Odette Lienau is a scholar of international economic law, bankruptcy, and debtor-creditor relations. Over the summer, the LPE Blog (with input from the twitterverse) asked her some questions about global debt in the wake of COVID-19, recent international initiatives to provide debt relief, and the rise of China as a major lender to sovereign states. This is the first part of our Q&A. Read part two here.
Let’s start with the pre-COVID context. What was the global debt situation at the time? Were there countries already in distress?
Yes, the situation was already dire in a number of areas, with public and publicly-guaranteed debt becoming unsustainable in the years prior to the crisis. Going in, it was clear that developing country debt would become an even more serious problem. In many countries, debt repayment was already consuming an increasing share of resources, leaving insufficient funds for other expenditures. Collateralized lending had also been on the rise, meaning that creditors could seize specific assets in the event of nonpayment, further tying countries’ hands. By late 2019, global debt denominated in foreign currencies (especially US dollars and euros) had hit an all-time high. This kind of debt might allow a country (or firm) to pay lower interest rates, because foreign investors will not be concerned about local currency fluctuations. But it also means that, if a local currency’s value falls due to some shock or crisis, the relative cost of servicing the foreign-denominated debt can increase significantly.
Furthermore, the pre-pandemic mechanisms for dealing with any debt crisis were already insufficient and in need of an overhaul. For example, over the past decade plus, creditor groups, lending instruments, and forums for dealing with debt have become increasingly fragmented; many different types of creditors from different geographic regions now lend to sovereign states, using lending instruments that include bonds, bank loans, and collateralized debt obligations. On the one hand, this can be a good thing, because financing power is less likely to be concentrated in a small range of entities or financial centers. On the other, when something goes wrong, coordination becomes more difficult, which can lead to free rider and holdout problems among creditors (like the much-discussed vulture funds). This can make any needed restructuring more complex and less likely to be sufficient. This also means that restructuring outcomes—or legal interpretations if different countries’ courts get involved—can vary significantly across creditors and across sovereign debtors, raising questions about fairness. These process-oriented problems have only increased the tendency of major international actors to overlook issues of legitimacy and of what makes for a more sustainable and equitable debt restructuring.
What impact has COVID had? Does it complicate this picture?
COVID definitely has exacerbated the financial distress that many countries were already experiencing. And this is very likely to have long-term ramifications for global debt. To begin with, the economic shock of the pandemic itself—over and above the devastating health outcomes—has been significant, in terms of disruptions to supply chains, drops in certain export commodity prices, declining income from tourism and remittance flows, and, as a result of all this, decreased access to foreign exchange. In terms of impacts on the ground, the World Bank has estimated that almost 100 million people globally have been pushed into extreme poverty as a result of the pandemic. And, of course, even short of these extremes, overall measures of wellbeing have dropped as well. Recent work has also demonstrated that pandemics tend to cause long-term social dislocation, and there is no reason to believe that COVID will be the exception.
Efforts to deal with all this have necessitated a significant rise in government expenditures—to address higher healthcare costs, unemployment, and in some cases food insecurity. Countries have sometimes turned to new debt to provide a financial cushion for these social safety measures—adding to already mounting debt obligations. And, to return to the issue of foreign-denominated debt mentioned above, through much of the crisis, interest rates have been low and liquidity high—leading both countries and firms to borrow even more, including in foreign currencies. These additions undermined the already-fragile financial situation and worsened the risk of a debt surge that existed in many places prior to the pandemic. When major economies such as the US return to standard monetary policy, raising their interest rates and becoming more attractive to investors, there is a risk that capital will leave other areas and make them that much more vulnerable.
Is there a Global North/Global South divide in this picture?
It is absolutely the case that not all countries have been impacted equally—and of course the pandemic has differentially impacted groups within countries too. In terms of basic economic strength and healthcare capacity, states encountered the crisis from wildly varying starting points. They also had different levels of vulnerability to the vagaries of the international economy—in terms of their reliance on imports, their dependence on exports and other sources of foreign exchange, and their external borrowing costs. Not to mention their exposure to other shocks, such as climate change-related weather patterns.
It is unsurprising that World Bank President David Malpass warned of an “inequality pandemic” that may come on the heels of the broader public health and economic crisis. The pandemic is likely to worsen inequality across a number of axes, including by accentuating the concentration of poverty in certain countries—not just in low-income countries but also middle-income countries, particularly in Africa.
All that said, it is worth pointing out that the US is facing its own potential crisis with the looming debt ceiling deadline, now extended into December. Though, of course, this is more a crisis of Congress’s own making; most countries do not have the luxury of manufacturing a debt crisis as costly political theater.
You mentioned earlier the entry of new creditors into sovereign debt markets. There has been discussion about the rise of China as a major lender to sovereign states. How should we think about this?
Chinese entities, and in particular the Chinese state and its subsidiaries, have become massively important in sovereign debt markets, and China is now the world’s largest official creditor. This is one reason, among many, for the more generalized anxiety in the US about the rise of China—the realization that the US doesn’t have a monopolistic hold on financial power (or, for that matter, on the chance to use it badly). Previously, we knew little about the terms and conditions of China’s lending policy. This situation changed this past spring, with the publication of an in-depth study of Chinese lending contracts with foreign governments. This partly instigated a hearing in the US House Committee on Financial Services that focused on Chinese lending (and at which I testified).
The study highlighted that these contracts take problems that have been endemic in sovereign debt for a long time to a new extreme—a lack of transparency, creditor efforts to gain advantages that undermine collective restructuring processes, and the control and limitation of borrowing countries’ policy space. In some cases, the contracts actually write in these defects. For example, they include clauses barring the publication of debt terms, or promising not to restructure debt in collective processes. So they move in the opposite direction of what is needed.
That said, some of the ‘China as big, bad lender’ narrative is oversimplified—particularly the insistence that Chinese entities target countries for the nefarious purpose of entrapment through debt. As in many cases, countries may seek out financing and find little available at reasonable terms. Chinese entities have been more willing to lend over the last decade, though this has slowed down recently. As always, if things go awry, borrower countries can end up in untenable debt situations.
In terms of what might be done, I think that any effort to focus exclusively on Chinese lending is virtually certain to fail. The best way to constrain troublesome practices by one set of creditors is to establish rules and norms relevant to all creditors. Otherwise, efforts to constrain any actors are unlikely to stick. Many US affiliates have benefited just as much—and sometimes much more—from deficiencies in the international framework. If US and European officials are serious about curbing problematic lending practices by other countries or their affiliates, they will have to make that commitment clear to domestic constituents as well. The rise of China as a lender does not change the underlying problems of the system or the need for more generalized improvements in international financial practices.