Written Evidence for UK House of Commons Inquiry
Clemence Landers, Policy Fellow, Center for Global Development
Nancy Lee, Senior Policy Fellow, Center for Global Development
About the Center for Global Development and the authors
The Center for Global Development (CGD) is a non-profit think tank that works to reduce global poverty and improve lives through innovative economic research that drives better policy and practice by the world's top decision makers. Ms. Landers and Dr. Lee are Fellows on CGD’s Sustainable Development Finance (SDF) team, whose research focuses on formulating ways that the world can ramp up development financing from ‘billions to trillions’ to meet the Sustainable Development Goals. Given debt crises’ negative impact on countries’ development and their ability to mobilize additional sustainable financing, much of Ms. Landers and Dr. Lee’s work analyzes existing international debt relief efforts and how they can be improved. Because of this, the UK House of Common’s inquiry on debt relief in low-income countries is very relevant to their work and expertise, and the analysis below represents their professional insight into the questions posed.
Introduction
Since the onset of the COVID-19 pandemic, a growing number of poor countries are confronting an impossible fiscal choice between servicing increased sovereign debt or spending more to meet the basic needs of their citizens. This tension has been exacerbated by both the Russian invasion of the Ukraine which has led to a major spike in commodity prices, as well as the broader inflationary pressures and rising interest rates that have provoked a surge in borrowing costs for emerging and frontier markets.
Today, more half of the world’s poorest countries are at high risk of or experiencing debt distress. Depending on the severity of the global economic downturn, many poor countries could find themselves in a full-blown debt crisis over the next few years.
Swift and orderly action on international debt is a moral, political, economic, and security imperative. A series of disorderly and protracted debt crises would be catastrophic for the world’s poorest countries. Countries in debt crises often struggle to maintain the value of their currency and attract foreign investment, putting downward pressure on productive public spending and real income growth. This means that the debt crises on the horizon would add significantly to the damage already wrought by the pandemic, reversing decades of development gains, throwing millions into poverty, and leading to years of lost growth. It would also be costly for the international community and international financial institutions (IFIs), whose shareholders would end up footing a big portion of the bill for collapsing economies. It would amplify political instability and the risk of conflict in already fragile poor countries, with potential long-run security consequences.
While the world has grappled with high-profile restructurings for individual countries in debt distress from Greece to Argentina, the international community is now confronted with the prospect of synchronized debt crises across dozens of low-income countries for the first time in several decades. But the instruments that the international community has for addressing such crises are losing their relevance largely because of the changing composition of LIC country debt. In the context of the Heavily Indebted Poor Countries Initiative (HIPC) and Paris Club collaboration among bilateral official creditors, most of the debt was owed to official bilateral and multilateral creditors and governed by a well-trodden framework based on the principles of transparency and comparability of treatment across creditors. Today, non-Paris Club and private sector lenders largely dominate the LIC debt landscape. This complicates the debt restructuring process since not all creditors agree to the same principles, as evidenced by the failure of the recent Debt Service Suspension Initiative (DSSI) to deliver relief across all creditors. The G20’s Common Framework represented a step forward by attempting to bring all creditors together under a core set of principles to restructure DSSI country debt (as opposed to just suspending debt payments), but it has yet to deliver. Renewing the international debt restructuring architecture is a matter of urgency and will require forceful action. The UK has a clear role to play on this front.
What’s broken?
LICs entered the COVID-19 crisis with preexisting serious external vulnerabilities that have only been exacerbated by the recent global economic downturn. LIC’s gross external financing needs are expected to grow from $101 billion in 2019 to $166 billion in 2025, and the external debt service coming due for these countries in 2021-2025 will be more than double the average before the COVID-19 crisis (2010-2019).[1]
The rise in non-Paris Club creditors makes navigating today’s looming debt crises more complex. Over the last decade, low-income countries and lower-middle-income countries have diversified their sources of external finance. China has emerged as a top lender, rivaling only the World Bank. And many poor countries enjoy access to bond markets and loans from private creditors. While the Paris Club has historically been the key forum for coordinating restructuring of official debt, China has eschewed participation, instead preferring to renegotiate its loans bilaterally and often in secret. This approach is costly for countries in debt distress since piecemeal restructurings often kick larger sustainability issues down the road. And it carries serious disadvantages for creditors: some official creditors may be repaid at the expense of others, and development lending needed to expand the fiscal space of poor countries instead services unsustainable debt.
