September 18, 2022
Odette Lienau, Cornell University and Boston College
The COVID-19 pandemic and associated economic crisis have emphasized a disheartening feature of the international debt architecture—namely, its depressing tenacity. This institutional framework’s rigidity has, of course, been on full display for some time. But one silver(y) lining of a massive global crisis could have been the summoning of enough collective willpower to enact more substantial, far-reaching change. Instead, so far, we have seen piecemeal, short-term efforts that will prove insufficient. The international community needs to prioritize serious movement on multiple tracks—contractual, international, and domestic—to put in place a framework that embeds widely accepted sovereign debt resolution principles before it is desperately needed.
Debt Upon Debt
Prior to 2020, the sovereign debt situation was already deeply problematic in many regions, with public and publicly-guaranteed debt becoming unsustainable and debt repayment consuming an increasing share of resources. Collateralized lending had also been on the rise, meaning that creditors could seize specific assets in the event of nonpayment, further tying countries’ hands. By late 2019, global debt denominated in foreign currencies (especially U.S. dollars and euros) had hit an all-time high. This kind of debt might allow a country (or firm) to pay lower interest rates, because foreign investors will not be concerned about local currency fluctuations. But it also means that, if a local currency’s value falls due to some shock or crisis, the relative cost of servicing the foreign-denominated debt can increase significantly. In the 1980s and today, foreign currency debt leaves sovereign borrowers exposed to U.S. and euro area policy shocks, including interest rate hikes to combat inflation in the United States and Europe. The pandemic has exacerbated the financial distress that many countries were already experiencing, and the shortages resulting from Russia’s invasion of Ukraine have worsened the situation, all with long-term ramifications for global debt.
Deficient Restructuring Foundations and an Opening
The pre-pandemic framework for dealing with any debt crisis was already insufficient and in need of an overhaul. A successful, sustainable debt restructuring requires collective effort. But, over the past decade plus, creditor groups, lending instruments, and forums for dealing with debt have become increasingly fragmented. Many different types of creditors from different geographic regions now lend to sovereign states, using instruments that include bonds, bank loans, and collateralized debt obligations. On the one hand, this can be a good thing, because financing power is less likely to be concentrated in a small range of entities or financial centers. On the other, when something goes wrong, coordination becomes more difficult, which can lead to free rider and holdout problems among creditors (like the much-discussed vulture funds). This can make any needed restructuring more complex and less likely to be sufficient. This also means that restructuring outcomes—or legal interpretations, if different countries’ courts get involved—can vary significantly across creditors and across sovereign debtors, raising questions about fairness. These process-oriented problems have only increased the tendency of major international actors to overlook issues of legitimacy and of what makes for a more sustainable and equitable debt restructuring.
Despite these and other challenges, there is no binding international restructuring mechanism for sovereign states akin to domestic bankruptcy procedures, which could provide a degree of consistency across cases and a better chance at comprehensive relief. Existing restructurings rest on an incomplete institutional framework that can involve the invocation of contractual clauses in some cases, a mix of carrots and sticks from the IMF working in conjunction with other lenders, and strenuous efforts to get often-reluctant creditors on board. Some creditors decline to participate altogether and, too often, the outcome offers insufficient relief to fully put countries on the path to recovery.
The dire situation brought about by COVID-19 certainly reignited discussion and attention. Very soon after things shut down in 2020, UNCTAD (the United Nations Conference on Trade and Development), which tends to be more attentive to the concerns of developing countries, called for massive debt relief and also for the establishment of a new international debt authority. Civil society groups renewed and intensified their longstanding demands for a global debt restructuring body based at the UN. Establishment policymakers and observers in the G30 suggested a more modest standing consultative mechanism. Somewhat paralleling the call for a ‘Green New Deal’ in the US, other analysts called for a green debt relief program. And many other proposals emerged—virtually all of which could improve things in one way or another.
An Opportunity Missed
The pressure of COVID-19 and the economic fallout from the public health crisis did not bring about impressive steps to move beyond the status quo. The main international initiatives thus far have centered around the G20’s Debt Service Suspension Initiative (DSSI) and the subsequent ‘Common Framework for Debt Treatments beyond the DSSI,’ for which only 73 lower-income countries are eligible. These were useful first steps, particularly because they have involved China, which is not an official member of the ‘Paris Club’ of previously dominant bilateral creditor states. But they fell far short of the fundamental changes required to deal with today’s debt crises.
