Is debt relief in need of relief?

Sovereign debt has been at the center of global attention lately, as tortuous negotiations between Greece and its international creditors polarized public opinion and sent shockwaves through global markets. In many other parts of the world, however, debt is a pervasive phenomenon that rarely makes headlines. Between 1950 and 2010, 95 developing countries have had their debts restructured more than 600 times. However, write offs from the past have done little to prevent developing countries from falling back into debt traps. Today, a quarter of all low-income countries are in or at high risk of debt distress. So what lies beneath debt relief to poor countries? Devex takes a closer look at the logic and practices underwriting current debt restructuring mechanisms. Current mechanisms not up to the task In the past two decades, wealthy donor countries and powerful international financial institutions have taken action to relieve debt burdens in many of the world’s poorest countries. A well-known mechanism is the Heavily Indebted Poor Countries Initiative. Launched in 1996 by the International Monetary Fund and the World Bank — and later strengthened by the Multilateral Debt Relief Initiative — the HIPC initiative provides debt relief to 39 impoverished nations that meet predefined economic criteria. But what about all the others? According to the European Network on Debt and Development, which gathers 54 nongovernmental organizations working on debt and development finance, debt reduction and renegotiation outside of the HIPC initiative is possible — but not predictable nor guaranteed. “Debt relief is currently a highly political and arbitrary affair,” Bodo Ellmers, Eurodad’s policy and advocacy officer, told Devex. A prime example can be found in recent debt relief decisions made by the so-called Paris Club — an informal grouping of major creditor nations including France, Germany, Japan, the United Kingdom and the United States. “The Paris Club has terms which determine the magnitude of debt relief and the rules for its operations. But these terms just determine how a debt relief operation is conducted — not if it is conducted,” Ellmers explained. Take the case of Myanmar. The country’s debt indicators were well below the IMF’s threshold for debt distress. Yet eagerness of foreign investors to venture into one of Southeast Asia’s most promising emerging markets led to a “sudden creditor rush” that effectively relieved the country of more than 60 percent of its foreign debt in 2013. Another famous example is the generous debt relief provided to Iraq in 2005 after the U.S.-led coalition toppled Saddam Hussein’s regime. Many analysts argued the Middle Eastern country received flexible debt arrangements that its oil reserves should have rendered it ineligible for. Meanwhile, debt relief is made all the more unpredictable by the fragmentation of forums charged with negotiating sovereign debt restructuring. “A country needs to approach the Paris Club for Western bilateral creditors’ loans, the London Club for private banks’ credits, and might even need to talk with China or Russia too,” Ellmers underlined. “And then there are a myriad individual bondholders that have invested in country bonds, some of which sell their claims to vulture funds which use aggressive litigation strategies, and undermine and delay debt restructuring.” Finally, creditors’ overall disregard for development and poverty indicators has led certain countries to be completely excluded from international debt relief mechanisms. This is notably the case of several middle-income developing countries — such as the Philippines, Jamaica and El Salvador — which spend a growing portion of government resources servicing their debts. Dangerous trends in the making According to the Overseas Development Institute, the past few years have seen a surge in lending through sovereign bonds in sub-Saharan Africa. This, experts believe, points to a broader trend in which developing countries are borrowing from increasingly risky sources because of the few strings attached. “The main dangers for future debt sustainability come from new commercial debt, such as the international bonds several former heavily indebted poor countries have issued over the past few years,” Dennis Essers, a development finance specialist and Ph.D. candidate at the University of Antwerp, told Devex. As a result, the external debt of many developing countries — including those that benefited from debt write offs — are building up once again. Between 2008 and 2012 external loans to low-income countries increased by 75 percent, the Jubilee Debt Campaign has found. The movement also predicts two-thirds of impoverished countries to face significant increases in the share of government revenues spent on debt payments over the next decade. Meanwhile, the inexistence of all-encompassing and binding rules to ensure responsible lending by all creditors has left the vital question of debt sustainability vulnerable to politicking. “The IMF conducts debt sustainability analyses and has a debt limits policy, which implies that heavily indebted nations should primarily get grants or highly concessional finance. The World Bank, as a multilateral institution, sticks to certain rules,” Eurodad’s Ellmers said. “[But when it comes to] bilateral donors, if political interests are involved, debt sustainability criteria play no role. There is also increasing competition between the old creditors of the North-West, and new ones such as China and Brazil.” Where to now? In a landmark resolution adopted in September 2014, the U.N. General Assembly created a committee to work toward the creation of a multilateral framework for sovereign debt restructuring. But many key actors — including the U.S. and the European Union — are dragging their feet. Nongovernmental organizations however note that the much-awaited third International Conference on Financing for Development, which kicked off Monday, July 13, in Addis Ababa, Ethiopia, presents a unique opportunity to drive the agenda forward. But what would a revamped debt relief architecture look like? Ultimately, a new workout mechanism should be impartial, predictable and comprehensive, Eurodad’s Ellmers told Devex. Independent in analysis and decision-making, the mechanism should be situated in a neutral forum, with the power to hold lenders and borrowers accountable for irresponsible behavior. Also, debt relief assessments should be based on human development indicators, while allowing for a restructuring of all debt in one single and speedy process. But there are certain dangers associated with debt relief evolving into “business as usual.” In fact, some close observers believe it should be kept as an option of the last resort. “If it becomes all too easy for countries to walk away from their debts, borrowing costs would rise and many countries would no longer have the opportunity to finance certain productive investments at reasonable cost,” Essers stressed. Although not opposed to countries benefiting from “a fresh start once in a while,” the expert suggests the international community shift its focus toward preventing debts from becoming unsustainable in the first place. “Donors would do good to sustain, or even increase, their investments in the debt management capacity of developing countries,” Essers said. And there is much good work to build upon. “The IMF, the World Bank and regional organizations are running several initiatives aimed at better managing debt in poorer developing countries. The U.N. Conference on Trade and Development, for example, has drafted a charter on responsible sovereign lending and borrowing,” he concluded. Check out more insights and analysis for global development leaders like you, and sign up as an Executive Member to receive the information you need for your organization to thrive.