Developing countries around the world are in trouble. As economies grapple with uncertainties exacerbated by the Covid pandemic, more than 70 low income nations are struggling to bear a collective burden of $326bn of debt, according to the International Monetary Fund.
Many face rising costs to service their external debt in the next two to five years. Alarmingly, over half of them are teetering on the brink of debt distress.
The fate of these nations hinges on the delicate balance between debt restructuring, financial assistance offered by multilateral and bilateral lenders — and the role of China, a global economic leader which has emerged as a pivotal lender to numerous Asian, African and other emerging market countries.
Of the 137 countries rated by S&P Global Ratings, says Roberto Sifon-Arevalo, its global head of sovereign ratings, more now have negative credit outlooks, especially emerging and frontier markets. Seven are in default, an “unusually high number compared to before”.
A lot of these countries have benefitted over the past decade from low interest rates, which allowed them to raise debt at levels that appealed to both the governments and investors on the hunt for returns.
“Fast forward to 2019, and cracks started showing around the fiscal positions of countries,” says Sifon-Arevalo, who is based in New York. “The Covid-19 pandemic just exacerbated all the weaknesses across countries.”
The disease emergency triggered a slew of support measures from multilateral development banks and developed countries. The G20 agreed a Debt Service Suspension Initiative that allowed the poorest countries to stop servicing debt to public sector lenders during the worst of the health crisis.
But the DSSI expired at the end of 2021. Despite the G20’s invitation to the private sector to join in, “regrettably, only one private creditor participated”, said the World Bank.
Then came another critical development — the Common Framework, a mechanism through which struggling countries could restructure their debt.
This, too, is an initiative of the G20, but it marks a significant change from previous restructuring agreements as it brings to the table not just the developed creditor countries that are members of the Paris Club, but also major bilateral creditors like India and China, both of which have steadily been increasing financial support to troubled countries across Asia and Africa.
The idea was that a country overburdened by debt needed to be able to restructure all its official loans in one process, fair to all the creditors.
But the results of the Common Framework so far leave much to be desired.
Complicated evolution
A breakthrough came in June when Zambia finally reached a preliminary agreement to restructure roughly $6.3bn of its bilateral debt, having first sought relief under the Common Framework after defaulting in early 2021.
The deal — still waiting for official sign-off — is the first agreement under the Framework, and includes China as a party.
That is certainly a landmark, but getting there was not easy. As the first to use the Framework, Zambia may have had a tougher time — the negotiations took two and a half years.
“The assumption when starting this [the Common Framework] was that it would be easier to bring everyone, or at least the bilateral creditors, on one table,” says Jan Friederich, head of EMEA sovereigns at Fitch Ratings in Hong Kong. “But it initially hasn’t played out so well, partly because the Framework was a departure, and it needed a fair bit of sorting things out and clarifying questions like who qualifies as a bilateral lender among the major Chinese lending institutions, and who qualifies as commercial.”
China undertakes a lot of its international lending through two policy banks — the Export-Import Bank of China (Chexim) and the Agricultural Development Bank of China — and five big state-owned commercial banks. Many projects financed by the state-owned banks are insured by Sinosure, the state export credit agency.
Typically, Paris Club agreements include claims insured by ECAs, and they are restructured alongside other government claims. That was the initial plan with Zambia’s Sinosure-backed loans. But in the end, the restructuring only covers loans provided by Chexim. Claims of the state-owned commercial banks and debt backed by Sinosure were handled in a separate commercial restructuring.
Chexim agreed to cut the interest on its claims to 1% for the remaining life of Zambia’s IMF relief programme. But if Zambia’s recovery exceeds expectations, the interest jumps to 4% and the pace of amortisation will pick up.
There are different schools of thought on what this agreement means for China, developed market creditors and other nations facing a debt restructuring.
“The Chinese offer the Zambia example as a model of what can be done, but it’s still quite burdensome for Zambia,” said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis CIB in Hong Kong. “One reason is because the legal framework in China is such that it’s very, very difficult for banks to accept a haircut, because they have to put their capital to account for it and it’s very costly. So they avoid that and instead extend duration and lower the interest rate.”
Others say the agreement is still a good sign and shows the innovation that may be possible on future government debt restructurings, by combining traditional traits from Paris Club agreements with twists that cater to Chinese lenders and sovereign bondholders.
Distress rises
That kind of compromise by all creditors will be important, considering how far China’s reach has grown.
A study this year by researchers at AidData, the World Bank, the Harvard Kennedy School and the Kiel Institute for the World Economy revealed that by the end of 2021, China had undertaken 128 rescue loan operations in 22 debtor countries, worth a whopping $240bn.
In 2010, less than 5% of China’s overseas lending went to countries in distress, but this had soared to 60% by 2022, the research showed. That was driven in large part by lending to the nearly 150 countries involved in China’s ambitious Belt and Road Initiative to fuel infrastructure development.
“It goes without saying that the role of China as a trading partner, as an investor, a lender and a creditor has certainly increased over time in Asia and the Pacific,” says Hamza Ali Malik, a director in the macroeconomic policy and financing for development division at the United Nations’ Economic and Social Commission for Asia and the Pacific, in Bangkok. “The growth in Chinese official lending is unprecedented — and it happened fairly quickly — and the scale is enormous. But for many countries adopting that influx of money, it creates problems.”
Kim Eng Tan, S&P Global’s Asia Pacific sovereigns head in Singapore, points out that the countries that received early Belt and Road funding are now “experiencing quite a bit of debt distress”. Restructuring attempts are complicated by tensions between China and the US.
For example, Sri Lanka — which has in the past relied on China, India and the IMF for financing support — defaulted on its international and domestic debt in 2022.
The government wrapped up a revamp of some of its local currency debt in September, but a restructuring of its dollar debt, including bonds and bilateral loans, is still in the works.
China is also a big lender to Pakistan, long a supporter of the Belt and Road.
In recent months Beijing rolled over nearly $8bn of debt to prevent a default by Pakistan.
China’s importance as a lender of last resort means countries and MDBs will need to think differently about how best to tackle sovereign debt restructuring in the future.
Herrero at Natixis argues that with China just an observer to the Paris Club, it is very hard to coordinate restructurings with different creditors. She says: “I’m hoping that the Paris Club gets reformed, and China becomes a full member, because it’s such a large creditor.”
Debt sustainability in Asia may need longer term thinking
Home to 4.3bn people — three out of every five on Earth — Asia and the Pacific countries are facing an unprecedented challenge.
High inflation, fiscal stress, rising public debt and slowing economic growth have put pressure on governments. Market watchers are hunting for solutions on how best to help nations achieve the Sustainable Development Goals when faced with such obstacles.
The problem with assistance from the International Monetary Fund or multilateral development banks is that the loans often come with onerous policy requirements, like raising taxes, cutting spending and abolishing subsidies.
These measures often have unpalatable economic costs in the short term, impacting people’s lives, leading to spikes in poverty and periods of austerity.
Hamza Ali Malik, director at the UN Economic and Social Commission for Asia and the Pacific, argues that countries should instead think long term, with the IMF’s help, and invest in three broad areas: social development, green development and digital transformation.
“We call this the Build Forward Better policy package,” says Malik, who previously worked in the State Bank of Pakistan’s monetary policy team. “We assess this over the long run, modelling for 2040, and we see that countries can actually benefit on all fronts: economically, socially and on the environmental front.”
Making these investments will cause the debt levels of already beleaguered countries to spike.
But Malik says: “The traditional approach would be to raise alarm bells and red flags and countries being asked to contain their fiscal spending. But we are saying: don’t do that. Wait and see the impact of how those investments mature over time.” —RK