China Joins Effort to Avert Sovereign Debt Crisis
As China has emerged as the largest creditor to developing countries it is taking on a new role with global lenders helping sovereign borrowers restructure repayments amid the worst debt crisis for poor countries since the 1980s.
Since 2020, a new wave of international sovereign debt default risks has surfaced, exacerbated by the Covid-19 pandemic. According to the World Bank, more than 70 low-income nations were collectively managing $326 billion in debt as of the end of 2021. More than half of them are in or near debt distress, including Zambia, Ethiopia, and Ghana.
Increased borrowing costs and a stronger dollar have made refinancing and repaying loans more expensive for developing countries, tightening their liquidity squeeze. In Africa, the debt servicing averages 17% of government revenue, the highest since 1999, according to Debt Justice, a London-based group that advocates for reforms on behalf of borrowers.
“This is the most severe debt crisis since the 1980s,” Sean Hagan, former general counsel at the International Monetary Fund (IMF), said in an interview with Caixin.
The growing threat is reminiscent of the debt crisis of the 1980s when highly indebted Latin America and other developing regions struggled to repay borrowings amid spiking oil prices and a recession among developed economies.
What is different this time are structural changes in sovereign debt and the rise of new creditors including China buoyed by robust economic growth and expansion of foreign investments.
For the first time China, India, Saudi Arabia, and the Paris Club of mostly Western traditional creditor nations are collaborating on debt resolution cases in multiple countries, said Guillaume Chabert, IMF’s deputy director for strategy.
The share of debt from low-income countries that is held by the 21 Paris Club nations has sharply declined. The proportion of such debt held by the United States averaged 2.4% from 2016 to 2021, down from 27.5% from 1980 to 1985, according to World Bank data. By contrast, China’s share over the same period has risen to 30.4%, the highest among major creditor nations, from 2.1%.
China is the largest creditor to many countries under imminent debt distress. For instance, three-quarters of Zambia’s borrowings that must be restructured are owed to China, according to the IMF.
Lengthy negotiations on debt reduction have been underway among creditors to determine who should bear potential losses and how restructuring plans should be arranged. Whether and how China will provide debt relief is a key element of these discussions.
In late 2020, the Group of 20 nations representing the world’s leading economies including China agreed to a roadmap called the Common Framework for restructuring debt from poor countries on a case-by-case basis. The process has been plagued by delays.
During the World Bank and the IMF’s spring meetings in April, People’s Bank of China Governor Yi Gang called for collective action and “fair burden sharing” to address the sovereign debt issues of developing countries. Yi said China is committed to work with all parties to implement the Common Framework on debt relief.
Some progress has been made recently. At the World Bank and IMF meetings in April, a consensus was reached at the Global Sovereign Debt Roundtable (GSDR). The World Bank committed to providing debt relief to debtor countries through grants or highly concessional loans. Based on this consensus, major bilateral creditors, including China and France, pledged to provide debt relief in accordance with the IMF’s debt sustainability analysis, or DSA, an important tool for assessing sovereign vulnerabilities.
Following the agreement, the IMF in May approved a $3 billion assistance program for Ghana and immediately disbursed an initial payment of $600 million, marking the start of the African country’s debt restructuring process and a major breakthrough in the international sovereign debt resolution.
On June 22, Zambia reached an agreement in principle to restructure $6.3 billion of debt with bilateral lenders, as creditors led by China and France agreed to extend the maturities on loans over some 20 years. The deal marks the first major relief won by a developing country under the Common Framework.
Zambia’s case could pave the way for other nations such as Ghana, Sri Lanka and Ethiopia to achieve similar agreements in their negotiations with creditors.
About 20 countries are currently in default or seeking debt restructuring, according to the IMF. The combined population of these countries is 718 million.
“When we talk about debt, we’re not talking about an abstract issue,” said IMF Managing Director Kristalina Georgieva told Caixin in March. “We are talking about something that touches the lives of millions and millions of people.”
Restructuring terms with borrowers is in the best interest of lenders, Georgieva said. “Early debt resolution allows countries to grow,” she said. “When they grow, they can pay back their creditors.”
Emerging debt crisis
Over the past decade, middle- and low-income countries have taken on a new wave of borrowings. The total debt overhang of such counties reached $5.3 trillion in 2021, or about three times their debt level in 2006, according to studies by Lu Feng, a professor at the National School of Development at Peking University.
Since 2019, nine countries — Argentina, Belize, Ghana, Ecuador, Lebanon, Sri Lanka, Russia, Suriname and Zambia — have defaulted on borrowings.
About 60% of low-income countries face high debt vulnerabilities, according to an IMF report in April.
Multiple factors contributed to the debt accumulation in recent years, according to Hagan, the former IMF official. Some countries have borrowed excessively for political purposes. Then, the surge in public spending related to the pandemic combined with higher borrowing costs resulting from increased interest rates have worsened the position of borrowers.
“Even if the Federal Reserve stops raising interest rates soon, rates are unlikely to return to the low level seen before the pandemic,” said an overseas private equity manager.
As debt risks continue to accumulate for debtor nations, the existing framework for international debt resolution is also facing more limitations, mainly due to the changing creditor landscape.
