July 2020
Joseph Stiglitz and Hamid Rashid
Columbia University
The United Nations has described vividly the magnitude of the problem. More than half of countries worldwide – and two-thirds of the world’s population – will suffer the consequences of inaction. Stagnation and high unemployment in developing countries will push 140 million more into extreme poverty, breeding discontent and instability and wiping out years of development. Their recovery from what the United Nations (UNDESA, 2020) and the IMF (2020) predict will be an unprecedented global slowdown will take years
The credibility of the multilateral system will indubitably (certainly) be tarnished, with millions suffering the consequences of an avoidable debt crisis. Almost surely, and deservedly, the global financial structure and the democracies of the West will get part of the blame for failing to prevent the catastrophe. The international community has recognised the gravity and the urgency.
The United Nations has called for immediate debt relief for the least developed countries and other low-income countries in debt distress (United Nations, 2020). The G20 has rightly called for a moratorium on debt servicing for low- and middle-income countries (G20, 2020). But beyond the calls, there is little progress.
The stay on official debt for the poorest countries that they called for was a beginning, but just a beginning; it didn’t deal with private debt, it didn’t deal with the debts of emerging markets, and it didn’t deal with the restructuring of debt that will be required. The likelihood of a calamitous debt crisis continues to tick like a time bomb.
One hundred years ago, during another global pandemic, John Maynard Keynes warned the world against the risk of the unsustainable debt burden that the victorious powers imposed on Germany in Versailles. His warnings were prescient.
Between the two world wars, European countries – both those who won the war and those who lost – were saddled with unsustainable war debt. A highly profitable – but perilous – global financial system emerged during the Roaring (loud) Twenties.
The United States – the largest creditor at the time – supplied huge sums of credit to Germany so that it could repay its war debt to the United Kingdom, France, Belgium, the Netherlands and others. These debtor countries then used the German debt payment to pay down their own debt to the United States.
As the Roaring Twenties came to an end and the world economy plunged into the Great Depression, nearly 70 governments met in London in 1933 to discuss the path to recovery. The United Kingdom – the most heavily indebted country at that time – urged for debt relief, but the United States prevailed in keeping the issue off the table. The London conference failed (Eichengreen et al, 1990) and the sufferings of the Great Depression lingered. It took another devastating war to put the world on the path of recovery.
There is no need for a war to get us out of the current debt crisis. But we must forge global collective action. Unless we address the unsustainable debt burden of the developing countries, a dystopian future will become a reality. Forcing developing countries to make $130 billion in debt service payments this year is tantamount to squeezing water out of stone. Pre-emptive measures to prevent a cascading debt crisis in these economies will save the world billions of dollars in humanitarian assistance, peacekeeping and peacebuilding operations in the near term.
The current crisis presents a unique opportunity to address the systemic problem of excessive debt burdens of developing countries. In this Policy Insight, we focus on the high cost of sovereign debts owed to private creditors, who often find it advantageous to block timely and orderly debt restructuring and stand to gain from a debt crisis. It is time to jump start the sovereign debt restructuring workout mechanism, as envisaged in the UN General Assembly resolution that 136 countries adopted in 2015
A rules-based, fair and equitable sovereign debt workout mechanism will ensure orderly restructuring of sovereign debt and prevent the rule of the jungle where the strongest survives. But it will take months, if not years, to put in place such a system. The debt crisis – and its devastating fallout – will not wait. We must act now to find a comprehensive solution to the immediate problem.
This Policy Insight includes four sections. In the first, we describe the nature of the current debt problem, identifying some of the factors that led so many developing countries and emerging markets to such a precarious position in which they are so vulnerable to the shock of the pandemic. In the second, we explain why urgent actions are needed and why current proposals, mostly entailing debt standstills, will not suffice. In the third, we consider a number of alternative proposals to reduce debt burdens, including encouraging and enforcing comprehensive standstills and debt restructurings. We suggest one in particular that has not received sufficient attention – bond buybacks. In the fourth section, we discuss some measures that might be taken to prevent future debt crises.
