Debt relief in limbo

International efforts to alleviate the massive debt burdens facing developing countries as a result of the pandemic are failing.

Launched in May 2020 as countries went into Covid-19 lockdowns, the G20’s Debt Service Suspension Initiative (DSSI) aimed to provide more than US$12bn in suspended debt payments, allowing that money to be channelled instead to crucial parts of developing countries’ economies, such as healthcare provision. In reality, however, only US$5bn was actually suspended, according to the Center for Global Development, a US think-tank. The G20 had envisaged private investors (eg global institutions) as well as official investors (eg other countries or NGOs) participating, but few in fact did.

In a bid to achieve more, the G20 replaced the DSSI with the Common Framework for debt treatment in November 2020, this time insisting on ‘comparable treatment’ between official and private creditors in an attempt to force private creditors to the table. This too has failed.

There is a simple reason for this failure: credit ratings.

Creditor exodus

Previous debt treatment initiatives that have affected the world’s poorest and most vulnerable countries have, by and large, been effective. This is because their effectiveness was related to reducing or clearing the debt burdens held by countries in relation to official creditors.

The Heavily Indebted Poor Countries Initiative of 1996 and the Multilateral Debt Relief Initiative of 2005 both provided eligible countries with much needed fiscal space on their balance sheets. However, since then, traditional official creditors have been seeking to withdraw from the international debt scene while private creditors have been faced with an international post-financial crisis era characterised by depressed yields and interest rates.

The result has been a perfect storm. Vulnerable countries, now with a clearer balance sheet, could issue more debt but, owing to their risk profiles, had to do so with higher interest rates in order to entice private creditors into the space. At the same time, China embarked on its Belt and Road initiative, which has led to the country arguably becoming the dominant official creditor in the developing world. The result is a world in which traditional official creditor-based debt reduction initiatives no longer have the same effect.

Default event

Credit rating agencies and private creditors are two sides of the same coin. Although private creditors are merely expected to use credit ratings as part of their risk profiling, the global financial system relies on the easy-to-understand and easy-to-signal-with credit rating scales employed by the Big Three credit rating agencies – S&P Global, Moody’s and Fitch Ratings.

The ratings agencies exist to warn private investors when they may face the prospect of not receiving their investment back, or not receiving it back on time. Any perceived threat to this can result in a rating downgrade for the issuer. However, when an issuer is actively seeking to restructure their debt obligation – which almost always will result in some sort of loss for the investor – then the rating agencies, methodologically, consider this a default and downgrade the issuer’s rating as a result.

The DSSI and the Common Framework essentially insist that countries restructure their debt obligations. But that, in light of the rating agency-private creditor relationship, counts as a ‘default event’. With the rating agencies making this point to countries showing interest in joining the G20’s initiatives, no country with a credit rating has yet taken part.

Countries were allowed to join the DSSI from a credit rating perspective, because the G20 dropped the early ‘comparable treatment’ requirement. However, this requirement was reinstated for the Common Framework with the result that only three countries – Chad, Ethiopia and Zambia – have signed up to it, and all three were in default or unrated anyway. This, ultimately, is what I call the ‘credit rating impasse’ in my book Sovereign Debt Sustainability: Multilateral Debt Treatment and the Credit Rating Impasse.

Impasse buster

A novel and outside-of-the-box idea is to develop a special programme to complement the Common Framework that would include special legislation to inject flexibility into the credit rating process for eligible countries. This would take the form of a ratings ‘overlay’ to be applied on top of the normal credit rating scale that would prevent a country’s request for a restructure of its debt obligations being automatically treated as a default event.

This overlay, which would form a temporary part of the special programme, would alter the weightings within the credit rating methodologies to favour different criteria such as climate preparedness, ESG integration and different time horizons. It would, essentially, change the definition of a sovereign ‘default’ in line with a changing landscape for sovereign debtors – ie multilateral initiatives that consciously seek to foster debt restructurings with private creditors. It is a plan that is needed purely because of the lack of movement on the international debt scene. That lack of movement is costing the lives of citizens in vulnerable sovereign states and will hamper their development for years to come.