For many decades, the Paris Club was able set norms and principles—both comparability of treatment and debt transparency—for sovereign restructurings, which it was able to impose by virtue of the size of the creditors it represented. So while the international community was able to find workable solutions to the last round of low-income country debt crises with the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiative (MDRI), the relative homogeneity of the low-income country creditor base made it possible to anchor HIPC in Paris Club principles without having to seek consensus across an unwieldy cast of creditors.
Against this backdrop, the lack of debt transparency—both on the creditor and debtor side—has become a major issue. Much official bilateral lending, including China, and private creditor lending has often been opaque, failing to disclose amounts, terms, and conditions. An AidData report on “How China Lends” found that Chinese loan contracts often contain confidentiality clauses that require borrowers to keep all terms and conditions confidential.[2] In addition, these contracts often require collateral in the form of revenue control placed in escrow accounts controlled by the lender, as well as “No Paris Club clauses” meaning the debt is not subject to comparable treatment under the Paris Club. These provisions complicate debt sustainability analyses (DSAs) and undermine restructuring exercises.
DSSI: One size fits all LICs
To prevent a series of disorderly defaults and give countries breathing room to mount a health and economic crisis response, in April 2020 the G20 launched the DSSI, allowing eligible countries to suspend their debt service to G20 countries—and, theoretically, the private sector—through mid-2021. But the initiative faced several limitations. Private creditors, which constituted close to 20 percent of DSSI debt service in 2020, declined to participate. Several countries that have requested DSSI treatment were downgraded by the rating agencies, which interpreted these requests as a step towards default. As a result, very few DSSI-eligible countries were able to access international bond markets in 2020, at a time when they badly need financing and global interest rates hover near record lows. Finally, China—the largest single creditor to DSSI countries—largely exempted its government-owned lenders from the initiative, claiming they are private sector entities that should be treated in the same way as other private creditors that did not participate in DSSI.
In the end 48 out of 73 eligible countries participated in the initiative. As a result, only $12.9 billion was suspended, representing just a quarter of the amount the G20 announced that the initiative would deliver in April 2020.[3] These implementation flaws combined with disagreements among G20 countries around the treatment of their loans blunted the DSSI’s effectiveness. But they also exposed profound weaknesses in the underlying international architecture for resolving sovereign debt that have also plagued the Common Framework.
Common Framework: An Improvement?
In November 2020, the G20 reached agreement in November 2020 on a Common Framework for Debt Treatments which aimed to deal with insolvency and protracted liquidity problems. The value added by the Common Framework was to bring non-Paris Club official creditors, notably China, into a process akin to the Paris Club process. It also stipulated that private creditors must provide relief on comparable terms.
So far three countries have sought relief under the Common Framework but none have officially secured a deal. Chad was the first country to request restructuring under the Common Framework in January 2021 for $3 billion in external debt and has struggled to conclude negotiations with private creditors despite reportedly reaching an agreement with bilateral creditors. This has held up Chad’s ability to access funds from its IMF program. Zambia requested restructuring under the Common Framework in February 2021 after becoming the first African country to default during the COVID crisis. But its debt resolution process has also been slow and fraught with China only agreeing to join the creditor committee in April of this year. Ethiopia also applied for restructuring under the Common Framework in February 2021 which has also failed to reach completion.
