Debt levels are high, but will solutions come through?

A growing number of countries face unsustainable public debt loads — which are eating into their spending on development priorities — and existing systems have struggled to provide solutions. At the World Bank-International Monetary Fund annual meetings in Washington, D.C., this week, debt will be on the table, but the question is whether there will be any headway. The statistics paint a bleak picture: Low-income countries’ average annual spending on repaying their debts jumped to $60 billion from $20 billion between 2010 and 2020. And last year, emerging markets and low- and middle-income countries paid tens of billions of dollars more in debt repayments than they received in new lending and official development assistance, according to research released by the ONE Campaign earlier this year. The lowest-income and most climate-vulnerable countries now pay twice as much in debt repayments as they receive in climate finance, according to a recent analysis by the think-tank International Institute for Environment and Development. These trends mean that many countries are spending more on debt service than they are on critical public services such as health and education or addressing climate change. “As debt increases, fiscal space contracts disproportionately more in low-income countries — not all debt burdens are made the same,” IMF Managing Director Kristalina Georgieva said during her curtain-raiser speech last week. “We can immediately see how the tough spending choices have become tougher with higher debt payments. Schools or climate? Digital connectivity or roads and bridges? That is what it comes down to.” Not all debt is the same The debt crisis in many countries today is largely caused by outside shocks including the COVID-19 pandemic, conflict, and climate change, though in some cases, poor policy decisions by national governments have exacerbated the problem, Kalpana Kochhar, the director of development policy and finance at the Gates Foundation, told Devex. For some, the financial picture is starting to improve and what they need is more money now to “tide them over” until they are in a stronger financial position, she said. That could help countries facing a liquidity crunch, where countries are capable of repaying their debt over time but debt levels today account for too much of their overall spending and they need additional resources to help their economies grow. However, other countries face a solvency crisis where they are close to defaulting on their debt and need their debt reduced and restructured. A liquidity crunch and a solvency challenge have different potential solutions. Much of the debate this week may be about which area leaders will focus on. Major donors such as the United States and IMF and World Bank leaders will likely focus on the liquidity issue — sidestepping the issue of debt reduction and restructuring — sources told Devex. A key question is whether countries can grow out of debt or whether more lending today will just kick the can down the road and lead to greater debt challenges in the future. Some experts point to the past and warn that ramped-up lending by international financial institutions to debt-distressed countries risks repeating mistakes from the 1980s and ’90s that resulted in a worse debt crisis. What’s actually needed in many countries, they argue, is debt relief where public and private creditors come together and cancel part of the debt and restructure the rest. A troubled existing system The G20 Common Framework on Debt was created in 2020 to bring together creditors to restructure debt for low-income countries that have defaulted or are at risk of defaulting on their debt. Despite high hopes, the endeavor has been widely viewed as ineffective for a variety of reasons, including the snail’s pace of negotiations, the difficulties in getting private creditors on board, and what many see as not enough debt relief being provided. Part of the problem is that people thought the Common Framework would create a new structured system to address debt, but instead, it has essentially replicated the way Western governments restructure debt, through the Paris Club with public creditors coming together behind closed doors and hammering out debt deals — albeit with China involved this time. It hasn’t tried to be better and that has undermined the process, said Tim Jones, the head of policy at Debt Justice, a U.K.-based campaigning organization focused on debt. U.S. Department of Treasury official Jay Shambaugh called the Common Framework “frustratingly slow” in a recent speech. The countries that have used the Common Framework have had long, drawn-out debt discussions. It took Zambia nearly four years to strike a deal with its creditors. The result was a cut of around $900 million from the country’s external debt — which had totaled about $18 billion — and spreading its future payments over a much longer period. The Common Framework is a “misnomer” because an actual framework would suggest rules and guidelines were in place but there were none, Kochhar said. So the Global Sovereign Debt Roundtable was established in 2023 to bring together public and private creditors with debtors to air issues in a forum where they all sit together. The roundtable meets this Wednesday at the annual meetings and will be a key opportunity to discuss proposals to address the debt crisis. While there are new mechanisms on the table, many people believe that the Common Framework could be improved and there seems to be some consensus around how that could be done. It needs to set rules or norms for the debt process so that countries have a high degree of certainty