José Ocampo | The urgency of sovereign debt restructuring

Since the onset of the COVID-19 pandemic, the developing world has faced growing public-sector debt vulnerabilities. Interest-rate hikes and limited access to international capital markets have only exacerbated the problem – so much so that even solvent countries are now grappling with liquidity challenges.

Furthermore, the International Monetary Fund, IMF, predicts that, in the coming years, developing countries’ debt levels will remain higher than in 2019. It seems clear that many low and middle-income countries will continue to experience debt stress, even if they are not at risk of default.

Yet the severity of the crisis is not reflected in the agenda for global cooperation. Last year’s G20 Summit in New Delhi, for example, advanced important proposals for development finance but made little progress on addressing the over-indebtedness of low- and middle-income countries. Most crucially, the world still lacks a comprehensive debt-restructuring mechanism to deal with this widespread and recurrent problem.

Heavily Indebted Poor Countries

The oldest existing debt-restructuring mechanism, the Paris Club, covers only sovereign debt owed to its 22 members – mainly OECD countries. On occasion, multilateral lenders and foreign governments have adopted ad hoc responses to sovereign-debt crises. For example, the United States-backed Brady Plan, implemented after the Latin American crisis of the 1980s, helped reduce some countries’ debts and catalysed the development of a sovereign-bond market for developing countries. In 1996, the IMF and the World Bank launched the Heavily Indebted Poor Countries Initiative to provide a much-needed reprieve for low-income countries; this was supplemented in 2005 with the Multilateral Debt Relief Initiative, which cancelled eligible countries’ debts to multilateral creditors.

Other reactive measures have aimed to improve the restructuring process. Following the Mexican crisis of 1994, the OECD’s G10 proposed introducing collective action clauses, or CACs, in bond contracts, enabling a qualified majority of bondholders to modify the terms and conditions, if necessary.

Moreover, in 2013, after the Greek debt crisis, the European Union mandated the inclusion of aggregation clauses for CACs in its members’ bond contracts, facilitating joint renegotiation of several issues.

But despite these reforms, creditors can still build blocking majorities, owing partly to the lack of expanded CACs in roughly half of sovereign bonds issued by emerging and developing countries, and partly to the incompatibility between bond agreements and other debt contracts.

The IMF attempted but failed to create an institutional framework for sovereign-debt restructuring in 2001-03. The proposed mechanism would have allowed unsustainable external debts to be restructured through a rapid, orderly, and predictable process while protecting creditors’ rights. Moreover, the overseeing body would have been independent of the IMF’s Executive Board and Board of Governors. Ultimately, the United States rejected the initiative, as did some developing countries (notably Brazil and Mexico), fearing that the mechanism would restrict their access to capital markets.

Debt Service Suspension Initiative

During the pandemic, when public-debt levels soared, the G20 and the Paris Club created the Debt Service Suspension Initiative, DSSI, for low-income countries, which stopped debt payments for 48 of 73 eligible countries from May 2020 to December 2021. Then, at the end of 2020, they endorsed the Common Framework for Debt Treatment to coordinate and provide debt relief to DSSI-eligible countries.

But, so far, only three countries – Ghana, Zambia, and Chad – have reached an agreement under the framework, while only one other – Ethiopia – has applied. Fears of credit rating downgrades have reportedly deterred several other potential beneficiaries from participating.

There is obviously a need for a permanent solution: an institutional mechanism for sovereign-debt restructuring, preferably under the aegis of the United Nations. The IMF could also house such a mechanism, but only if the dispute-settlement body remains independent of the Fund’s Executive Board and Board of Governors, as proposed in 2003. The renegotiation framework should call for a three-stage process of voluntary renegotiation, mediation, and arbitration, each with a fixed deadline.

But even if agreed, a statutory mechanism would require long and complex negotiations. Thus, an ad hoc instrument is an essential complement. To that end, the United Nations and other entities have proposed a revised Common Framework, which should set a clear and shorter time frame for restructuring, suspend debt payments during negotiations, establish clear procedures and rules, guarantee the participation of private creditors, and expand eligibility to middle-income countries.

To ensure post-restructuring stability, any agreement should include not only revised maturities and interest rates, but also debt reduction if necessary.

As I have previously suggested, an alternative could be a mechanism supported by the IMF, the World Bank, or regional multilateral development banks or MDBs. In addition to providing the renegotiation framework, the presiding institution would be able to facilitate financing, address the macroeconomic imbalances of the countries involved, and support the restructuring process. If new bonds are issued, they should have a guarantee attached, similar to the Brady bonds.

There is also the question of whether debts owed to MDBs and the IMF should be included in the restructuring processes, as was done for low-income countries in 2005. Given that these institutions are responsible for a significant share of the debt owed by highly indebted low-income countries, especially in Sub-Saharan Africa, it may be necessary to include them. If so, it would be essential to ensure a steady flow of development aid to cover their losses.

Moreover, the traditional separation between official and private creditors has been complicated by new official lenders, notably China, and the rise of various debt contracts, including guarantees to private investors, that are separate from bonds. Future ‘aggregations’ must encompass all obligations. Therefore, establishing a global debt registry covering all liabilities with private and official creditors is required to ensure equitable creditor treatment and enhance transparency.

To mitigate future debt crises, the World Bank and others have suggested the widespread adoption of state-contingent bonds that adjust returns based on economic conditions or commodity prices. This would alleviate pressure on sovereign balance sheets during downturns.

Over-indebted developing countries will never get the relief they need if the international community does not push the issue at the centre of its agenda.

Debt restructuring should be a top policy priority at this year’s G20 summit in Rio de Janeiro and at the Fourth International Conference on Financing for Development, which will be held in Spain in 2025.

José Antonio Ocampo, a former United Nations undersecretary general and a former minister of finance and public credit of Colombia, is a professor at Columbia University, a member of the UN Committee for Development Policy, a member of the Independent Commission for the Reform of International Corporate Taxation, and author of Resetting the International Monetary (Non)System and co-author of The Economic Development of Latin America since Independence.© Project Syndicate 2024 www.project-syndicate.org