HEADING FOR A CRISIS?
The G20’s debt service suspension initiative missed a trick when it excluded Chinese and private creditors. Will a rethink be enough to avert a sovereign debt crisis?
Last year was an annus horribilis for most of Africa. The continent experienced its first recession in 25 years as per the International Monetary Fund (IMF), suffering under the weight of lower commodity prices, Covid shocks and a rapid rise in the cost of funding.
Faced with this trifecta, and with already weak balance sheets, many countries struggled to find the fiscal resources to fulfil their external obligations. This left them with three options in the face of rapidly escalating debtservice costs: delay, restructure or default.
It was against this backdrop that African leaders called for a moratorium on interest payments to avert humanitarian and economic catastrophes. The subsequent creation of the debt service suspension initiative (DSSI) in April 2020 — pioneered by the G20 group of official creditors — initially looked as if it would prevent a full-blown sovereign debt crisis.
But while well intentioned, it was not comprehensive enough to make an impact, due to opacity around its mechanics and its limited scope. Importantly, the DSSI suffered from two major flaws: private participation was voluntary rather than mandatory, and it didn’t adequately account for bilateral creditors such as China.
This was a big miss. At present, “Chinese” and private credit form the lion’s share of Africa’s sovereign debt obligations, accounting for about 55%.
This meant the proposed solution was not fit for purpose. And the failure by African governments, creditors and ratings agencies to find a resolution to this impasse led Zambia to default in November. With fears of contagion taking root, this cast doubt on the capacity of several other African countries to service their debt.
Highlighting the concern, the World Bank predicted that average debt in Sub-Saharan Africa could reach 67.4% of GDP in 2021. That’s substantially higher than the 60% threshold typically recommended by the bank and the IMF. But it’s also a problem given the fiscal position on the continent. In its debt sustainability template, the World Bank suggests that most African sovereigns are already either at moderate or high risk of debt distress.
Though regional growth could recover to about 3% in 2021, this is both precarious and contingent on a global recovery — something that’s not guaranteed, given the sluggish vaccine response in some regions.
So where do things stand?
In recent months, the DSSI has been replaced with the common framework for debt treatments. It proposes a collective creditor approach and policy support under a pre-emptive restructuring exercise.
As a result, several gaps have already been remedied, including the participation of China and the introduction of new processes and conditionalities.
What it means:
Compromise on all sides is needed to rescue African countries and their creditors from the looming debt crisis
In this respect, debt treatment will be undertaken on a country-by-country basis, with several prerequisites in place.
Countries seeking debt restructuring through the framework will be required to undergo a debt sustainability analysis, conducted jointly by the IMF and World Bank. They’ll also be required to sign up to an unspecified IMF programme, which could be taken up even if they are in arrears with private creditors.
But it’s still unclear how the private sector will participate, and on what terms.
Here, the central issue remains the same: how to create a solution that addresses the immediate shortterm funding needs of distressed sovereigns while preserving future market access — and doing so in a way that is not punitive towards private sector creditors.
So what is fuelling the reluctance of private sector participants?
First, why does the private sector even need to participate when the terms and conditions of private debt were clearly laid out from the start?
It’s a difficult argument to dismiss.
There’s the issue of moral hazard: debt forgiveness breeds misbehaviour, especially in the absence of binding commitment to prudence
Sovereigns willingly sought out private debt and agreed to terms, knowing full well that external shocks could arise. They should have anticipated such a scenario, and left fiscal room for debt service obligations.
That said, the pandemic-induced crisis is exceptional. Very few actors could have expected something like this — particularly a crisis of this magnitude and duration. It has severely constrained revenue sources while requiring significant outlays on public health and social security.
Africa’s existing public health and economic deficiencies left it disproportionately vulnerable to the crisis, compared with its more developed and diversified counterparts. This has placed a “moral” obligation on creditors to demonstrate extraordinary goodwill. Multilateral and bilateral creditors have done so — and incurred some losses — so there’s little reason private creditors shouldn’t follow suit.
The second issue is credibility. Private investors say African countries haven’t shown sufficient transparency about their economic conditions. And there’s a risk that funds for debt repayments are reallocated towards nonessential, political expenditure. Zambia, and to a similar extent Chad and Ethiopia, are cases in point.
For much of the past five years, Zambia has been engaged in talks to restructure its eurobond debt and acquire an IMF programme. But the country has been loath to fully disclose its entire debt profile, despite bondholders, the IMF and the broader international community requesting that it do so.
In late 2020, Zambia revised the estimate of its external debt profile to about $13bn — but this is thought to be an understatement, given the large slice of debt that’s embedded in complex infrastructurerelated agreements.
In the absence of transparency, private creditors cannot get an accurate gauge of the country’s true financial status.
And, most concerning, funds that have been saved as a result of debt forgiveness could well be used to finance the ruling party’s electoral bid in elections later this year.
This also applies to Ethiopia, which has requested restructuring under the G20’s new common framework and is also due to hold an election in June.
Then there’s the issue of moral hazard: debt forgiveness breeds misbehaviour, especially in the absence of binding commitment to prudence.
Evidence of this is apparent in the IMF and World Bank’s heavily indebted poor countries initiative.
In 2005, Zambia’s debt was slashed from about $7bn to $500m under the initiative.
But it rapidly climbed in the years that followed. As a percentage of GDP, it went from more than 200% in 2000, to 35% in 2006, and up to 94% in 2009. Elections in 2008 are said to have played a major role in this debt build-up.
So in the absence of stringent checks and balances, there’s a risk that forgiveness under the current framework will follow the same trajectory and breed further spendthrift behaviour.
But private investors’ apparent disengagement is not just due to reluctance on their part. States with favourable balances have been hesitant to approach private creditors due to the risk of downgrades by ratings agencies.
After it signalled its intent to restructure its debt under the G20’s new common framework, Ethiopia’s sovereign rating was slashed by Fitch in February.
It’s a move that has undoubtedly left many an African sovereign with cold feet. How can this be resolved?
Importantly, the first step has already been taken in acknowledging that Africa is barrelling towards a crisis that cannot be mitigated without the participation of all stakeholders. So governments, bilateral and multilateral partners and private investors need to meet each other in the middle.
Policymakers across the continent must realise there’s no free lunch. Investors are unlikely to budge unless there is greater transparency and commitment to both short- and long-term financial reform.
Debt treatment also needs to be paired with adjustments that remedy the continent’s structural vulnerabilities and its susceptibility to boom-bust cycles. This includes deepening domestic markets, increasing domestic savings, promoting diversification and widening the growth base.
While somewhat paternalistic, precedent suggests that accountability measures — with tangible consequences — must be put in place to stop governments shirking their debt obligations. Good behaviour should be rewarded through increasingly preferential repayment terms and other forms of assistance.
Investors, on the other hand, must come to terms with the fact that the continent is dealing with extraordinary circumstances. And while they are well within their legal rights to insist on repayment, the letter of the law and the spirit of the law are entirely different matters.
Potential defaults could result in outcomes that are unfavourable for all stakeholders. But this only means that a proactive approach, rather than a reactive one, may be in everyone’s interests. The ability of all parties to reach a compromise is evident. Their willingness to do so, however, is another question altogether. x