In the past few years, the economies of developing countries and emerging markets have been upended by the once-in-a-century COVID-19 pandemic and the fallout from the war in Ukraine. As a result, these economies have suffered from a array of major economic problems, including skyrocketing inflation, sharply reduced growth levels (apart from a strong rebound in 2021), dwindling foreign exchange reserves, significantly depreciated currencies in relation to the U.S. dollar, and shortages of key imports such as fuel, foodstuffs (especially grains), and even medicines.
It is therefore not surprising that numerous developing countries and emerging economies are seen as experiencing some level of sovereign debt distress. Estimates in the last year or so have shown that as many as 60 percent of low-income countries are either already in debt distress (15 percent of such countries) or at high risk of distress (45 percent of such countries). Furthermore, according to a Bloomberg index of emerging economies, at least 15 emerging economies (out of a total of 72 emerging economies tracked by the index) have seen their sovereign debt trading at distressed debt levels (i.e., 1000 basis points above Treasuries).
Moreover, there has been a high level of sovereign debt defaults in the last few years. For example, in Sub-Saharan Africa, defaults have occurred in Zambia, in November 2020 ,and Ghana, in December 2022.Other countries in Sub-Saharan Africa such as Ethiopia and Chad have also run intop debt difficulties. In April 2022, Sri Lanka became the first Asian nation to default on its debt in over 20 years.
Other countries, such as Egypt and Pakistan, have experienced severe economic stress and have approached the International Monetary Fund for financial rescue packages. Countries such as Kenya appear to be on the precipice of financial difficulties as major debt service payments loom in the coming period. Financially distressed sovereigns such as Kenya may be forced to make tough decisions as to what to do with limited government resources amid challenging economic conditions, including decisions on whether to prioritize debt service payments to its creditors (so as to avoid a sovereign default) over other important government expenditures.
Several countries experiencing sovereign debt distress that have embarked upon sovereign debt-restructuring exercises in the last few years have generally made only halting progress in reaching agreement with their creditors. For example, it took Zambia two-and-a-half years to finally reach a deal in late June with its principal bilateral creditors, including members of the Paris Club of advanced industrialized countries and other non-Paris Club creditors, particularly China, which reportedly holds roughly one-third of Zambia’s outstanding external debt.
Even so, Zambia has not yet come to an agreement on a restructuring with its foreign bondholders (who hold both local and foreign currency-denominated debt) or other creditor constituencies such as commercial banks. And in Zambia and certain other pending sovereign debt restructuring situations, private sector creditors, principally bondholders, hold a significant portion of the sovereign’s total outstanding debt. However, it is not clear that private-sector creditors will be willing to agree to the same restructuring terms as official-sector creditors such as bilateral creditors, whether under a “comparability of treatment” principle set forth in the G-20’s Common Framework or otherwise.
For its part, Sri Lanka has experienced a severe economic (as well as political and social) crisis in the last year since it defaulted, and it too has made limited progress on any comprehensive restructuring of its sovereign debt. Sri Lanka has a large external debt burden estimated to be over $35 billion, and both China and India are important bilateral creditors to Sri Lanka.
With its massive lending to developing countries and emerging markets in the last decade (particularly pursuant to its globe-spanning Belt and Road Initiative (BRI)), China has emerged as a pivotal player in many of the current sovereign debt restructurings. But many Western observers, including former World Bank President David Malpass, International Monetary Fund Managing Director Kristalina Georgieva, and U.S. Treasury Secretary Janet Yellen, have in the past harshly criticized China for blocking progress or dragging its feet in a number of these sovereign debt restructurings.
China has faced a barrage of criticism from the Western international financial community for not being willing to agree to debt relief (i.e., debt forgiveness or “haircuts”) for the countries currently experiencing sovereign debt distress and instead favoring only debt rescheduling (i.e., stretching out the maturities on loans), its long-preferred approach.
These Western parties generally believe debt rescheduling is inadequate and only debt forgiveness will help the financially distressed countries achieve debt sustainability. They also believe that China is reluctant to join multi-creditor negotiations with sovereign debtors and argue that China instead prefers to deal with sovereigns on a bilateral basis, where China can pursue its interests without transparency.
To be sure, China has its own criticisms of Western financial interests and how they handle sovereign debt restructurings. For instance, China has sharply criticized the special “preferred creditor status” of international financial institutions (IFIs) such as the World Bank and the International Monetary Fund, which effectively exempts these institutions from any of the effects of restructurings (such as haircuts) affecting other creditors. China believes that all creditors, including IFIs, should participate equally in the sharing the burdens involved in a sovereign debt restructuring.
Nonetheless, China’s position on “preferred creditor status” runs directly counter to a precept held dear, if not considered sacrosanct, by the IFIs and the Western international financial community generally. In the last few months, though, China appears to have softened its stance in exchange for an assurance that the IFIs such as the World Bank will provide below-market-rate financing to those sovereigns undergoing debt restructuring.
The standoff between the Western international financial community and China over much of the last two years has led the IMF to hold up disbursement of funds to several of the sovereigns in question. The reason is that the IMF looks for what it considers to be credible “financing assurances” that the sovereign has received restructuring commitments from the sovereign’s principal creditors before it provides disbursements to a sovereign in connection with an IMF financial rescue package. But if China proves to be unwilling to commit to participate in a restructuring, then the IMF would not have the financing assurances it needs to be able to disburse funds to the relevant sovereigns.
In short, the current sovereign debt restructuring situations in developing countries and emerging economies have revealed fundamental tensions in the international financial system for restructuring sovereign debt. That system was in effect predicated on the IMF and the Paris Club of creditors serving as the prime drivers of the sovereign debt restructuring process. However, the system has been challenged by the emergence of China (a non-member of the Paris Club) as the largest official bilateral lender to developing countries . Without some sort of understanding between the Western international financial community and China on how to deal withemerging sovereign-debt restructuring, the economic prospects of distressed sovereigns in developing and emerging economies may be at risk.
This post comes to us from Steven T. Kargman, founder and president of Kargman Associates, international restructuring advisers. It is based on his recent article “The Brave New World of Sovereign Debt Restructuring: The China Conundrum and Other Challenges,” published in International Insolvency & Restructuring Review 2023/24 (IIRR). The article is available here and is reprinted with the kind permission of the publisher of IIRR, Capital Markets Intelligence.