The statistics are stark: 54 governments, of which 25 are African, are spending at least 10% of their revenues on servicing their debts; 48 countries, home to 3.3 billion people, are spending more on debt service than on health or education.
Among them, 23 African countries are spending more on debt service than on health or education.
While the international community stands by, these countries are servicing their debts and defaulting on their development goals.
The Group of 20’s current approach for dealing with the debts of low income countries is the Common Framework.
It requires the debtor to first discuss its problems with the International Monetary Fund (IMF) and obtain its assessment of how much debt relief it needs. Then it must negotiate with its official creditors – international organisations, governments and government agencies – over how much debt relief they will provide. Only then can the debtor reach an agreement – on comparable terms to the official creditors – with its commercial creditors.
Unfortunately, this process has been sub-optimal.
One reason is that it works too slowly to meet the urgent needs of distressed borrowers. As a result, it condemns debtor countries to financial limbo. The resulting uncertainty is not in anyone’s interest. For example, Zambia has been working through the G20’s cumbersome process for more than three and a half years and has not yet finalised agreements with all its creditors.
The need for a new approach is overwhelmingly evident. Although the current crisis has not yet become the “systemic” threat it was in the 1980s when multiple countries defaulted on their debt, it is a “silent” sovereign debt crisis.
We propose a two-part approach that would improve the situation of sovereign debtors and their creditors. This proposal is based on the lessons we have learned from our work on the legal and economic aspects of developing country debt, particularly African debt.
First, we suggest that official creditors and the IMF create a strategic buyer of “last resort” that can purchase the bonds of debt distressed countries and refinance them on better terms.
Second, we recommend that all parties involved in sovereign debt restructurings adopt a set of principles that they can use to guide the debtor and its creditors in reaching an optimal agreement and monitoring its implementation.
The current approach fails to deal effectively and fairly with both the concerns of the creditors and all the debtor’s legal obligations and responsibilities. Our proposed solution would offer debtors debt relief that does not undermine their ability to meet their other legal obligations and responsibilities, while also accommodating private creditors’ preference for cash payments.
Our proposal is not risk-free. And buybacks are not appropriate for all debtors. Nevertheless it offers a principled and feasible approach to dealing with a silent debt crisis that threatens to undermine international efforts to address global challenges such as climate, poverty and inequality.
It uses the IMF’s existing resources to meet both the bondholders’ preferences for immediate cash and the developing countries’ need to reduce their debt burdens in a transparent and principled way.
It also helps the international community avoid a widespread default on debt and development.
Bondholders are a major problem
Foreign bondholders, who are the major creditors of many developing countries, have proven to be particularly challenging in providing substantive debt relief in a timely manner. In theory, they should be more flexible than official creditors.
Developing countries have been paying bondholders a premium to compensate them for providing financing to borrowers that are perceived to be risky. As a result, bondholders have already received larger payouts than official creditors. Therefore, they should be better placed than official creditors to assist the debtor in the restructuring processes.
However, despite having received large returns from defaulted bonds, bondholders have remained obstinate in debt restructurings.
Our proposal seeks to overcome this hurdle in a way that is fair to debtors, creditors and their respective stakeholders.
How it would work
First, the official creditors and the IMF should create and fund a strategic buyer “of last resort” who can purchase distressed (and expensive) debt at a discount from bondholders. The buyer, now the creditor of the country in distress, can repackage the debt and sell it to the debtor country on more manageable terms. The net result is that the bondholders receive cash for their bonds, while the debtor country benefits from substantial debt relief. In addition, the debtor and its remaining official creditors benefit from a simplified debt restructuring process.
This concept has precedent. In 1989, as part of the Highly Indebted Poor Countries Initiative, the international community’s effort to deal with the then existing debt burdens of poor countries, the World Bank Group established the Debt Reduction Facility, which helped eligible governments repurchase their external commercial debts at deep discounts. It completed 25 transactions which helped erase approximately US$10.3 billion in debt principal and over US$3.5 billion in interest arrears.
Some individual countries have also bought back their own debt. In 2009, Ecuador repurchased 93% of its defaulted debt at a deep discount. This enabled the government to reduce its debt stock by 27% and promote economic growth in subsequent years.
Unfortunately, the countries currently in debt distress lack sufficient foreign reserves to pursue such a strategy. Hence, they need to find a “friendly” buyer of last resort.
The IMF is well positioned to play this role. It has the mandate to support countries during financial crises. It also has the resources to fund such a facility. It can use a mix of its own resources, including its gold reserves, and donor funding, such as a portion of the US$100 billion in Special Drawing Rights (SDR), the IMF’s own reserve currency, which rich economies committed to reallocate for development purposes.
Such a facility, for example, would have enabled Kenya to refinance its debts at the SDR interest rate, currently at 3.75% per year, rather than at the 10.375% rate it paid in the financial markets.
It is noteworthy that the 47 low-income countries identified as in need of debt relief have just US$60 billion in outstanding debts owed to bondholders. Our proposed buyer of last resort would help reduce the burden of these countries to manageable levels.
Second, we propose that both debtors and creditors should commit to the following set of shared principles, based on internationally accepted norms and standards for debt restructurings.
Guiding principles
1. Guiding norms: Sovereign debt restructurings should be guided by six norms: credibility, responsibility, good faith, optimality, inclusiveness and effectiveness.
Optimality means that the negotiating parties should aim to achieve an outcome that, considering the circumstances in which the parties are negotiating and their respective rights, obligations and responsibilities, offers each of them the best possible mix of economic, financial, environmental, social, human rights and governance benefits.
2. Transparency: All parties should have access to the information that they need to make informed decisions.
3. Due diligence: The sovereign debtor and its creditors should each undertake appropriate due diligence before concluding a sovereign debt restructuring process.
4. Optimal outcome assessment: The parties should publicly disclose why they expect their restructuring agreement to result in an optimal outcome.
5. Monitoring: There should be credible mechanisms for monitoring the implementation of the restructuring agreement.
6. Inter-creditor comparability: All creditors should make a comparable contribution to the restructuring of debt.
7. Fair burden sharing: The burden of the restructuring should be fairly allocated between the negotiating parties.
8. Maintaining market access: The process should be designed to facilitate future market access for the borrower at affordable rates.
The G20’s current efforts to address the silent debt crisis are failing. They are contributing to the likely failure of low income countries in Africa and the rest of the global south to offer all their residents the possibility of leading lives of dignity and opportunity.
