A good but incomplete start to debt relief

By Paola Subacchi

LONDON – A global fall in economic activity during the COVID-19 pandemic has significantly increased the risk of debt distress in many countries, pushing the poorest to the brink. In response, various international organizations have unveiled a number of initiatives to address circumstances that require an adequate response to the current public health and debt servicing crisis.

Most notably, the G20 has established a Debt Service Prevention Initiative (DSSI), which allows the world’s poorest countries to suspend official bilateral debt service payments until next year. And this month, G20 leaders adopted a new common framework to address the restructuring needs of sovereign debt on a case-by-case basis.

For poorer countries tackling the pandemic, debt not only limits their fiscal space for responding to the crisis but also closes on future development. In the face of the sudden costs of the COVID-19 crisis, many countries already struggling to service existing debt need fresh funding, only to find that it is too difficult or expensive to borrow more. And even if they can manage to do so, the additional debt burden will hamper them for years, limiting their prospects for growth and development.

Far from including a few disgruntled countries on the periphery, today’s sovereign debt distress poses a potentially systemic risk. Since 2014, total sovereign debt as a share of GDP has not only risen significantly; it has also become more fragmented, due to the use of more diverse debt instruments among a wider range of creditors.

Given these circumstances, there is an urgent need to widen the global financial security net beyond the support currently offered by international financial institutions such as the International Monetary Fund and the World Bank. To that end, the DSSI took the first step by stopping principal and interest payments on debt due between May 1, 2020, and June 30, 2021 (after being extended from December 31, 2020), and by expanding the safety net for at least 77 developing countries.

But while the DSSI does offer some respite, it also only kicks the debt repayment down the road, allowing the deferred payments to be repaid in full between 2022 and 2024. So it will debtor countries must make up the difference with larger repayments, and may need to borrow more to service their frozen debt, in addition to any other debt incurred during the COVID-19 crisis. Ultimately, the 46 countries that have applied for debt prevention to date will have to pay $ 5.3 billion of deferred payments, on top of $ 71.54 billion of existing commitments; and any other debt contracted since the outbreak of COVID-19 is added to the burden.

While the latest G20 debt initiative misses the mark on many fronts (especially in addressing the disparities between debtors and creditors), it has at least put a common framework for reducing debt squarely on the international agenda. The new venture has two distinct qualities.

First, by allowing for a case-by-case approach, it addresses a specific concern raised by private sector creditors, a key constituency not included in the DSSI.

Second, the new framework brings China aboard the ship, after overcoming some initial opposition stemming from the definition of a state-owned bank (which raised concerns that the China Development Bank and Export-Import Bank of China themselves exposed to debt restructuring). Because China has about 63% of the overall debt owed to G20 member states, its participation is vital for the success of the initiative.

The common framework is an important first step in the right direction. But the G20 can’t stop there; the initiative needs to be expanded into a common plan for the restructuring of sovereign debt. Sovereign debt is the only debt class without a bankruptcy mechanism. Although individuals and companies can declare bankruptcy, a country cannot.

To date, the international community has relied on a contractual approach to prevent and resolve sovereign debt problems. But this approach often involves deep asymmetries between the treatment of debtors and creditors, leading to an unfair distribution of losses among different types of creditors. We need a multilateral agency tasked with coordinating creditors, sharing information, and reducing the scope for information arbitration.

In addition, the new framework should assist debtor countries throughout the restructuring process. For example, as the IMF has already suggested, the G20 should task international financial institutions to provide limited funding to give debtors some room to secure a sustainable debt restructuring deal.

To tie it all together, the G20 should draw on its Operational Guidelines for Sustainable Financing to promote responsible lending and borrowing alongside organized multilateral debt restructuring. It should also support debt transparency and provide the necessary technical assistance, so that countries can strengthen their debt management capacity before getting themselves into debt distress.

Clear procedures, transparency, oversight, and accountability for sovereign debt management are widespread public goods. Everyone deserves to be fully informed of the steps their respective countries are taking in borrowing internationally, just as they should be aware of their countries’ debt obligations and obligations. A framework that explains each stage of the debt process – including the necessary checks and balances – is essential for ensuring responsible (and borrowing) more generally.

Paola Subacchi, Professor of International Economics at the Queen Mary’s Global Policy Institute at the University of London, is the author of, most recently The Cost of Free Money (Yale University Press, 2020).

Copyright: Project Syndicate, 2020.