The United States Treasury secretary, Janet Yellen, World Bank chief Ajay Banga and a host of world leaders looked on as Hakainde Hichilema, the president of Zambia, took the microphone. The occasion: a Paris summit hosted by French President Emmanuel Macron on June 24 to brainstorm solutions to a debt crisis sweeping the developing world.
It was a moment of respite for Zambia, which in 2020 had become the first African country to default on its sovereign debt following the devastation of COVID-19. In Paris, its biggest lenders including China and Western nations agreed to restructure $6.3bn of Zambia’s loans under an initiative driven by the G20.
Yet, after thanking France, China, South Africa – which played a key role in the negotiations – and others, Hichilema struck a note of caution. It had taken more than two years of talks for the approval of Zambia’s debt restructuring plan, he pointed out. “For the countries that are coming after us, there is a need to expedite the processes,” Hichilema said. “Every day we don’t deliver these things that are within our control, we are basically increasing the costs and the damage gets compounded.”
The queue of countries seeking debt restructuring like Zambia is only growing.
The majority of low-income developing countries are today either already in or near debt distress. Meanwhile, the world’s two large economies, the US and China, are expected to see a jump in their public debt at higher levels than before the pandemic.
Ghana and Sri Lanka defaulted on their external debt in 2022, two years after Zambia did. Pakistan and Egypt are on the verge of a default. On June 30, Pakistan secured a tentative $3bn funding deal with the International Monetary Fund (IMF), promising it potential, short-term relief.
Global public debt levels remain high – at 92 percent of gross domestic product (GDP) at the end of 2022 – despite falling from the record levels seen during the COVID-19 pandemic, when they touched 100 percent of GDP at the end of 2020.
So, is the debt crisis a global contagion? Are low-income countries at a much higher risk than the others? Would countries be forced to accept tough conditions for bailouts? And what can richer countries and financial institutions like the IMF and World Bank do to ease the pain?
The short answer: The growing debt of poor countries is alarming but there is no evidence of a contagion that could trigger a global crisis. Yet. However, economists and debt-management experts say richer countries need to act fast to bring relatively new creditors, including China and the private sector, on board for debt restructuring deals for a quicker economic recovery and to avoid a repeat of the 1980s debt crisis that hobbled dozens of less-developed nations for years.
The collapse
The COVID-19 pandemic crushed economic activity globally, leading to revenue shortages and increased spending by governments to shield the economy from the adverse effects of a slowdown and layoffs. As a result, global public debt shot up the highest in a year from 84 percent of GDP at the end of 2019 to 100 percent a year later.
Poorer nations, which were hit the worst by the public health crisis, had to depend more on external loans to survive.
About 60 per cent of low-income developing countries are now either high risk or in debt distress and have either had, or are about to start, a debt restructuring process. This figure was 40 percent before the pandemic.
The debt situation was compounded by Russia’s full-scale invasion of Ukraine in February 2022, which led to an increase in global commodity and food prices.
“Now, the resurgence of inflation means major central banks have increased interest rates, making the cost of debt servicing costly and this is a problem for both low-income and middle-income countries,” Ugo Panizza, a professor of economics at the Geneva-based Graduate Institute of International and Development Studies, told Al Jazeera.
In all, 52 developing countries – home to half the world’s population living in extreme poverty – are facing severe debt problems and high borrowing costs.
As often happens amid crises, the dollar’s value strengthened over 2022 compared with most emerging and advanced-economy currencies as investors’ demand grew for the US currency, viewed as a safe asset. This, in turn, has made it even costlier for lower- and middle-income countries to meet their debt obligations as most cross-border loans and international debt is denominated in US dollars.
“A lot of global liquidity coming up for refinancing is in dollars and if your currency deteriorates, as it happened in the case of Ghana, where the cedi collapsed, your ability to meet the debt payments is hugely damaging,” Judith Tyson, a research fellow who specialised in private investment and financial development at the Overseas Development Institute (ODI), told Al Jazeera.
“There’s probably going to be some more years of high levels of dollar and interest rates and that’s a significant problem. ”
Ghana’s currency, the cedi, lost more than 50 percent of its value between January and October 2022, causing Ghana’s debt burden to rise by $6bn. Ghana defaulted on most external debt in December and now aims to reduce its external debt repayments of $20bn by half over the next three years to secure a $3bn loan deal from the IMF as a part of its debt restructuring.
Yet, the struggles of Ghana, Sri Lanka, Zambia and dozens of other nations teetering on the edge of default are not unprecedented.
‘The lost decade’
The oil price shocks of the 1970s led to high spells of inflation, pushing the global economy into a recession in 1981 as central banks hiked interest rates to control the high price rise.
As many as 16 Latin American countries, led by Mexico, and 11 other less-developed countries, had to reschedule their debts, prompting the first global debt crisis.
The period of the 1980s is also referred to as the “lost decade” as many less-developed countries agreed to spending cuts on infrastructure, health and education in exchange for debt restructuring, with several nations ending the decade with income levels that were lower than in 1980.
More than 30 cases of unsustainable debt from poor countries, especially in sub-Saharan Africa, led to the creation of a joint debt-relief measure by the IMF and the World Bank, known as the Heavily Indebted Poor Countries Initiative, in 1996. Countries had to meet certain criteria and commit to policy changes to reduce poverty to receive 100 percent relief on eligible debts from the IMF, the World Bank and the African Development Fund.
