Yves here. By Jayati Ghosh, Professor of Economics, Jawaharlal Nehru University. Originally published at the Institute for New Economic Thinking website
As the United Nations warns that the “Great Lockdown” threatens to become the “Great Meltdown”, it’s now clear that most sovereign debt of developing countries is simply unpayable. Even before the Covid-19 pandemic, total public and private debt in developing countries was nearly double their GDP. External short-term debt is a real problem: as much as $1.62 trillion is due to be repaid by developing countries this year, with another $1.08 trillion due in 2021.
This would have been a struggle before; now, the Covid-19 crisis makes it impossible. Developing countries are being battered by a tsunami of falling export and tourism revenues and dramatic outflows of capital, causing sharp currency depreciation. Without quick and substantial action, many governments will be forced into debt defaults.
So does the international community (assuming that there is still one) want a perfect storm of disorderly defaults that could wreck the global financial system? Or a more equitable distribution of costs among lenders and borrowers, with less damage to people? The UN has argued for a new “Global Debt Deal” for developing countries, involving a $1 trillion debt write-off, recognizing that this is one of those unusual moments in history when the fate of the international system hangs in the balance.
Fortunately, there is a concrete example of how this could be done. The new government in Argentina has proposed a set of principles and a framework for debt sustainability that make eminent sense. If adopted by creditors, it would set the stage for a manageable debt reduction in Argentina that would enable the country to grow its way out of the currently unsustainable debt. It would also provide a template for dealing with other unsustainable developing country debt.
A brief history first. When Mauricio Macri took over as President of Argentina in 2015, he took the typical neoconservative route: financial liberalization (including current and capital account movements and a freely floating exchange rate initiated with a huge devaluation), reducing progressive taxes, increasing the fiscal deficit, increasing public debt, then reducing public spending to balance the budget. The borrowing spree that rapidly increased Argentina’s public debt by more than a third to $321 billion in 2017, mostly in US dollars. That party was over quickly: by 2018, fiscal and current account deficits were more than 5 per cent of GDP, public debt ballooned to nearly 90 per cent of GDP, the currency collapsed as capital fled, and inflation soared. The IMF was called in, and provided a controversial bailout with its usual conditions—massive budget cuts, primary budget balance in 2019 and a reduction of the external deficit. Argentina did everything the Fund asked for, and the economy got steadily worse. Growth had collapsed well before the pandemic, inflation is surging, and there is immense hardship among people.
Public debt is 90 per cent of GDP and foreign currency debt is 70 per cent of GDP; both will explode without restructuring. A lot of repayment is due this year, making it both currently unaffordable and unsustainable over time. The new Finance Minister Martin Guzman has put forward a proposal that aims to enable the country to move to a more sustainable debt trajectory by enabling the economy to recover and grow.
This requires a restructuring of existing foreign debt – and Argentina’s proposal is a relatively modest one. The projections are based on a smaller fiscal contraction than required by the IMF, and medium term growth of 1.2 to 2 per cent, along with realistic trade balance projections and a plan to build up foreign exchange reserves. The idea is to make the debt service manageable and enable sufficient buffers to protect against exogenous shocks like Covid-19. To this end, Argentina is offering to restructure $65 billion of foreign debt to bondholders, under which interest payments would resume in 2023 and principal payments in 2026. While some creditor groups rejected the offer, the negotiations continue.
Interestingly, the IMF—both its head Kristalina Georgieva and staff—has supported the essentials of Argentina’s plans. Perhaps trying to atone for its past sins with Argentina, a technical note from IMF Staff noted that restoring public debt sustainability “will require a decisive debt operation, with a meaningful contribution from private creditors”, to bring foreign exchange debt servicing levels to 3 per cent of GDP over the medium term. In other words, creditors who want to be paid at all should recognise that they have to take a haircut now.
There have been past cases in history of dramatic restructuring of sovereign debt. For example, the London Debt agreement of 1953 that effectively cancelled around half of Germany’s debts and converted the rest into long-term, easily repayable loans that limited repayment to 3 per cent of export earnings in a year. It is true that this was a specific case dominated by the impact of World War II and the nascent Cold War, but it shows that where there is political will, significant debt reductions can occur. It is also worth noting the role this agreement played in enabling Germany to grow out of its external debt problems and become an economic powerhouse—and laid the seeds for western prosperity over the subsequent decades.
That was a much bolder and extensive debt relief package than what Argentina is proposing today. Then, the consortium of Germany’s creditors recognized that the alternative to substantial restructuring was economic disarray and even collapse, with terrible global implications. We may be heading for an ever-greater debt conflagration today, if creditors do not learn this important lesson.
