President Biden reportedly plans to meet with China’s president Xi Jinping on the sidelines of the G20. He should raise the issue of resolving developing country debt, much of it held by China, a problem requiring a political solution.
In the last 15 years, developing countries have increasingly borrowed from China and the “private sector” — a diverse set of financial players. The COVID-19 shutdowns, Russia’s invasion of Ukraine, food and energy price spikes, and interest rate increases in the G-7 countries all mean that we are likely going to see a wave of defaults and political instability — unless something is done now.
Forty years ago, developing countries borrowed money from a handful of “money center banks,” bilateral governments organized under the Paris Club, such as France and the United States, as well as development banks such as the World Bank.
The big challenge now is China, which has been lending money to these developing countries; China has a big surplus of dollars due to its export growth strategy and needs to recycle those dollars. China also has, for now, a cohort of people in the workforce that need jobs and state-owned enterprises seeking new markets. Outside groups such as AidData have provided some information, but there are limited official sources about China’s debt and its terms.
China until now has resisted writing down any of its debt across its portfolio. First, it would be an embarrassment for China — and for Xi personally — to admit to bad loans overseas. Second, there are serious debt problems domestically; if China writes down debt in Africa, it will face domestic debt holders who will demand their domestic debt be written down. Third, China will almost certainly say, “We are a developing country; you should not treat us as a wealthy lender nation.” Fourth, the Chinese say they do not have the “legal authority” to write off debts. Fifth, China does not have a separation between the public and private sectors, so it does not understand why the U.S. cannot “order” a private financial institution to enter into a standstill agreement.
The G20 has tried to deal with this problem through an arrangement called the “Common Framework for Debt Treatments.” The Common Framework has tried to get all the different debt holders — the traditional ones along with private sector actors and China — at one table and all agree to the same terms. To get on the same page about how much debt and the chances that countries can pay the debt back, the World Bank and the IMF have pulled together country Debt Sustainability analyses. Since its creation, Ethiopia, Ghana, Zambia, Chad, and Sri Lanka have all sought to use the Common Framework. Yet only three have managed to sign up for it: Chad, Ethiopia, and Zambia. Sri Lanka was found not eligible, and Ghana may have to restructure its debt to qualify.
In addition to the Common Framework, the G20 set up the Debt Service Suspension Initiative (DSSI) to respond to the immediate challenges of COVID. Apart from Zambia, China has not even come to the table to begin to negotiate. Another problem is that institutions such as the World Bank and the IMF are not in a position to “force” the Chinese or the diverse set of private sector stakeholders to negotiate. Due to low interest rates over the last 10 years, debtholders are tempted to not negotiate hoping to get all their money back if countries return to growth.
The additional challenge is that China is the largest trading partner for Africa and others — so, if the IMF or the World Bank, at the instigation of the U.S., force a country to demand new terms for China’s debt, China could stop purchasing soybean meal from Zambia or might collect the debt by taking a port as it did in Sri Lanka.
What is to be done?
First, we need a true “debt standstill,” where all developing country debt service payments are halted from both public and private sector creditors for debt distressed countries. A standstill would provide relief to debtor countries during debt renegotiation and restructuring as well as provide incentives to negotiate.
Second, the current arrangement needs to be fixed. For example, why does France get to permanently co-chair the International Financial Architecture (IFA) working group, the obscure G20 debt rule-setting group? Clearly, France wants to control the process as an extension of the Paris Club. Yet, in many cases France does not hold significant debt in the countries where the Common Framework is being applied.
Third, the IMF and others have called for the Common Framework to be reformed. The World Bank and IMF should take a much larger role in ensuring that the Common Framework works.
Finally, a group needs to be formed that can carry out debt reduction. There are debates about reducing debt. Restructuring debt will require much more efficient cooperation than current efforts, and cooperation is more difficult when debt repayment costs are quickly rising.
Debt crises are not new. In the late 1990s, at the instigation of poverty advocates, lender governments forgave poor country debt. With U.S. leadership and a handful of lenders, the “Heavily Indebted Poor Country” (HIPC) process was pulled together to allow for debt forgiveness. There was an explicit assumption that these same countries would not borrow monies again in the same way. In less than 25 years, we find ourselves in a similar but more complex place. As then, only a political solution is possible.
Originally published on thehill.com on November 13, 2022.