The case of Zambia’s highlights the complexities and consequences of global debt dynamics, demonstrating that comprehensive debt relief is not only crucial for economic stability – but also for reducing global inequality. Reforming the G20’s Common Framework would be a key place to start.
By Tim Hirschel-Burns
Zambia recently announced a deal to restructure $3 billion of its debt. However, Zambia’s debt ordeal is not fully resolved—it has made agreements with private investors who bought its bonds and governments who lent it money but it still needs to reach a deal on commercial loans—and the deal is far from perfect. Nevertheless, the agreement is a major breakthrough, given that it has been three years since Zambia defaulted on its debts.
With the pandemic exacerbating debt challenges, the Group of 20 (G20) set up the Common Framework in 2020, and this process has guided Zambia’s debt negotiations. This process has come with years of delays and failed deals, with negotiations with private creditors proving especially problematic.
Zambia’s saga—and the similar travails of many other emerging market and developing economies (EMDEs) including Ghana, Sri Lanka and Suriname—highlights the dual inequality of the world’s current sovereign debt architecture. This system exacerbates inequality among countries as money flows from indebted poor countries to governments and financial institutions in rich countries. But it also widens inequality within countries, as money is pulled from government services relied on by vulnerable populations.
However, there is a way out of this quagmire: the G20 has a new president—Brazil—and it has pledged to use its presidency to “place the reduction of inequalities at the center of the international agenda.” Reforming the G20’s Common Framework to provide comprehensive debt relief for those in need would be a key place to start.
A case study in debt’s inequality-amplifying effects
Zambia’s years of default have produced devastating impacts. In a country where malnutrition has left nearly one in three children with stunted growth, the government has slashed spending to keep up with its austerity program. Zambia has had to delay plans to expand clean water and sanitation services to 1.5 million people, and in total, cut health and social spending by one-fifth in the span of two years. The onset of a drought has only worsened the situation.
Private lenders may argue that, as unfortunate as the situation is, financial obligations should be respected. In fact, private creditors have charged Zambia high interest rates precisely because they wanted to compensate themselves for the risk of default, leading Zambia to pay exorbitant interest rates, nearly four times as high as what the US pays in interest on its government bonds. Even with this hedging baked into agreements, private lenders were still hesitant to accept ex post losses. Indeed, a restructuring deal bondholders proposed in October would have left them with as much money if Zambia had never defaulted.
Private creditors can offer leeway without suffering severe consequences. For example, Zambia’s bonds are owned by a large number of private creditors, but a steering committee negotiates on their behalf. Several of the companies on this committee manage assets worth several times Zambia’s gross domestic product (GDP). For their clients, bonds from riskier developing countries are often a small share of investments, meaning that investors would not incur major costs from debt relief—but it would have dramatic effects on the well-being of Zambia’s population and economic stability. After three years, Zambia’s bondholders finally agreed to forgo some money—though they will still easily earn back the principal they loaned.
The dual inequality of sovereign debt
Although during the decades preceding the COVID-19 pandemic within-country inequality expanded while among-country inequality narrowed, the world is currently experiencing the reversal of this long trend: Inequalities among countries are also on the rise again.
Inequality among countries – especially between advanced economies and EMDEs – stems from several sources, including uneven access to technology, finance and trade. Inequality is further reinforced by the disproportional impact of the climate crisis on developing countries, though they played little or no part in creating it.
The sovereign debt architecture is especially tilted against developing country borrowers. The World Bank recently estimated that more than half of low-income countries are facing debt distress. These numbers come as no surprise. Developing countries face higher borrowing costs, making it more difficult to keep debt sustainable. Best-laid plans to ensure financial stability can be undone by monetary policy decisions in rich countries, and when crises emerge, governments have few options but to rely on loans from the International Monetary Fund (IMF) with heavy austerity measures attached. Then, once a debt crisis has emerged, the lack of a sovereign debt workout mechanism slows recovery efforts. Middle-income countries are not even eligible for the G20 Common Framework.
Developing countries’ debt repayments tend to flow to rich country governments, multilateral development banks (MDBs) in which rich countries are the main shareholders, and bondholders that are disproportionately from rich countries. While Chinese-owned debt receives a great deal of attention, of the 47 countries identified as in debt distress in a new report by the Debt Relief for a Green and Inclusive Recovery Project, 14 percent of their debt stock is owed to China. A much larger share—40 percent—is owed to multilateral creditors, while 27 percent is owed to private creditors and 8 percent to Paris Club lenders.
The growing complexity of the creditor landscape and the importance of bondholders in developing country debt has also accentuated within-country inequality. Because debt is now spread across a dizzying array of private financial institutions—whereas a small number of governments and MDBs used to hold the most debt—the increased number of actors makes it difficult to come to an agreement, and governments can struggle to compel private bondholders to enter a negotiation. Meanwhile, 3.3 billion people live in countries where their governments are paying more to service the interest on their debt than they are on health and education. In essence, the current architecture redirects resources from the common person living in debt-distressed developing countries to affluent individuals in wealthy countries.
A Common Framework for the common person
The existing G20 Common Framework falls short of meeting the moment, but what would a Common Framework that works for the common person look like?
First, there should be an automatic debt servicing standstill for any country that applies to participate in the Common Framework, incentivizing creditors to come to a prompt resolution rather than letting debts pile up while creditors quarrel. Government creditors and MDBs should also play their part, offering sufficient debt relief that allows for achieving shared climate and development goals. For at least 21 countries, MDB participation is an essential piece of regaining debt sustainability, and relief can be provided without jeopardizing MDBs’ financial health.
Second, private creditors must be compelled to the negotiating table. An approach building on the successful Brady Bonds of the 1990s could be the answer: private creditors would swap original loans for bonds with future guarantees, with the bonds being worth less than the original loans, allowing countries to regain fiscal stability. In determining the size of these “haircuts,” the Common Framework should establish a clear benchmark with parity between public and private creditors, considering that private creditors charged higher interest rates up front to compensate for default risks.
Third, the Common Framework should be expanded to include middle-income countries. A significant number of middle-income countries face unsustainable debts, especially if they are going to make necessary investments in climate action. Many middle-income countries also face high levels of domestic inequality, inequalities that only expand when government services have to be cut to finance excessive payments to creditors.
Debt relief alone is not a cure-all. To address the significant development and climate challenges confronting developing countries, it is essential to boost financing from multiple sources, such as affordable loans from MDBs, Special Drawing Rights and Official Development Assistance. Incorporating debt relief into a comprehensive financing strategy can swiftly expand fiscal capacity and help the common person living in debt-distressed nations.
Inequality-fighting Brazil is the ideal G20 President for this moment. It should seek to align its actions with its aspirations for a fairer world—starting by reforming the Common Framework to alleviate the debt burden that weighs most heavily on the shoulders of those least able to bear it.
*
Tim Hirschel-Burns is Policy Liaison for the Global Economic Governance Initiative at the Boston University Global Development Policy Center.