As COVID-19 continues to interrupt economic activities, induce higher public spending and decrease tax revenues, sovereign debt issues in emerging countries are worsening. The World Bank has noted that the debt burden of low-income countries rose 12 per cent to a record US$860 billion in 2020.
Authors: Mengdi Yue and Christoph Nedopil, Fudan University
The International Monetary Fund (IMF) sounded alarm bells in December 2021, warning that 60 per cent of low-income countries are at high risk or already in debt distress, up from 30 per cent in 2015.
Analysis from a Green Finance & Development Center report published in March 2022 shows that outstanding public external debt in most countries eligible for the DSSI has increased from 2019 to 2020. But some countries did decrease debt levels, such as the Republic of Congo and Mozambique.
Outstanding public external debt owed to China by 68 Debt Service Suspense Initiative (DSSI) countries increased from US$105 billion in 2019 to US$110 billion in 2020. This accounted for about 18 per cent of total outstanding public external debt in these countries and only the World Bank was a larger creditor (21 per cent).
China was the largest official bilateral creditor in 17 DSSI countries, comprising at least 40 per cent of total public external debt in Tonga, Djibouti, Lao PDR, Cambodia, the Republic of Congo and Kyrgyzstan.
The data suggest that 26 per cent of the total debt service to be paid by DSSI countries in 2022 will go to China. This compares to 17 per cent to bondholders and 9 per cent to the World Bank.
In response to debt challenges in low-income countries, the G20 launched the Debt Service Suspension Initiative (DSSI) in April 2020. As the largest bilateral creditor, Chinese lenders had deferred payments of about US$2.1 billion under the DSSI by December 2020, about 37per cent of the total deferred payments of US$5.7 billion under the DSSI. In comparison, Paris Club members suspended US$2.5 billion by December 2020.
Among Chinese lenders, official creditors such as CIDCA (China’s development agency) and China Exim Bank suspended about US$1.353 billion, and China Development Bank, which considers itself a commercial lender, suspended US$748 million. In addition, China has also promised to redistribute US$10 billion — 23 per cent of its IMF Special Drawing Rights (SDR) — to African countries, compared to a commitment by various G20 countries to redistribute 20 per cent of their SDR to emerging markets.
Despite these promises and initiatives, the current approaches have been slow to make a difference. The DSSI was not extended past December 2021 while the broader ‘Common Framework’, which includes private lenders, has not led to meaningful results.
One challenge is the complexity of sovereign liabilities as commercial and non-traditional lenders play a larger role. Another is a lack of transparency of debt and creditors, which undermines the willingness of creditors to restructure debt and the ability of borrowers to access new loans.
Debt classification also remains unclear — development bank loans are official bilateral debts due to the lender’s legal status but can be regarded as commercial debts based on the lending terms. Finally, China argues that multilateral lenders need to equally contribute to multilateral debt relief rather than insist on seniority in repayment.
To accelerate debt relief and avoid the further deterioration of sustainable development potential in DSSI countries, Chinese policymakers have the opportunity to play a greater role in improving current strategies and driving the global efforts on debt relief.
The consistency of debt classification and transparency can be improved by reaching greater agreement among bilateral and multilateral creditors on the category (official or non-official) of outstanding debts. Debts that governments do not directly owe but have contingent liabilities for should also be properly calculated. China’s official lenders could take a leading role in enhancing transparency by lifting some confidentiality clauses, especially in cases of urgent debt relief.
Bilateral and multilateral creditors also need to increase their coordination. This might require granting more powers to existing institutions such as the IMF, which is challenging but preferable to creating new institutions. China could contribute by formulating a ‘common’ debt relief and restructuring program.
Highly-indebted countries with limited access to capital markets or high borrowing costs could be supported to issue sustainability-linked debt instruments to attract patient capital, with interest rates depending on the sustainability performance of the country. These instruments could be enhanced through public guarantees and default insurances with development.
For debts that would likely never be paid back, innovative solutions could swap part of them for environmental protection, health or broader development, rather than debt-for-equity or debt-for-resources swaps that entail higher political, economic and reputational risks. Some solutions have proven successful, such as debt-for-nature swaps in Seychelles in 2015 and Belize in 2021, and a debt-for-health swap between Germany and Indonesia in 2021.
Chinese-invested infrastructure projects in Belt and Road countries could securitise project-based loans by pooling and selling the securities on a secondary market or through a national/multilateral project securitisation fund. This would facilitate raising capital through asset-backed securities while reducing the debt burden of debtor countries.
While the debt crisis alone hampers sustainable development prospects for many emerging countries, growing inflation and exchange rate volatility driven by higher energy and food prices, as well as rising interest rates in the US are a potent accelerator of the existing challenges. With many debtor countries requiring a specific mixture of solutions to deal with debt issue alone, more efforts and better coordination are urgently needed to avoid a quickly worsening crisis. As G20 finance ministers and central bank governors have called for ‘more timely, orderly and predictable’ debt treatment in their recent meeting, especially in Chad and Zambia, progress will hopefully come soon.
Mengdi Yue is a visiting researcher at the Green Finance & Development Center at Fudan University.
Christoph Nedopil is Associate Professor and Director of the Green Finance & Development Center at Fudan University.