Jeromin Zettelmeyer, the director of Brussels-based economic think tank Bruegel, who co-authored a paper in April titled “Are We Heading for Another Debt Crisis in Low-Income Countries?”, told Al Jazeera there are similarities and differences between the present debt situation and past shocks.
“Most sovereign debt crises are preceded by periods of higher (budget) deficits, built up of debt, and some are triggered by higher real interest rates,” he said. “So, these ingredients of a sovereign debt crisis are present right now.”
Yet, other “ingredients” are missing, he said, pointing to how this crisis is not just a repeat of what the world has seen previously. Many previous crises have come in the wake of lower commodity prices. Several poorer nations are also major exporters of oil, gas and minerals. A decline in commodity prices hurts their incomes. “But the commodity prices are relatively high right now,” Zettelmeyer said.
Zettelmeyer said the debt crisis does not look global in scale for now and, in the worst case, could be confined to developing countries. In their April paper, he and his colleagues concluded that debt vulnerabilities in low-income countries were substantially less alarming than they were in the 1990s. Zettelmeyer said the economic fundamentals of poorer nations also look stronger than in the 1980s and 1990s.
In the case of Sri Lanka and Zambia, Zettelmeyer said their defaults were the result of poor domestic economic management, with the COVID-19 pandemic exacerbating the situation.
But in both instances, the search for a solution to their debt crises has spilled over from the world of global finance to geopolitics, because of the emergence of a major new player: China.
Whose money is it?
Traditionally, poorer countries primarily borrowed from the so-called Paris Club of creditors, most of them richer countries such as the US, UK, Australia and Germany, as well as multilateral institutions like the World Bank, the IMF or the African Development Bank.
However, over the past 20 years, China and private bondholders have become significant lenders to these countries.
The share of external debt owed by low- and middle-income countries to Paris Club creditors dropped from 28 percent in 2006 to 11 percent in 2020. Over the same period, the share owed to China increased sharply, from 2 percent to 18 percent, while the share of Eurobonds – international bonds denominated in a currency other than that of the issuing country – sold to private lending institutions rose from 3 percent to 11 percent.
China holds more than half of Zambia’s external debt. Sri Lanka owes more than 10 percent of repayments to Beijing. In fact, for more than half of the 73 countries that are part of the G-20 Debt Service Suspension Initiative – under which debt payments to creditors were suspended owing to COVID-19 from May 2020 to December 2021 – China is now the largest official bilateral creditor.
To integrate creditors such as China and the growing number of private players into the multilateral debt relief process, the G20 set up a “common framework” in 2020 to coordinate debt treatments for low-income countries between the Paris Club and other major bilateral creditors such as China, India and Saudi Arabia.
But three years later, this common framework has not proven to be much of a success. Only Zambia, Chad, Ethiopia and Ghana have requested its use, with Zambia becoming the first country to reach an agreement with the official creditors committee.
And in case after case – whether Sri Lanka or Zambia – negotiations have been shadowed by a blame game, with Western nations accusing China of dragging its feet in agreeing to restructuring plans and thereby delaying the process. Beijing has denied those allegations.
The real problem might be deeper, according to some analysts.
‘Design mistake’
The very design of the common framework is limiting its chances at success, these experts argue.
The framework follows the Paris Club’s step-by-step approach. The debtor country initiates a restructuring process, which is followed by an economic reform programme supported by the IMF. The country in debt fully discloses all of its loan commitments. Official creditors (foreign governments) and private sector creditors then offer comparable, if not matching, relief.
Meanwhile, multilateral development banks like the World Bank or Asian Development Bank enjoy a preferred creditors status – meaning the repayment of sovereign debt to them takes precedence over other creditors.
China has demanded that this change and that multilateral development banks take haircuts during the debt restructuring process for Zambia and Sri Lanka, just like commercial creditors and foreign governments.
“The framework hasn’t really considered how to bring China fully into the picture,” Thomas Laryea, an international law and policy expert at US-based law firm Orrick, Herrington & Sutcliffe, who specialises in advising governments and creditors on international finance matters, told Al Jazeera. “The common framework had the intent to do that but one of the weaknesses was that it was designed around the old Paris Club processes and that, I think, was a design mistake.”
Zettelmeyer agreed.
“The newcomers and, in particular, China, which is now the biggest lender, are a bit wary of simply following the rules of the game of the West,” he said, adding that the IMF’s central role also rankles Beijing. “The main difficulty is that China does not want to delegate decisions on debt relief to an institution like the IMF, so it has been reluctant to sign up to the Western debt restructuring procedures.”
Laryea also criticised the common framework for “relegating the private creditors to the residual creditor”.
Under the current process, bilateral government lenders negotiate deals with the indebted country and private creditors are expected to match the terms of those agreements. That “is a significant mistake because private creditors are a material source of financing in some countries,” Laryea said.
Unhappy private lenders often end up refusing to match the terms offered by bilateral creditors, thereby stalling the debt restructuring process.
Tyson at ODI agreed that one way around this would be to bring private creditors on board the restructuring process proactively, rather than trying to get them to agree on terms decided without consulting them.
There is a growing recognition of the need for change. Earlier this year, the IMF, World Bank and the G20 set up the Global Sovereign Debt Roundtable (GSDR) to fix the common framework and speed up debt restructuring already facing delays.
Ultimately, Laryea said, no one gains if a country’s debt becomes and remains impossible for it to repay.
“If a country’s debt is unsustainable, then the quicker it’s restructured, then it’s better for everyone, including the rich country creditors,” he said.