The gathering storms of a debt crisis
AN ASSESSMENT OF THE CURRENT SITUATION
Most alarmingly, sovereign debt owed to private creditors increased nearly three-fold during the past decade, from $186 billion in 2008 to $535 billion in 2018. Nearly 90% of this is sovereign bonds. Seven years ago, we warned against the risks of excessive public borrowing from private creditors, particularly in sub-Saharan Africa (Stiglitz and Rashid, 2013). As quantitative easing in advanced countries injected trillions of dollars of liquidity, more money became available at more attractive terms.
Many African governments began to issue sovereign bonds to raise money in the international capital market. By 2013, ten sub-Saharan governments had issued sovereign bonds worth $8.1 billion. A number of these countries – Côte d’Ivoire, Ghana, Senegal and Zambia, among others – had received debt relief under the Heavily Indebted Poor Countries (HIPC) initiative less than a decade earlier. We thought it was reckless and irrational, because servicing these high-cost bonds would require still more borrowing and put these countries in debt shackles. We wondered, “are shortsighted financial markets, working with shortsighted governments, laying the groundwork for the world’s next debt crisis?” During the next seven years, African governments – many of them rated below investment grades – issued over $90 billion in sovereign bonds. Clearly, our warnings did not stop the borrowing spree.
The borrowing extravaganza with sovereign bonds has not been exclusive to subSaharan Africa. Commodity-dependent governments elsewhere – Ecuador, Peru, Colombia, Jordan, Lao PDR or Mongolia – issued billions of dollars of sovereign bonds. Non-commodity exporters – Philippines, Sri Lanka or the Dominican Republic – also joined the bandwagon. During the past decade, low- and middle-income countries issued sovereign bonds, most of them for the first time. Collectively, they now owe over $480 billion to private bondholders. The remaining $55 billion are bank loans owed to commercial banks and other private lenders. More than 70% of these sovereign bonds were issued during the past ten years (Figure 2).
Countries that borrowed with sovereign bonds saw their annual public debt servicing burden – interest plus principal repayment – increase from $47 billion in 2008 to $117 billion in 2018. At the same time, more than two-thirds of these countries saw their ratio of tax revenue to GDP decline during the past decade. In Angola, for example, the tax revenue to GDP ratio has declined by over 16% since 2008. Countries that did not issue sovereign bonds experienced a less dramatic increase in debt servicing, from $6.3 billion in 2008 to $10.9 billion in 2018.
Export revenues are the main source of foreign exchange for these countries to service their external debt (other than by borrowing more). Latest forecasts from the WTO and UNCTAD suggest developing countries will experience at least 20% decline in exports this year, given that commodity prices have declined by nearly 30% since January 2020. For reference, exports from developing countries declined by about only 5% during the Great Recession in 2009. Many of these countries serviced their external debt – and avoided a debt crisis – by rolling over existing debt and taking on new debt.
Mongolia’s debt service, for example, was more than its total export revenue in 2018 (Figure 3). It did not face a debt crisis because it could borrow. The external debt of these countries remained manageable so long as the external borrowing window remained open for them. Abundant liquidity in the international capital market – not economic fundamentals – ensured that countries like Mongolia, Lebanon, Montenegro or Sri Lanka did not default. But as soon as the pandemic hit the world economy, the faucet of new debt flows stopped, capital quickly flowed back to developed economies, and many of these countries are now on the verge of default. Ecuador and Lebanon are already in default and Gabon, Mozambique, Suriname and Zambia, among many others, may soon follow suit.
As export earnings and remittances diminish, countries will have to turn to foreign reserves to service their debt. But as Figure 4 points out, there are many countries whose total debt servicing burden – i.e., servicing of both public and private sector debt – exceeded 40% of their reserves before the pandemic. A run on reserves, which is increasingly likely, will put their currencies, which have already depreciated by 15% or more since the beginning of 2020, into a downward spiral. A depreciated currency, of course, makes it all the more difficult for them to meet their dollar-denominated commitments.
The falling exports and contraction of economic activities at home are translating into sharp declines in fiscal revenue at a time when governments are hard pressed to increase health and social sector spending to fight the pandemic. Against the backdrop of tightened international capital, a ‘sudden stop’ in new lending (or rollingover of existing debt) and mounting fiscal challenges, governments countries will still need to service $130 billion in interest and principal repayment in 2020. About half of this ($65 billion) must be paid to private bondholders. Thus, the critical issue on which this Policy Insight focuses is how best to manage the debt owed to private creditors.
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To be continued
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