The DSSI, announced in April 2020 and concluded at the end of 2021, only temporarily suspended debt payments. This meant that the debt remained and indeed increased, and interest continued to run. Furthermore, the DSSI targeted only certain public bilateral creditors; private creditors were encouraged to join, but a grand total of one (yes, one!) private creditor ultimately participated.
The Common Framework, endorsed by the G20 in November 2020, improved upon this by creating the possibility of debt reduction, if only as a last resort. It also requires burden-sharing by private creditors and other lenders on comparable terms with the principal creditors, although international finance industry groups lobbied hard to water down more significant participation. The Common Framework also requires the type of IMF-backed program mandated in many official restructurings; these aim to stabilize a country’s financial situation but continue to be associated with austerity and increased inequality. Hopefully, future programs will make more realistic assessments of country economic capacity and be attentive to how the burdens of restructuring are distributed, so that the most vulnerable are not harmed even more.
Perhaps unsurprisingly, even countries in distress have not rushed to use the Common Framework; only three have applied for restructuring under its auspices. Countries have been deterred in part by concerns about credit rating downgrades. And borrower country officials and citizens may doubt the promise of comprehensive debt relief—that all creditors actually will participate and that efforts will be made to deal with any holdouts—and also doubt the likelihood of an orderly restructuring that is not so painful as to cause unrest. Depending on how a restructuring is implemented, countries could end up in a situation with many downsides that still does not offer sufficient relief.
Another major initiative with potential to ease debt pressures at the margin has involved the injection of additional liquidity into the international system through the issuance of IMF Special Drawing Rights (SDRs) in August 2021. This could ease the burden of debt payments or relief efforts for some countries, although there is a mismatch between SDR allocation and country need. So, again, the devil is in the details, and particularly in how those allocations are used. Without a commitment to reallocating those resources—a complicated process—in part through properly funding the new Resilience and Sustainability Trust, these allocations will fail to meet their stated goals.
In Need of More Serious Commitment and Deeper Thinking
The global community will have to go further—in terms of the scope of financial support and debt relief, the pressure for greater creditor participation, and the range of countries covered. The call for deeper reform made by UNCTAD in 2020 remains just as relevant today. The World Development Report published in February 2022 by the World Bank focused on the need for significant multi-level reform, and acknowledged the benefit of solidifying widely accepted sovereign debt restructuring principles into national and international law. And it is essential to push for progress on multiple tracks—through market/contractual improvements, incremental work in the multilateral arena, and also changes to domestic legislation in key jurisdictions. The gold standard might still be a multilateral treaty-based sovereign bankruptcy mechanism with real teeth. But there seems to be little appetite for this—even in the face of rolling crises. So it makes sense to move toward an explicitly multi-track process in furtherance of shared sovereign debt resolution principles—something that I have called disaggregated sovereign bankruptcy. Ideally this would be supported by an independent international body that could coordinate across these tracks, build actor networks, and act as a focal point for initiatives and proposals to improve the sovereign debt system.
Most generally, the financial dimensions and long shadow of the COVID-19 crisis should encourage a rethink of our values on the international economic front. How might any reorientation of economic policy toward people on the ground (i.e., a renewed focus on ‘Main Street’) translate globally? And, to the extent that the U.S. and other Western countries claim to favor self-determination—so vocally on display in Ukraine—how might that apply in the international financial arena? We claim that people should have a say in how they are governed, and that their political and economic futures should not be shaped to maximize the preferences and profits of others. We can even quickly allocate billions of dollars and take significant international political risks in support of this principle. There is no reason for these commitments to evaporate when we move from a political-military arena into an economic one—or from international geographies associated with the West to those associated with the global South.
Taking these principles seriously would involve really listening to the concerns and proposals coming out of those countries and places most at risk—without the kind of intensive and exhausting effort that this too often requires. And, as part of this deeper rethink, we might also consider what support for broader understandings of economic self-determination might mean in this complex international arena.
Even though the direst predictions of a complete global economic meltdown have not yet come to pass, there is urgent need to make progress on serious questions large and small. By the time a full-fledged emergency is upon us, it will be too late.
Portions of this roundtable contribution draw from and update a Q&A on sovereign debt issues published by the LPE Blog in October 2021.
Return to Sovereign Debt Architecture, Suspended prompt.