Economic angst: How to avoid another global debt crisis

THE EDITORIAL BOARD

If one country defaults on its loans, it’s a big problem for its citizens. If a dozen countries default, it’s a big problem for the world. In the 1980s, defaults in Latin America led to hyperinflation, riots and political instability in Argentina, Brazil and Peru.

The world appears to be on the verge of yet another debt crisis — and leaders in the United States and elsewhere have a chance to come together to support the measures that would avert it. They should dust off the tool kit that helped end the Latin American debt crisis, especially the measures that convinced creditors to share the pain and accept less than what they were owed.

Today’s crisis has several immediate causes: Lenders, again, ignored prudence, so some countries had been borrowing excessively and had unsustainable debt even before Covid struck. The pandemic forced countries to borrow even more to stay afloat as business activity ground to a halt. Then the war in Ukraine drove up the price of food and fuel. Now, rising interest rates have greatly increased the cost of servicing that debt. An estimated 56 countries are in debt distress or at risk of it — more than twice as many as in 2015.

This means that in many countries, an enormous share of the national budget is being spent on debt: In Pakistan, more than half of government revenue may have to be devoted to repaying foreign debt unless the country gets relief. It has announced cuts in food subsidies, and the economic situation there has gotten so dire that 11 people were recently killed in a stampede at a flour distribution site.

In Laos, which owed $2 billion in debt payments in 2020, the government cut its health care budget in the middle of the pandemic to bring down spending. Ecuador told some government employees to work two hours fewer a day to get spending under control as a condition of an emergency I.M.F. loan.

When countries have to devote such a large chunk of government revenue to servicing debt, they don’t have enough to pay for basic necessities like food and energy needed for an economy to function and for people to thrive in it.

Nor do they have enough to invest for the future: in health systems to get ready for the next pandemic or in the green energy transition. Foreign investors, too, stand to lose a lot of money, and large-scale losses can have unpredictable effects on financial markets.

There has been some progress at meetings of the International Monetary Fund and the World Bank in Washington last week. Creditors — a varied group that includes bondholders and other private sector financial institutions, multilateral development banks, and sovereign lenders including the United States and China — sat down with debtor countries to discuss how to speed up the restructuring of debt and overcome bottlenecks in the process.

This new Global Sovereign Debt Roundtable, led by the IMF, the World Bank and India, the current president of the Group of 20, has reached agreement on some issues, although there is much that remains unresolved about how the restructuring will be done.

Any progress is good news; the levels of debt in too many parts of the world are unsustainable, and any solution requires coordinated and collective action.

That’s what happened, crucially, during the pandemic: The G20, a group of 19 nations and the European Union, suspended debt payments for dozens of the most vulnerable countries. After that program expired in 2021, they put in place the so-called Common Framework for Debt Treatments to help low-income countries restructure their debt.

But so far, that process is failing. It is not designed for lower middle-income countries that are among the most worrisome cases. It is also far too slow. Zambia, which was reclassified as a low-income country last year, has spent over two years trying to restructure its debt and has little to show for it.

It has done its part and made required reforms. But it can’t receive emergency IMF funds without progress on restructuring its debt — and its creditors are squabbling over what relief should be offered. As a result, Zambia has been in debt purgatory, shut out of IMF funds but unable to attract private investment while the talks continue. All the while, Zambia’s debt continues to grow.

This is the opposite of coming to the rescue, so it’s no wonder that only a handful of countries have followed Zambia’s example and applied for relief under the Common Framework.

There are ways to change this: Freezing the debt for countries like Zambia while they engage in good-faith negotiations would give creditors an incentive to speed up the process and would encourage more indebted countries to apply.

And countries that go through this process should also see their debt repayments reduced to levels that can allow their economies to grow. That is a solution supported by David Malpass, the departing president of the World Bank, and the United Nations secretary general, António Guterres.

Geopolitical squabbling is a major reason that debt negotiations are bogged down. The Common Framework encompasses a group of creditors that don’t have much in common and whose interests are often at odds: They include private and public lenders and creditors from China as well as the so-called Paris Club countries (in Europe and the United States). China’s presence is a sign of how much things have changed since the 1990s, when China was primarily a borrower. Today, it is the world’s largest bilateral creditor.

In this new landscape, it’s far more difficult to reach agreement about who should get paid back what, and on which timetable.

China, which has lent an estimated $900 billion to developing countries over the past 10 years mainly for infrastructure projects under its Belt and Road Initiative, has been reluctant to grant debt relief unless commercial bondholders and multilateral development banks do the same, though it appeared to have backed away from that demand at the meetings last week.

Multilateral banks have typically been exempt from pressure to forgive loans since they lend money at such low interest rates already, something that China appears to have now accepted.

But commercial lenders that made risky loans in pursuit of higher returns should have to take their losses and write off some of these debts. Governments should not be forced to again take the hit so private investors can be made whole. The road to resolution is for everyone to share the pain — sooner rather than later — instead of waiting for others to step up on debt relief.

One promising proposal for getting China and commercial bondholders to agree on deeper debt relief is a new version of the Brady bonds, which helped solve the debt crisis in Latin America after they were introduced in the late 1980s.