt is undoubtedly problematic. Therefore, the appeals for urgent debt standstills, cancellations and restructuring, are understandable.
However, they are distractions. As highlighted in an UN-DESA Policy Brief, "Addressing sovereign debt distress is a long-standing challenge. While there is no shortage of policy ideas, progress in addressing [sovereign debt distress] has remained piecemeal, with little appetite among key actors".
Therefore, none of the proposed mechanisms can address developing countries' more urgent need for money to roll out adequate and inclusive relief and transformative recovery packages, needed to protect and advance development gains; most of the debt relief measures are messy and time-consuming.
The G20's debt service suspension initiative (DSSI) has already been criticised even by the President of the World Bank as inadequate. According to Financial Times, the amount postponed in 2020 under the G20 initiative is about a tenth of the additional external borrowing needs of the 73 eligible countries, estimated at about US$54bn by the IMF. As the OECD noted, the G20 initiative only "provides temporary respite, not relief", while covers only a narrower set of poor countries.
Therefore, despite extending the initiative for another six months, DSSI still only "kicks the can down the road". Unlike the Heavily Indebted Poor Country (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI), the G20 initiative does not cancel the debt, which is to be repaid in full over 2022–2024, while interest due continues to grow.
Additionally, private creditors remained outside of the G20 initiative. Of the 44 countries that have applied for the DSSI, only three have asked for comparable treatment from private creditors and no agreements have been signed as of 13 October.
According to Financial Times, the G20 initiative was criticised at a recent meeting of the UN Economic Commission for Africa (UNECA), the Institute of International Finance (IIF) which represents private creditors, and a group of African finance ministers – ahead of the G20 finance ministers' meeting at the IMF-World Bank annual meeting – for not taking into account debtor countries' views. It quoted the World Bank's President as saying, "the G20 is a forum primarily for creditors and it has been reluctant to move forward with the broader theme [of debt relief], and bilateral creditors are seeking to get as many repayments as possible".
It is in this context some are proposing debt buybacks from private creditors. In April, Bloomberg reported that the African Union (AU), the UNECA, and a group of African finance ministers were designing a special-purpose vehicle to swap their sovereign debt for new concessional paper.
The potential debt exchange would be similar to the 1989 Brady plan that restructured sovereign debt, mostly owed to large US commercial banks, backed by the zero-rated US Treasury bonds, conditional upon the IMF-World Bank structural adjustment programmes (SAP).
Except for a June Bloomberg report of the claim by the initiators that three developed country central banks expressed interest to underwrite the proposed special-purpose vehicle, no further progress of the African initiative is known so far.
Yet, there still seems enthusiasm for debt buybacks from some influential quarters, such as Nobel Laureate Joseph Stiglitz. In a joint working paper and an opinion piece with Hamid Rashid, he proposed a 'Brady Plan' like multilateral bond buyback facility with funds from a global consortium of countries, to be implemented and managed by the IMF.
I argued (with Jomo) that bond buybacks are no panacea and do not necessarily benefit the debtor countries. Furthermore, the private bond markets have changed significantly from what was during the Brady era, with more varied and powerful private creditors than just the US commercial banks. The prospect for a comprehensive arrangement involving all creditors is a taller order now as there are more heterogeneous creditors.
Nevertheless, bond buybacks could be one on the menu of possible debt restructuring options. In recent history, only one sovereign debt buyback – Ecuador's 2008-2009 – has been regarded as a win for the debtor country. And recently, Argentina's similar initiative has also been seen as a positive outcome for the country by observers in Wall Street. After successfully restructuring its commercial debts, the country is now in a stronger position to negotiate with its official creditors, in particular the IMF, for a better deal.
These two "success" cases are exceptions; they are led by the countries themselves on their terms and money using the opportunity presented by global crises as part of comprehensive debt restructuring.
No donor country consortium or multilateral financial institutions were involved in underwriting such restructuring, which incentivises moral hazard by encouraging hold-outs. If the creditors know that money is there, they are likely to bargain hard to capture as much rent as possible.
Debtor countries may end up buying at a higher price than what was prevailing at the start of the negotiation.
Furthermore, such an institutionalised approach can also encourage trading in risky sovereign bonds attracting higher returns. Private investment funds are likely to buy such bonds if there is a high likelihood that they can sell them off, and still make money even when sold at discounts because of high interests.
Urgent financing needed
The Chief Economist of the World Bank, despite her well-known stance against high debt, seems to have understood the gravity of the situation and recently advised in an interview with Financial Times ahead of the IMF-World Bank annual meeting to borrow more: "First fight the war, then figure out how to pay for it."
However, she did not say, borrow from whom. Low-income countries do not have access to international capital markets. Developing countries, which do have access, often have to pay high-risk premia, due to poor rating, not always related to their economic fundamentals.
For instance, compared to near-zero to negative rates in Europe, America and Japan, African governments are paying interest of 5~16 percent on 10-year government bonds, with Kenya, Zambia and others having to pay more onerous interest rates to European bondholders.
If emerging economies have to pay higher interest in return for supposedly greater risk, for the so-called commodity/tourism-dependent "frontier markets", with smaller or underdeveloped stock exchanges and currency markets the cost of bond finance will remain significantly high. Countries are already priced out of the Eurobond market by high-interest rates. Bond yields have more than doubled the cost for most countries intending to issue Eurobonds.
For the majority of the developing and poor countries, the only safe option is to stay with official creditors who lend (ostensibly) for a public purpose.
Therefore, I argued (with Jomo) that the current World Bank leadership trying to reduce developing countries' debt "must urgently abandon its 'Maximizing Finance for Development' (MFD) hoax. Instead, it should resume its traditional multilateral development bank role of mobilizing funds at minimal cost to finance developing countries".
Others (e.g., Gallagher, Ocampo and Volz; and Herman) have pointed to the developmental dimension of IMF's Special Drawing Rights (SDRs) when the international monetary assets were first conceptualised. They argue for issuing of massive new allocations of SDRs, following the precedent in the wake of the 2008-2009 GFC that witnessed the largest issue of SDRs to increase the lending capacity of multilateral development banks.
Unfortunately, the latest IMF initiative to issue new SDRs was blocked by the US and India. Hopefully, this will change after the US presidential election in November.
Longer-term durable solutions
As argued by the United Nations, the longer-term durable solution lies in addressing structural issues in the international debt architecture, such as an agreed orderly mechanism for sovereign debt restructuring or work-out. The unprecedented global health and economic crisis triggered by COVID-19 should also trigger unprecedented global cooperation to urgently implement the UN General Assembly resolution (A/RES/68/304) to create a "multilateral legal framework for sovereign debt restructuring".