The sovereign-debt Challenge

One of the Covid-19 pandemic’s many complex legacies will be a high level of public-sector debt in most countries. This reflects governments’ increased spending to tackle the crisis, as well as the collapse of tax revenues as economies imploded in 2020. As a result, many lower- and middle-income countries are at risk of sovereign-debt distress.

Although many developed countries are heavily indebted, their interest rates are low by historical standards – and negative in real terms. Developing countries, despite increasing their public spending less sharply during the COVID-19 crisis, must pay higher interest rates on their sovereign debt. These rates, and the risk spreads that poorer countries pay in international capital markets, may rise as interest rates in advanced economies – and the United States in particular – start to climb. Shortly before the annual International Monetary Fund and World Bank meetings in October 2020, IMF Managing Director Kristalina Georgieva called for urgent reforms to the international debt architecture. But action has been quite limited. True, the G20 launched the Debt Service Suspension Initiative for low-income countries at the pandemic’s onset, and extended and complemented it last November with a mechanism that allows these countries to renegotiate their debts on a case-by-case basis. But private-sector participation in this initiative has been limited, and nothing similar has been offered to middle-income countries (though some – notably Argentina and Ecuador – have been able to renegotiate their debts based on existing frameworks). “Responding to Risks of COVID Debt Distress,” a recent report from the Friedrich Ebert Foundation New York bureau and the Consensus Building Institute, outlines the challenges facing developing countries. Drafted by a panel (including me) comprising former senior government officials, private attorneys, and academics who have studied sovereign-debt restructurings, it contains several key messages

. Not all developing countries need to restructure their debts. In fact, one of the notable features of the current crisis has been that private capital flows to these economies returned quickly – in around two months – after a sharp initial “sudden stop” in financing in the northern spring of 2020. But the Brookings Institution’s Homi Kharas, a member of the panel, warns that the risks are high. Of the 120 developing countries he analyzed, 90% are speculative or high-risk debtors. Together, they account for more than half of all debt service due in 2021-22.

International policymakers must therefore pursue two objectives that, as the report underscores, should be mutually reinforcing. They need to promote full, equitable, and transparent private-creditor participation in debt reprofiling and restructuring when needed. And they must provide additional financial support that enables developing countries to maintain their investments in sustainable development. The first of these objectives requires transparency of public and private sovereign debt for both creditors and debtors. In the short term, this involves sharing detailed sovereign-debt information (obviously with provisions to preserve the confidentiality of commercially sensitive information). This should include details of collateralized liabilities and the debts of state-owned enterprises and subnational governments that are backed by national governments.

The long-term solution is to create a sovereign-debt registry where detailed information can be shared between sovereign debtors and their creditors, with aggregate information being made publicly available. Equally important, developing countries’ domestic legal systems need to adopt debt-transparency standards, and creditor countries need stronger rules limiting the enforceability of debt contracts to cases where these standards are in place. In addition, the principle of comparable treatment of creditors in debt reprofilings and restructurings must be upheld. All parties participating in these processes – with the exception of recognized preferred creditors – should publicly commit to adhere to this principle, and international financial institutions should use the means available to them to ensure that sovereign debtors and all creditors abide by it.