The shocks of the past three years have hit low and lower-middle income developing countries hard. But the damage does not just lie in the past. It is lying in wait in the future. The world’s poorest countries, which contain a large proportion of the world’s poorest people, are threatened by a lost decade. That would be a human catastrophe and a moral failing. It would affect all our futures, especially those of Europeans, being so close to some of the worst-hit countries. Something must be done, starting with tackling the debt crisis that is now looming.
Kristalina Georgieva, managing director of the IMF, says “about 15 per cent of low-income countries are already in debt distress and an additional 45 per cent are at high risk of debt distress. Among emerging markets, about 25 per cent are at high risk and facing default-like borrowing spreads”. Sri Lanka, Ghana and Zambia are already in default. Many more will follow. Something must be done urgently.
Why has this happened? The answer is that low and lower-middle income countries have taken on too much of the wrong kind of debt. That mainly reflects the lack of good alternatives. The world opened up a debt trap, by making the terms of borrowing attractive but risky. Covid-19, soaring energy and food prices, higher interest rates, a strong dollar and a global slowdown have now rendered the costs prohibitive, duly closing the trap upon these vulnerable countries.
When debt becomes unaffordable, it needs to be restructured. This is as true of countries as it is of companies and households. But restructuring has become even more difficult than it was in the 1980s, after the Latin American debt crisis in 1982. Back then, the main creditors were a few large western banks, western governments and western-dominated international financial institutions (IFIs). It was at least relatively easy to co-ordinate these entities. The main difficulty was to admit how bankrupt some western banks were.
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Just between 2000 and 2021, the share of public and publicly guaranteed external debt of low and lower-middle income countries (other than that held by IFIs) owed to bondholders jumped from 10 to 50 per cent, while the share owed to China rose from 1 to 15 per cent. Meanwhile, the share held by the 22 predominantly western members of the Paris Club of official lenders fell from 55 to 18 per cent. Thus, co-ordinating creditors in a comprehensive debt restructuring operation has become far harder, because of their greater number and their diversity. Moreover, no one wants to restructure debt owed to themselves if that would merely benefit other creditors, not the country itself.
There exists no effective framework for bringing all these creditors together. Nor is there any credible template for restructuring that debt. The G20 created the “Common Framework for Debt Treatment”, to deal with the former difficulty. But it is in practice a Paris Club-led process. The other (and frequently much bigger) creditors are not really engaged. the IMF itself, the framework does not have traction. Equally, there is no approach to debt restructuring that is at all likely to deliver what is needed – a new start for heavily indebted crisis-hit countries.
Cleaning up the mess is just a part of the task. At least equally important is creating a system for financing development, including climate mitigation and adaptation
Two well-known debt experts – Lee Buchheit and Adam Lerrick – have sent me a proposal aimed at doing what Brady bonds did in bringing the Latin American debt crisis to a halt, but in an updated manner. They suggest the offer to creditors of two bond exchange structures. The entire stock of the government’s external bonds would be converted into an equal nominal amount of 25-40 year debt at a 3-3.5 per cent interest rate. The result should reduce the (currently unpayable) net present value of the debt by more than 50 per cent.
Under the “Cash Downpayment Structure”, investors receive a cash down payment of the existing bond equal to 30-35 per cent of its current market value plus a new standard long-term bond with no write-down of the principal amount. Under the “Floor of Support Structure”, investors receive a new long-term bond of equal nominal amount that has a liquid rising floor of support with an initial value of 60-70 per cent of the existing bond’s current market value. The floor of support is based on the investor’s ability to convert the new bond into a World Bank zero-coupon bond at any time. The IFIs would finance this through a combination of new loans and repurposing of undrawn amounts under existing loans, again following the Brady precedent. The IFI loans should also contain provisions that restrain excessive borrowing.
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Why should creditors accept this? The answer is that the alternative would be a long drawn-out mess in which they are likely to get far less. Meanwhile, IFIs could sort out the dire situation of so many clients at a predefined price. Someone would have to take this task on. In 1989 it was then US treasury secretary Nicholas Brady. Now, who would be better than his successor, Janet Yellen?
Cleaning up the mess is just a part of the task. At least equally important is creating a system for financing development, including climate mitigation and adaptation, that does a far better job of handling risk and recognises these objectives as global public goods. Excellent ideas have been put forward in Finance for Climate Action, from a high-level expert group and the Bridgetown Initiative developed by Avinash Persaud for the Barbadian prime minister.
The system we have for resolving the debts of poor countries is not, as people say, “fit for purpose”. The same is true of that for helping poor countries through adverse shocks and towards sustainable development. Change is needed urgently. Start now. – Copyright The Financial Times Limited 2023