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Hmmmmm……I note the markets are up, not back where they were but in the same zip code, apparently factoring in a fairly quick return to normality. But if the 1997Asian Debt crisis is a useful guide, the IMF better saddle up because it needed massive intervention to contain the crisis and avoid systematic collapse. Also note intervention was required in 1998 in the US capital markets, which also took a hit from the Asian crisis.
Let us see what the financial “engineers” come up with as this thing unfurls. The only thing I am sure of is increased volatility.
It is quite a contrast. 1.62 trillion is due from all developing countries this year. Meanwhile the US federal reserve creates 4.2 trillion in a week to send to Black Rock.
I wonder what category of the mind those with the power to create trillions will place these developing world debts?
If in the same category as material benefits for the lower 90%, like paying for a universal health care program, I doubt the funds will be forthcoming.
If in the same category as the $ sent to Black Rock – this was for bailing out the stock markets of the world – maybe the funds could be found.
Perhaps as the funds owed will be going to the same actors that benefit from the recent federal reserve bequests a bit more could be found to put the economies of many countries in a better place?
After all, it is not in the interest of a parasite to kill its host. We can say this rationally but many times a rational direction is not the way things end up going. We shall see.
Hmm, the problem is a parasite doesn’t care about the life of its host. It’s a parasite, not a symbiote or symbiont. A parasite is not aware of a host, just its environment, a symbiont is aware that it is in a mutual arrangement.
So I don’t expect Wall Street and the shadow banks, which are the holders of the developing country’ debt, to forgive anything, even as non-forgiveness destroys individual members of their community.
When I read articles like this, I find myself wondering “Who you calling ‘developing’?”
We don’t mean China, obviously. Do we mean Russia or Saudi Arabia, who have significant (though drawn-down for sure) USD reserves (or even Qatar)? Maybe not them. Is it Brazil, India, and South Africa? Maybe Eastern non-Euro Europe? Ms. Georgieva’s home country of Bulgaria?
Maybe the broader point is that any USD-denominated debt owed by a non-USA country is in deep trouble. But then the point isn’t about the countries really – it’s the risk that any country that has debt in a currency they can’t control may (will?) default or haircut eventually.
Fully agree. $1.6 trn sounds a lot. For sure not just the least developed countries. Also: is this official lending only (from multilateral development banks and the like) or also bond issues?
There is a proposal by the G20 to offer some debt relief to the LDCs, where even China has said it would participate (a first), but a lot of China’s lending is through the banks, so what this means in practice is anyone’s guess.
As always, the devil is in the detail.
Found the link to the UNCTAD paper in the meantime.
In 2020, $350 billion appear to be owed by “newly advanced economies” (HK, Singapore, South Korea, Russia, Ukraine, Turkey), about $850 billion by so-called high-income developing countries (Argentina, Brazil, Chile, China, Colombia, Lebanon, Malaysia, Mexico, Saudi, South Africa, Thailand, UAE) and the remaining ca $400 billion to middle- and low-income developing countries. This last category sounds manageable and many of the HICs had issues pre-COVID, not to say that this could not be problematic.
The Argentina proposal implied an NPV mark down of 65-70%. That is quite high for a number of reasons. One could easily argue that Argentinian debt is sustainable with an NPV markdown of 30%.
The issue is as ever burden sharing. How much of a hit should western investors take versus the amount Argentina should take.
Both sides have every reason to argue their case. However in looking at debt to GDP remember that Italian debt to GDP is markedly higher.
Argentina is not special. Jamaica or Costa Rica are both more “deserving” whatever that means. Argentinian debt has been haircut before.
Debt to GDP is not a reliable marker for determining debt sustainability. Japan’s debt to GDP is over 200%, but essentially any amount of debt it takes out would be sustainable because it can issue bonds to cover the debt at minimal and even negative interest rates. Meanwhile in a less egregious and more applicable example, holders of bonds issued by Lebanon (debt to GDP = 170%) will be taking haircuts of over 70% , less than the approx. 65% haircut on offer from the overly generous Argentine government.
This is not about “special” treatment as you claim. It is about what is collectible. Debts that cannot be paid will not be paid. The bondholders (predominantly BlackRock, Templeton Gramercy, and Fidelity) already have the bonds valuated at market value on their books. This means that they already account for them with a substantial haircut baked in.
The question now is not whether they will be paid what is rightly owed to them or who is “deserving” (a moralisation apt for schoolmarms but not financiers) but how much they can maximise out of them, as no one ever calculated the bonds at 100% at maturity.
Thus it is not as if Argentina is begging for some kind of mercy or alms; rather this is a game that all parties understood from the outset.
Of note is that Martin Guzman is an associate of Joe Stiglitz, and they have co-authored a number of papers. Let’s hope that this progressive academic economist has a better run as a national finance minister than the last one, Yanis Varoufakis.