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 second part of our Q&A. Read part one here.
What do you think of the international initiatives thus far to deal with the sovereign debt problems exacerbated by COVID? Do you think they will be enough to deal with a potential crisis?
I think they will have to go further, in terms of the scope of financial support and debt relief, the pressure necessary to ensure broad creditor participation, and the range of countries covered. The main international initiatives thus far have centered around the G20’s Debt Service Suspension Initiative (DSSI) and the subsequent ‘Common Framework for Debt Treatments beyond the DSSI,’ for which only 73 lower-income countries are eligible. These are useful first steps, particularly because they have involved China, which is not an official member of the ‘Paris Club’ of previously dominant bilateral creditor states. But the DSSI, announced in April 2020, only temporarily suspends debt payments; this means that the debt remains and indeed increases, as interest continues to run. Furthermore, the DSSI targets only certain public bilateral creditors; private creditors can voluntarily participate, but none have done so.
The Common Framework, endorsed by the G20 in November 2020, improves upon this in that it makes actual debt restructuring possible, so it could permanently cancel debt (or a portion of that debt). It also requires burden-sharing by private creditors and other lenders on comparable terms with the principal creditors. However, international finance industry groups have lobbied hard to water down real participation in these initiatives, so we’ll see how it goes in practice. Furthermore, countries have been deterred from participation by concerns about credit rating downgrades. The Common Framework also requires the type of IMF-backed program mandated in many official restructurings; these aim to stabilize a country’s financial situation but continue to be associated with austerity and increased inequality. Hopefully, future programs will make more realistic assessments of country economic capacity and be attentive to how the burdens of restructuring are distributed within a country, so that the most vulnerable are not harmed even more.
And it is worth pointing out that not all eligible countries have participated in even the more modest DSSI, and as of fall 2021 only three had applied for restructuring under the Common Framework. Honestly, I’m not very surprised at their hesitation, even if participation would be the right choice. Borrower country officials and citizens need to know that debt relief will be comprehensive and sufficient—that all creditors actually will participate and that efforts will be made to deal with any holdouts. They also need confidence that the programs adopted will lead to sustainability and will not be so economically disruptive as to cause social and political unrest. Otherwise, countries may end up in a restructuring situation with many downsides that still does not offer sufficient relief. So the nature of the implementation and the willingness of key actors to maximally support the process will matter, as was clear right from the beginning.
Another major initiative has involved the injection of additional liquidity into the international system, particularly through the recent issuance of IMF Special Drawing Rights (SDRs). This may ease the burden of debt payments or relief efforts for some countries, although there is a mismatch between SDR allocation and country need. But, again, the devil is in the details, and particularly in how those allocations are used, and the recent G20 and IMF/World Bank meetings did not make very much substantive progress. Without real attention to distributional effects, there is a risk that any future allocations go primarily to repaying private creditors instead of supporting health and economic recovery, as critics have pointed out.
On increasing global aid and liquidity, it seems that, any time there is a call for significant international relief, questions are raised about corruption and waste. Should this be a concern for pandemic-related sovereign debt relief? How do we think about this issue?
We absolutely want to make sure that funds go where they are most needed, rather than into the pockets of wealthy political or economic elites. But this should not become an excuse to avoid taking serious steps to address the crisis. Any such avoidance ultimately will hurt the most vulnerable. So punishing country populations for bad leaders, by withholding liquidity and needed funds, is not the right route. The magnitude of the current problem is so large that an incomplete recovery will only worsen inequality and have a detrimental effect on human welfare. And this would limit the ability of these countries’ citizens to hold their officials accountable.
If we really want to address these issues, we need to deal with the broader economic and legal structures that enable problematic financial flows. For example, we could try harder to constrain the capacity of self-dealing elites to hide funds, in order to limit the incentives and mechanisms for large-scale corruption. This might mean strengthening efforts to target tax havens and to uncover the ultimate beneficial owners of shell corporations. In addition, we need to establish rules and norms that place more burden on creditors to ensure that officials or state entities actually have the authority to enter into a sovereign debt contract. If they fail to meet this burden, then creditor recovery should be limited accordingly.
I also think efforts to enhance creditor-side transparency in lending are very important, and that current efforts led by the Institute for International Finance (a creditor industry group) and endorsed by the G20 are insufficient. It is sometimes said that borrowing countries are primarily responsible for transparency and other related reforms, perhaps as a facet of ‘country ownership’ of their financial futures. This makes sense to a degree. But it is also possible that ruling elites will prefer to delay these reforms, while a borrowing country’s citizens do not have the information or the power to implement them. So, given the power imbalances on the ground, more needs to be done from the creditor side. In the long run, this could help to undermine problematic internal dynamics in debtor countries as well.
How likely is it that looming defaults will reignite momentum for something more far-reaching, like a sovereign debt restructuring mechanism? What would such a mechanism look like?
The dire situation has certainly reignited discussion and attention. Very soon after things shut down in 2020, UNCTAD (the United Nations Conference on Trade and Development), which tends to be more attentive to the concerns of developing countries, called for massive debt relief and also for the establishment of a new international debt authority. Civil society groups have renewed and intensified their longstanding demands for a global debt restructuring body based at the UN. Senior scholars and establishment policymakers through the G30 have suggested a more modest standing consultative mechanism, at least initially to be attached to the G20’s Common Framework. Somewhat paralleling the call for a ‘Green New Deal’ in the US, other analysts have called for a green debt relief program. And many other proposals have emerged—virtually all of which would improve things in one way or another.
I personally would encourage progress on multiple tracks—through market/contractual improvements, incremental work in the multilateral arena, and also changes to domestic legislation in key jurisdictions. Sometimes these are presented as competing approaches, but in my view friendly competition can be productive. The gold standard might still be a multilateral treaty-based sovereign bankruptcy mechanism with real teeth. But there seems to be little appetite for this. So it makes sense to move toward an explicitly multi-track process in furtherance of shared sovereign debt resolution principles—something I’ve called disaggregated sovereign bankruptcy. Ideally this would be supported by an independent international body that could coordinate across these tracks, build actor networks, and generally act as a focal point for initiatives and proposals to improve the sovereign debt system.
What kind of effort would this more ambitious international approach take? Is there any chance the US might support such a move?
Setting up something along these lines would take leadership not only by international actors but also by countries. A smaller group of sponsor countries could get things going, with support from civil society organizations, sympathetic international officials, activists, and scholars. I don’t currently imagine that the US would be a key sponsor, though I would love to be proven wrong. Although the Biden economic team has been relatively progressive on the domestic front, it has not taken a very strong lead in the international arena, at least in dealing creatively with sovereign debt issues. There are longstanding US-based interests that favor the current global financial system, so perhaps this is not surprising. And, more generally, the US has not engaged in a real rethink of its values on the international economic front—for example, should any reorientation of economic policy toward people on the ground (‘Main Street vs. Wall Street’) extend globally? And, to the extent that the US claims to favor local self-determination, does that apply to the financial arena? What might support for economic self-determination even mean these days? All that said, the more modest approach internationally may not be a deliberate choice—there is certainly enough to stay busy with in domestic finance, and there remains no permanent Under Secretary for International Affairs at the Treasury Department (among many other vacancies). Unfortunately, by the time a crisis is upon us, it’s often too late.
Thank for sharing your insight with our readers.
Thanks for inviting me to do this!