about what they will get when they enter the process. It needs to include comparability of treatment — creditors need to be treated similarly, with no one getting better terms than the other — and ensure the participation of private creditors. There should also be a suspension of payments during the debt resolution process, both to provide temporary relief and pressure creditors to come to an agreement more quickly. The process should be available to all countries, not just low-income ones, said Jones of Debt Justice. Debt processes should also happen earlier and be more robust because existing systems tend to tackle the problem too late and cut debt by too little, he added, noting that the IMF has said as much. Debt relief deals in Chad, Ghana, Sri Lanka, Suriname, Ukraine, and Zambia will cut their debt burdens by an average of 18% and save about $30 billion in debt payments collectively over time. But they would still be paying an average of over 20% of government revenue on debt service, according to new research from Debt Justice. The problem is that their debt in many cases is reduced just to the threshold between moderate and high debt distress, which means one economic or climate shock could see them tumbling back into crisis, Jones said. And while private creditors typically gripe about having to take a financial hit in these deals, they will likely still make a pretty penny even after the restructurings in these countries — an estimated $14 billion in profits, Debt Justice found. Getting private creditors to the table is critical though, and one of their key demands is to be part of the discussions sooner, rather than being handed a deal they’re supposed to comply with. If they are not part of the process, there is a risk that funds countries borrow to give themselves breathing room will just be used to pay private creditors rather than grow their economies. Bridging the gap Outside of the G20 Common Framework, several proposals are being floated to address the debt crisis — and one that would tackle the liquidity crisis seems to be gaining traction. The U.S. and France are spearheading a proposal they call “Pathways to Sustainable Growth,” which would help heavily indebted countries stay afloat by managing liquidity risks. The proposal has three main features: Countries creating credible five-year growth plans; new money from MDBs and the IMF; and debt rescheduling or a pause to give countries temporary breathing space, Kochhar of the Gates Foundation said. Countries that participate would need to commit to reforms to access funding to “bridge” their liquidity needs. The IMF and World Bank would play a key role in providing additional financing and other support to help countries raise more of their own funds as part of the plan, which grew out of a proposal from economists at the Finance for Development Lab. Other components that may be discussed as part of the proposal are how the World Bank or other institutions might provide guarantees to creditors to entice them to participate in the process. They may also try to strike an agreement with credit agencies so they will not downgrade countries that participate in a liquidity facility, Eric LeCompte, the executive director of Jubilee USA, told Devex. While details have yet to be fleshed out, the proposal is “gaining traction” and was discussed at the last meeting of the Global Sovereign Debt Roundtable in September, Kochhar said. Whether it will go anywhere depends on support from other countries. Kate Donald, the head of Oxfam’s Washington, D.C., office, told Devex that she doesn’t think China will buy into the proposal. Either way, she’s skeptical. “It’s a bandaid on a bullet wound,” she said, adding that you can’t solve a debt crisis by creating more debt. Other experts and advocates expressed concern that a focus on the bridge plan would come at the expense of trying to actually fix the global system for resolving debt. Other proposals But that is just one of the proposals on the table. A group of economists has proposed a new two-pronged approach to debt. They suggest that bilateral and multilateral creditors and the IMF specifically purchase the bonds of debt-distressed countries and refinance them on better terms. In addition, all parties involved in restructurings would adopt a set of principles that could guide them in reaching an agreement and monitoring its implementation. Eurodad, a group of European civil society organizations, has another plan. In a new paper out Monday, they argue for an independent legal mechanism at the United Nations that would facilitate debt restructuring to prevent and resolve “unsustainable and illegitimate” sovereign debt. “We know it’s very difficult but the present system is not working and borrowers are not part of the discussion. We at least need to open the intergovernmental discussion at the U.N.,” Iolanda Fresnillo, Eurodad’s policy and advocacy manager for debt justice, told Devex. Other experts and advocates have called for a debt process that functions like bankruptcy for individuals and businesses — with a set procedure, specific rules, and consequences. “I do think it’s time to re-up some of the noise around that,” Kochhar said. Others are pushing to pass or update laws that would require private creditors to participate in debt talks with parallel efforts in the United Kingdom and New York, where most emerging market debt is held. There are divergent interests in play in all these debt discussions, and some distrust between individual countries — China and the U.S. — and between public and private creditors, but overcoming these barriers will be critical for countries saddled by unsustainable debt if they are to move past it.