Since the start of the coronavirus pandemic, the G20 has settled for repurposing established Paris Club mechanisms to tackle the problem of developing countries’ unsustainable debts. Going forward, a Paris Club-based approach to address debt vulnerabilities by the G20, in the form of the “Common Framework for Debt Treatments beyond the DSSI”, is unlikely to succeed. The predicted failure of the G20 response will condemn a large number of developing countries to a lost decade. The explanation behind this dismal prediction can be found in the complex interactions between creditors, as we will see below.

Who will bear the costs of the G20 Common Framework?

The core challenge faced by any process of debt resolution is the equitable distribution of losses arising from insolvency. On the one hand, between debtors and creditors. On the other hand, within the creditor base. In the case of the former, a historical and structural power imbalance has traditionally shifted the costs from creditors to sovereign debtors. This is exemplified by the too little, too late ongoing problem of debt restructuring. This pattern is set to continue. The G20 is a creditor forum where measures adopted are a result of the complex interaction of competing geopolitical interests. Solving the actual problems of developing countries isn't particularly high on the agenda in the aftermath of the pandemic, as symbolised by the failure of the DSSI.

By extension, the focus of the G20 discussions is on the latter element: the allocation of losses between creditors. Over the last decade, the proliferation of debt instruments and the diversification of the creditor base has increased the complexity of these processes. To address this problem, the International Monetary Fund (IMF) has suggested two mechanisms. First, an agreement on a common approach to debt restructuring between the Paris Club and others. Specifically, China. Second, the use of Debt Sustainability Assessment (DSA) risk ratings to limit eligibility for debt relief.

China is likely to subvert both mechanisms. In the first case, it is unlikely that China will agree, and most importantly, comply with a framework for debt relief under the Paris Club. The Club is a diplomatic tool that reflects the political priorities of its members through consensus. There is no natural room, nor incentive, for China to be a part of this. Efforts to force China into this space can only lead to acronymous confrontations across country-by-country debt relief negotiations. This dynamic could be exacerbated by the second mechanism. An explicit link between the IMF DSA and eligibility for the Common Framework would force official and private creditors from China to bear the brunt of the costs of debt relief (Table 1).

Table 1: Public Debt Composition for Countries Assessed to be in Debt Distress or at High-risk of Debt Distress (Average share in per cent, 2018)

Source: Eurodad (2020)

Tangled governance: Delaying the inevitable

History shows that creditors will rely on any mechanism available to delay the recognition of insolvency. This allows them to shift a substantial share of the losses towards the creditors. Examples include the US in the 1980s debt crisis and, more recently, Germany and France in the Greek debt crisis. By these standards, opposition to debt relief in the aftermath of Covid-19, by both China and private creditors, is to be expected. Both groups of creditors stand to benefit from complicated and opaque arrangements. Regime complexity and conflict enable key creditors to shape and delay the outcomes of debt relief. Thus, in contrast to transparent and standardised treatments, case-by-case negotiations are a perfect setting for undermining effective debt relief under the Common Framework.

If the Common Framework ends up being framed as an Evian+ approach, this will allow China and private creditors to exploit two related mechanisms to delay the inevitable: non-transparency of public debt and comparability of treatment.

Non-transparency of public debt

Despite being a matter of public interest, available information on public debt is hard to find and is often incoherent. This makes it difficult to gain a comprehensive overview of creditor composition. Without it, ensuring an equitable distribution of losses amongst creditors becomes an impossible task. This dynamic creates incentives for creditors to remain hidden. This allows them to avoid participation in debt relief efforts and to shift the losses on to the rest of the creditor base.

China and private creditors are both at fault of obscuring public debt information. Most of the focus on the debate and demands for transparency have been placed on China. Extensive use of collateralised loans and project financing under different arrangements have made it a difficult endeavour to assess the amount of debt owed to China. Private creditors are no better. Identifying bondholders and providers of credits is equally difficult. Use of structured repo agreements facilitated by investment banks has added a layer of complexity to debt restructuring processes. A consent solicitation to materially alter the terms of the bond, the step that precedes an official default, remains the only reliable mechanism to identify commercial creditors on an accurate basis.

The DSSI aimed to address this problem, but with little success. In the latest update on the implementation of the initiative, the IMF acknowledged that creditor disclosure on terms and amounts lent remains limited. This is unlikely to change with the implementation of the Common Framework. As can be seen in recent developments in Angola and Zambia, non-transparency in public debt lends arguments to both groups of creditors to lengthen negotiations and delay the implementation of debt relief.

Comparability of treatment and terms of debt restructuring

An even bigger obstacle for a swift implementation of the Common Framework is related to the terms of debt restructuring. Under the Evian approach, debt treatments are considered on a case-by-case basis. Countries with similar debt burdens may end up with different amounts of debt relief depending on the economic and political interests of creditors. From a technical perspective, it is difficult for the Paris Club to establish comparability between creditors that choose to reschedule flows and those that restructure their stocks of debt.

A central problem for the Common Framework will be the interaction between restructuring terms offered by China and private creditors. A review of debt restructuring terms involving credits from China shows a mixed picture. Debt write-offs have been applied only to official non-interest bearing loans. Restructuring of credits on commercial terms are negotiated on a loan-by-loan basis. Rescheduling is the most common form of treatment, while write-offs are a rare exception.

The potential for conflict is clear. It will be extremely difficult for the Paris Club to enforce comparability of treatment. Private creditors will refuse to agree to debt write-offs unless commercial creditors from China participate on similar terms. Under the principle of comparability they will have the right to do so. This rationale also applies the other way round.

This dynamic creates a series of problems. Even if a large number of private creditors agree to participate in debt restructuring, the potential for vulture funds − or any investment fund − to block agreements remains high. A review of the contractual terms for 52 series of bond issues of 16 low-income countries shows that at least 29 per cent of the bonds lack the last generation of Collective Action Clauses (CACs). This opens the door for vulture funds to block relief efforts on specific bond series, even if an agreement with China commercial creditors is reached by a majority of bondholders. Furthermore, if the Paris Club only manages to reach agreement − internally and with the rest of creditors − on debt reschedulings, the effective amount of debt relief that can be granted may be well below what is required to re-establish debt sustainability. “Steep and prolonged fiscal consolidation” would be the inevitable complement of insufficient debt relief. Austerity measures to free up resources to meet creditor claims would be implemented through the prerequisite IMF programmes that will likely be the foundation of the Common Framework.

Comparability between creditors… and what happens to the debtors?

An identified asymmetry of Paris Club processes is the emphasis of achieving solidarity and comparability between creditors while showing a complete disregard for applying the same criteria to debtors. By using the Paris Club modus operandi in drafting its response to the crisis, the G20 has replicated this flawed and outdated approach. Developing countries are being asked to deal with unprecedented economic, health and social crises while being crushed by competing groups of creditors.

However, there is still time to change course before it is too late. Even the IMF is aware that the Common Framework might end up in failure. In its recent assessment of the international architecture of sovereign debt, the IMF warns that an approach based on official creditor coordination and improvements in contractual arrangements “might not be adequate” to avoid a protracted debt crisis. The flaws of the current non-system of debt restructuring call for a complete overhaul of the international architecture. Now more than ever multilateral discussions should move to promote a systematic and timely approach to orderly, fair, transparent and durable sovereign debt crisis resolution. This involves establishing a multilateral debt work out mechanism. Failure to do so risks repeating the costly mistakes of the past. We cannot afford to let the prospects for development of an entire generation in the Global South be sacrificed to creditor interests as it happened in the 1980s.

Part I of this series can be found here.