As of the end of 2021, China and India, both non-Paris Club members, emerged among the top five creditors to low-income nations, according to the IMF. China is now by far the largest bilateral lender to most of these countries. “This adds to debt restructuring difficulties as non-Paris Club creditors have often provided debt treatment to debtor nations on a case-by-case basis, without a formal organizing framework like the Paris Club,” the IMF said in its April report.
Facing a more diverse group of creditors increases the difficulty for distressed borrowers to reach agreements on debt solutions. Protracted negotiations are costly for poor nations because delays in restructurings block the countries’ access to IMF aid and hinder implementation of necessary reforms, Hagan said.
“This kind of delay comes at a high cost, as there is a limited window of opportunity for effective economic and debt adjustments,” he said.
China has in recent years been mired in disputes with developed countries and multilateral banks over which parties should take the lead in restructuring sovereign debt.
Developed lenders have called on China to accept losses in debt reduction, but China has pushed for rescheduling payments instead of accepting so-called haircuts. It also wanted multilateral development banks, through which most developed creditors extend loans to poor countries, to participate more in debt relief.
But the inclusion of loans by multilateral development banks in debt restructuring has met opponents from developed creditors led by the U.S., the biggest shareholder in the World Bank. They argued that any loss would undermine the institutions’ ability to respond to crises and make concessional loans.
In April, the International Development Association, a World Bank arm that provides help to the poorest countries, announced a plan for more concessional loans and grants to nations facing higher risks of debt distress. The move, following the Global Sovereign Debt Roundtable meeting of creditor and debtor nations, is expected to help unlock the impasses.
More detailed negotiations are needed to clarify the scale and methods of debt reduction.
The current international sovereign debt resolution and IMF assistance model has evolved since the 1980s debt crisis, led by the Paris Club creditors and multilateral financial institutions. The mechanism can be roughly divided into two phases.
In the first phase, debt-distressed countries seek IMF assistance, undergo the organization’s debt sustainability analysis, or DSA, and negotiate assistance programs and reforms with the IMF. At the same time, the IMF engages in discussions with bilateral creditors for debt relief, and secure financing assurances before fund disbursement.
In the second phase, bilateral official creditors finalize the specific debt reduction methods and details and provide actual debt relief. The IMF disburses subsequent assistance funds and oversees the crisis-stricken country in achieving macroeconomic adjustments and reforms.
During the process of calculating debt reduction, the DSA led by the IMF is crucial and serves as a basis for debt reduction commitments made by creditors. But complaints over the transparency of the analysis have mounted over the past two years.
During the April GSDR, China proposed that the IMF and World Bank provide more comprehensive and timely information sharing, according to sources close to the matter. This would support China’s participation and decision-making regarding debt reduction.
The IMF and the World Bank agreed to share necessary information on low-income countries’ DSA at an early stage to help creditors assess debt relief plans.
The IMF is close to completing guidelines on information sharing. These rules will outline the types of information that can be shared and the types of creditors that can access this information at various stages of the restructuring process.
At least 65 countries owe China debts that exceed 10% of their total external debt. China is the largest bilateral creditor in many countries under the Debt Service Suspension Initiative framework, with a median share of 54% and reaching as high as 72% in some cases.
The DSSI is a G-20 initiative launched in May 2020 under which bilateral creditors temporarily halt debt service payments from the poorest countries that request the suspension. It was intended to help these nations focus on safeguarding lives during the pandemic.
The Ministry of Finance, and policy banks such as the China Development Bank and the Export-Import Bank of China, as well as state-owned commercial banks, are the main lenders. There are no official statistics on China’s external sovereign debt, but Caixin’s calculation based on public information and experts’ analysis show that sovereign debt that meets the conditions of the DSSI program is relatively limited at around $20 billion.
China’s external loans of all types are estimated to equal $30 billion.
The accumulation of foreign debts is closely related to China’s extensive involvement in foreign construction projects, said Lu, the professor at Peking University’s National School of Development. Chinese construction companies hold nearly 30% of the global share in terms of projects and contract value, making them the leading global player, according to data published by the U.S. Engineering News-Record.
“The persistent global sovereign debt risks have been periodically unleashed every few decades in modern times,” Lu said. “This is the first time that China finds itself directly involved and significantly impacted.”
China needs to contribute short-term actionable suggestions and opinions to improve the existing multilateral debt restructuring framework, according to Lu. At the same time, it should actively participate in the G-20 Common Framework to help prevent the escalation and worsening of global sovereign debt defaults, he said.
“China has engaged very constructively with the new global sovereign debt roundtable,” the IMF’s Georgieva told Caixin. “I am quite optimistic that when we bring (together) all public sector creditors — traditional and new, private sector creditors and debtor countries — we can find solutions that are faster, more efficient, and bring relief to countries and a better chance for creditors to be paid back.”
Chinese institutions including the Ministry and Finance, the Export-Import Bank and the central bank have been working closely to promote the country’s role in global debt relief efforts, said a person close to the IMF.
“We believe resolving debt issues will benefit both debtor and creditor countries,” the person said. “The world is currently divided in many ways, and it remains an area where the global community is working together to solve issues.”
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