These protracted restructurings serve as a deterrent for other countries that could benefit from proactive restructurings to avoid a default and restore sustainability. Indeed, the Common Framework countries find themselves in an unenviable limbo where they are cut off from much external financing – both private sector and official – until the completion of their restructurings. But at the same time, some countries continue to service their debt to private creditors. This situation could be particularly devasting in the context of the looming food crisis across Sub-Saharan Africa where countries may simply not have the foreign exchange resources to cover food imports. This has prompted calls for the IMF to make use of its lending into arrears (LIA) policy which allows the Fund to move forward with funding while a government accumulates arrears to creditors.[4] (The policy has recently been updated to include not just cooperative private creditors but also official ones.) This would also allow a Common Framework country in a protracted restructuring negotiation to access external financing from the IMF so they can finance food imports on the condition that they not use the resources to repay creditors.
Another related deterrent to proactive restructurings is the loss of market access. Over the past decade, many African countries have gained market access which has helped diversify and increase their external financing mix to fund their development agendas. But as discussed previously, African finance ministers were often reluctant to ask their private creditors for forbearance in the context of the DSSI, especially after it became clear that the credit rating agencies would treat such a request as a credit event. Similarly, Moody’s put Ethiopia on review for participating in the Common Framework (unlike Zambia, Ethiopia had not defaulted when it applied for the Common Framework).
One way around this could be to deploy guarantees in the context of restructuring negotiations. By limiting or minimizing default risk, guarantees could be simultaneously used to entice private creditors to join restructurings and help countries retain market access.[5] While there has been a dearth of successes so far, a recent Belize debt restructuring represents a possibly scalable model. Last year the government got its creditors to agree to a $553 million restructuring that required the government to commit to investing some of the savings in marine conservation.[6]
A Reform Agenda
Deeper reforms to the international sovereign debt architecture are needed so governments can proceed with faster and fairer restructurings.
Most immediately, the UK government should consider advancing a standard to systematically freeze debt service payments in the context of Common Framework debt restructuring negotiations. This could also provide an incentive to creditors for faster restructuring negotiations. With the right checks and balances in place, it could also help ensure that scarce foreign exchange is directed towards emergency social expenditure (i.e., imports of critical goods). The UK could also signal willingness for the IMF to lend into arrears during restructurings in the context of a broader debt service standstill.
The UK government could also explore the feasibility of modifying its sovereign immunity law so that the private creditors cannot initiate litigations against countries whose debt the IMF deems to be unsustainable due to global systemic crises or natural disasters, at least through the duration of their restructuring negotiations. In 2010, the UK Parliament passed the Debt Relief (Developing Countries) Act, which imposed a cap on the amount a litigious creditor could recover from claims on a HIPC country debt or the execution of a foreign judgment within the UK.[7] France and Belgium have more recently passed similar legislation. The UK could consider proposing a similar initiative as part of the climate negotiations around the costs of ‘loss and damage.’[8]
In addition, the UK government could also consider deploying its new loan guarantee mechanism in the context of debt restructurings. It could be designed to help countries restructuring reduce their commercial debt and refinance into cheaper loan arrangements with green or social conditionalities. More broadly, the UK could use its voice and vote in MDBs to support their deployment of guarantees for these purposes.
Going forward, the UK government should also consider “new rules of the road” to guide lending to lower-income countries, with an eye to avoiding future unsustainable debt build-ups in poor countries. This will require achieving consensus between G20 countries, the IFIs, and private creditors around sustainable and responsible lending practices.
A key aspect should be standards for transparency and disclosure that hold both debtors and creditors accountable, allow accurate debt sustainability assessments, and promote better debt management. Bilateral and private creditors should agree to make public their loans, including details about terms and conditions, in a global central debt registry. UK government could work with G7, IFIs, regulators, private finance representatives, and legal authorities to link the legal enforceability of bond and loan contracts to documented approval by the relevant public authorities of sovereign borrowing, and to public access to such documents.
Finally, the UK government could also press for the adoption of new contract standards that would include a provision to permit temporary suspension of debt service without triggering a default in crisis situations. Such provisions could be activated in the event of an IMF determination in the context of a global or regional crisis, unrelated to a country’s policies, that debt service to all creditors would demonstrably and materially push a country toward an unsustainable debt situation.