Debt Relief? Thank you but, no thank you! – Foreign and security policy
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In April 2020, the G20 offered the 73 least developed countries a temporary suspension of their debt service to the G20 and all members of the the parisian club. The goal of this Debt Service Suspension Initiative (DSSI) was to unlock funds in these countries to help contain the coronavirus pandemic.
While the virus itself claims the most lives in industrialized economies and large emerging economies, the recession triggered by the pandemic is hitting countries in the South particularly hard. As a result of slowing global supply chains, slowing tourism and declining demand for raw materials, government revenues decline and economic growth collapses.
Deferring debt service through a moratorium makes sense in this situation because, unlike disaster and development assistance, it mobilizes funds that are already in the country. They are available immediately and there are no transaction fees. However, as of September 1, 2020, only 43 countries had accepted the initiative. Of the remaining 30, eleven explicitly rejected the offer. Why?
The fear of a downgraded credit score
In principle, there are two reasons for rejecting the moratorium, each with a different degree of plausibility. A group of countries does not find the offer attractive because the funds released are too limited in absolute and / or relative terms compared to overall economic output. Therefore, the bureaucratic effort of negotiating with individual bilateral creditors is not in a reasonable proportion to the fiscal leeway that can be gained.
In two of the countries the amount involved is less than $ 2 million and in five it is less than $ 5 million. In ten of these countries the amounts concerned may be large in absolute terms, but relative to economic output – the relief is not even 0.2 per cent. For this reason, it would be easier to look for external subsidies or potential savings in public budgets.
In fact, Fitch, for example, threatened to downgrade Cameroon’s rating at the start of the initiative, but then left the country’s “B” rating unchanged after the government accepted the DSSI.
The second reason is much less plausible, but politically more interesting. Kenya is a good example: with $ 802 million, or about 0.8% of GDP, it is one of the countries that could have benefited the most from the moratorium, in absolute and relative terms. Already in mid-May, Finance Minister Yatani announced that Kenya would not use the DSSI initiative, so as not to question the country’s rating by the major agencies. If, by taking advantage of the moratorium, Kenya were to be downgraded by Fitch, Moody’s and Standard & Poor’s, it would increase the costs of refinancing its debts with foreign private creditors and thus constitute a losing proposition for Kenya.
In fact, Fitch, for example, threatened to downgrade Cameroon’s rating at the start of the initiative, but then left the country’s “B” rating unchanged after the government accepted the DSSI. Instead of using the DSSI, Kenya wants to negotiate bilaterally with individual creditor governments about debt relief – and this is where things get confused. With 212 million euros in claims on Kenya, Germany would have been considered relevant for a bilateral initiative. To date, however, the German Paris Club delegation has not been approached by the Kenyan government. Apparently, despite the economic situation which has deteriorated dramatically due to the coronavirus, Kenya has given up on debt relief with nothing in its place.
Forcing the private sector to participate
Is the fear of a deterioration linked to interest rates by the rating agencies plausible? This question of course applies not only to Kenya, but to other important countries among DSSI applicants that have access to the international capital market, such as Cambodia, Ghana, Laos and Mongolia.
In fact, in May, Fitch and Moody’s did not downgrade Kenya’s rating, but lowered its outlook from “stable” to “negative”. Unlike the threat to Cameroon in April, the detailed reasons Fitch published do not even mention possible relief through DSSI. Rather, he cites the sharp drop in tourism, the resulting slowdown in growth and the increase in debt due to the growing deficit anticipated by the agency.
The hypothesis that the use of a moratorium offered by public creditors would lead to a downgrading of the relevant rating for private investors is based on the idea that a debtor enjoying this advantage would turn out to be a bad debtor. Private creditors like to cultivate and communicate this idea to persuade their sovereign debtors to continue to service these debts, even during existential crises such as the coronavirus pandemic, despite high opportunity costs and questionable debt sustainability. .
At the meeting of finance ministers at the annual meeting of the IMF and the World Bank in October, the G20 will have the opportunity to correct a flaw in the design of the DSSI.
In the first phase of the initiative, both the head of the World Bank and the president of the Paris Club had urged that the private sector be forced to participate, but then they did not dare to take the opportunity to ‘such an application. In July, the Paris Club had to sheepishly admit that it would not use options like its equal treatment clause, which is usually the norm in debt rescheduling agreements. As a result, the waiver of the obligation to public creditors ensures the continued satisfaction of credit claims – even if the public waiver really should have been used to finance the fight against the pandemic.
The G20 can correct its mistake
Would mandatory private sector involvement lead to downgrading and therefore deterioration of market access? While many individual factors play a role in determining interest rates, future repayment prospects are much more important than past performance – provided a country has not arbitrarily and unnecessarily suspended payments. It can be argued that debtors should not have been intimidated.
As the reasons given for the limited devaluation of Fitch show, agencies that use more than 40 indicators for the assessment, mainly look at a country’s future capacity to service its debt, which is of course not negatively impacted by the write-off of debts by individuals. creditors, but rather positively, if at all. Where moratoria have been granted in the past in response to disasters, this has had no negative impact on countries’ access to the capital market. A prime example is the 2005 Paris Club moratorium on public creditors for Indonesia and Sri Lanka when they were hit by a tsunami.
Even when the poorest countries received not only moratoriums but also full debt relief from their private creditors, access to the capital market did not deteriorate, but – as logic suggests – did. is improved. The best example is the multilateral debt relief initiative for heavily indebted poor countries in the early 2000s, known as the HIPC / MDRI initiative (Initiative for Heavily Indebted Poor Countries and Multilateral Debt Relief Initiative). As a result of debt relief, some of the HIPC countries received for the first time a rating and access to the Eurobond market.
For example, after a long, vast and painful phase of rescheduling for all involved, Argentina had such free access to the international capital market from 2015 that the liberal Macri government was able to plunge the country into a new sovereign debt crisis in just three years. . And as long as investors in Western countries seek zero interest rates in their countries, bonds issued by emerging and developing countries will not lose their appeal – whether there has been a moratorium or debt rescheduling.
At the meeting of finance ministers at the annual meeting of the IMF and the World Bank in October, the G20 will have the opportunity to correct a flaw in the design of the DSSI. Proposals on how the private sector might be forced to share the burden are on the table: these include the Paris Club equal treatment clause in a UN Security Council resolution, the internationalization of the British “anti-vulture fund” law and the creation of a World Bank credit center. This would be very good news for a global containment of the pandemic and a rapid recovery of the global economy.