Introduction
In 2022, emerging nations faced a collective debt stock of USD 9 trillion, with annual service payments hitting USD 443 billion. [1] The situation has left roughly 60% of the world’s poorest 77 countries in distress. Ghana, Zambia, Sri Lanka, Ethiopia, Argentina, Kenya, Egypt, Lebanon and Pakistan are examples.
The New York Times, in a piece dated 16th December 2023 titled ‘The Debt Problem is Enormous, Experts Say the System for Fixing It Is Broken’, by Patricia Cohen, explains the difficult state of sovereign debt, sovereign default and sovereign debt distress resolution. [2]
‘The Debt Problem is Enormous, Experts Say the System for Fixing It Is Broken’
The piece critiques the existing sovereign debt ecosystem and queries: “Does the economic framework devised eight decades ago fit the economy that exists today, when new geo-political conflicts collide with established economic relationships and climate change poses an imminent threat? This 21st century clash of ideas about how to fix a system created for a 20th century world is one of the most consequential facing the global economy.”
Evolution of International Financial Institutions (IMF) and World Bank
The IMF was set up in 1944 to rescue countries in financial distress. The World Bank was focused on reducing poverty and investing in social development. The foundational ideology known as the ‘Washington Consensus’ held that prosperity depended on unhindered trade, deregulation and primacy of private investment.
The global economy has changed significantly since; there undisputedly exists a significant mismatch between funding to the IMF and World Bank and the needs of the poor and emerging borrowing nations, especially in the post Covid 19 scenario.
Specifically, the global economy and its problems have grown immensely, whilst funding to the IMF and World Bank and their outlook hasn’t changed much or kept pace.
Complexity of the Sovereign Debt Ecosystem
The sovereign debt ecosystem is further complicated by the existence of bilateral debt, predominantly China and private lenders.
“For the poorest countries, debt has become a near-paralyzing burden”.
Countries laden with debt are forced to spend their money on interest payments rather than on public health, education and the environment. [3]
Sustainable Debt
Existing debt burden significantly impairs future investments by nations, necessary especially to combat global crises like climate change. Under the circumstances the World Bank and IMF have moved from their austerity-based approach, which involves putting countries on a strict financial regime to the point that it often is at odds with public good, to ‘sustainable debt’.
- Emerging and poor countries need to invest heavily in human resource development and infrastructure, but the cost of the capital required is high because of the risk rating of such countries.
- Loans given to borrowing countries are in Dollars and Euros. Dollar and Euro loans are susceptible to exchange and interest rate fluctuations adding to the cost of loan, to no fault of the borrower.
- Bilateral lending and private lenders, and their loan agreements, incorporate different enforcement mechanisms. Different mechanisms make distressed debt negotiations and restructuring complex. There exists no international arbiter that can assist or force these discussions. For example, Zambia defaulted on its debt and there has been no restructuring of the debt on account of lack of consensus between I.M.F., China and bond holders/private debt.
- The rules that apply to loans from the IMF and World Bank do not apply to China or the private loans. Non-IMF/World Bank or Paris Club creditors have an incentive to draw out resolution of a sovereign debt crisis. Joseph Stiglitz, the renowned Nobel Prize-winning economist, identifies the problem: every country has a bankruptcy law but internationally there is none.
- Rescue loans add to the problem. Last resort loans or bail outs come at a significant cost. The cost inundates the debtor country further; Argentina has been endlessly trying to break out of the cycle of debt.
Climate Change and the Urgency for Action
Climate change requires immediate climate financing to help poor and emerging countries, to enable them to fight and contribute towards saving the planet. An ecosystem that enables ‘sustainable sovereign debt’ is perhaps no longer an optional luxury. To borrow from Joseph Stiglitz, since there is no bankruptcy system for sovereign debt, like what countries have for bankruptcies, International Sovereign Debt Restructuring (ISDR), introduced as part of the Common Framework, adopted a consensus-based approach to restructuring (as opposed to a ‘cram-down’ approach).
Global Sovereign Debt Round Table (GSDR)
The Global Sovereign Debt Round Table (GSDR) is co-chaired by the IMF, World Bank and G20. It attempts a consensus driven approach around sovereign debt and distress resolution in sovereign debt. GSDR supports the Common Framework also known as Debt Service Suspension Initiative.
The objective of the Common Framework is to design and implement a debt restructuring package that can fill a debtor’s financing gap in the short term and restore debt sustainability in the medium-long term. The foundational premise of the Common Framework is to ensure Paris Club Members get comparable treatment for their debt; however, comparable treatment has been a significant bottleneck especially in the context of private lenders and market-based lenders.
Challenges in Common Framework Implementation
The Common Framework was designed to coordinate debt relief, including debt from public and private lenders. It was meant to set debt treatment standards across traditional western lenders and new lenders like China, India and Saudi Arabia. It was hoped that private lenders would sign on using similar terms to those used by members using the Common Framework.
Unfortunately, no country has received substantive relief in 2023 under the Common Framework.
Disagreements between lenders include the types of loans to be included and how the lenders would share the burden of restructuring. [4] Especially contentious is the issue around how to measure what’s called ‘comparability of treatment’.
Chinese loans for example appear to present challenges to the Common Framework because
- There is no single authority handling Chinese claims considering that they come from a variety of sources.
- China would want to contest norms established by the Paris Club and IMF.
As indicated above this creates a cycle of failure leading to emerging and poor nations not being able to raise debt, service debt or invest in themselves, including tackling climate change.
Trailblazing the Future
We at Solvendo, have devoted considerable thought to the problem. We believe the solution to making the Common Framework workable and efficient is to first establish an Information Utility. Going back to the thesis of Martin Greenberger, a professor at MIT Sloan in the ’60s: capital of the future is data and intelligence. This would include capital that supports sovereign debt. [5]
To enable an Information Utility for sovereign debt, all lenders would have to concede the repository of data within the Information Utility as legitimate and acceptable; a departure from forcing a concession on ‘comparability of treatment’ by and between lenders. The Bank for International Settlements has over the past years conducted encouraging pilots and proof-of-concepts with respect to cross-border payments and finance. [6] Similarly, we at Solvendo are ready with solutions that could be deployed to significantly improve the efficiency of the Common Framework. We believe an Information Utility that enables transparency and automation will solve for existing inefficiencies that plague the sovereign debt ecosystem.
We believe an Information Utility that enables transparency and automation will solve for existing inefficiencies that plague the sovereign debt ecosystem.
References
- [1] Please see https://www.bloomberg.com/news/articles/2023-12-19/poor-nations-debt-crisis-and-the-g20-s-common-framework-explained
- [2] Please see article in the New York Times 16th December 2023 by Patricia Cohen, titled ‘The Debt Problem is Enormous, Experts Say the System for Fixing It Is Broken’ https://www.nytimes.com/2023/12/16/business/economy/imf-world-bank-sovereign-debt.html?smid=nytcore-ios-share&referringSource=articleShare
- [3] Please see [1].
- [4] Please see https://www.imf.org/-/media/Files/Publications/WP/2023/English/wpiea2023187-print-pdf.ashx
- [5] Please see working paper titled Banking And The Information Utility by Martin Greenberger, Associate Professor Sloan School of Management and Project MAC Massachusetts Institute of Technology at https://dspace.mit.edu/bitstream/handle/1721.1/46920/bankinginformati00gree.pdf?sequence=1&isAllowed=y#page61
- [6] Please see Bank for International Settlements at https://www.bis.org and the Innovation Hub of the Bank for International Settlements at https://www.bis.org/about/bisih/about.htm