By Dr. Brahima S. Coulibaly, Vice President and Director of the Global Economy and Development Program, and Wafa Abedin, Senior Research and Administrative Assistant to the Vice President and Director, Brookings Institution
Unsustainable sovereign-debt levels in the developing world threaten to erase several decades of hard-fought progress on development agendas. According to the International Monetary Fund (IMF), an estimated 50 percent1 of developing countries are in active debt distress or at high risk of debt distress. The costs of debt service now exceed outlays on education and health in several countries. The COVID-19 pandemic and Russia-Ukraine war are the latest in a series of shocks that have contributed to the recent buildup of debt2 since developing countries benefited from debt forgiveness under the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiative (MDRI). The world’s deteriorated fiscal situation and unsustainable-debt outlook were top of mind as heads of state and finance leaders gathered in June 2023 in Paris for the Summit for a New Global Financing Pact3 to rethink the global financial system.
The conference’s highlights, in terms of concrete outcomes, include progress on Zambia’s sovereign-debt restructuring. Zambia and its official creditors, namely China, announced a breakthrough deal4 to reprofile $6.3 billion of its debt. The agreement is the first of its kind through the G20’s (Group of 20’s) Common Framework for Debt Treatments (CF), an initiative through which mainly low-income countries can request debt restructuring to deal with insolvency and protracted liquidity problems. So far, only four—Zambia, Ghana, Ethiopia and Chad—of the 36 countries in or at high risk of debt distress have requested treatment under the CF, likely owing to its operational challenges. The CF has been criticized5 for its lack of clear timetables and, consequently, its inability to provide the swift action required to free up much-needed fiscal space. In Zambia’s case, it took two years to reach an agreement for a present-value reduction of around 40 percent6 of the restructured external debt. The agreement will help Zambia unlock a $188-million disbursement from the IMF. Although it falls short of the 50-percent reduction for which the government had hoped, some governments have lauded the deal as a historic breakthrough that could serve as a blueprint for a cooperative restructuring of unsustainable debts.
Zambia’s venture with the CF remains unfinished, however. A debt-treatment agreement with private creditors on comparable terms to those provided by government creditors is required. Private-sector participation in the CF remains elusive. Holdout creditors could delay debt relief, such as in the case of Chad7, where debt relief was delayed by an additional 18 months.
A notable feature of the current built-up debt is its higher share of private debt. Private creditors hold more than a quarter of the external debt stock, up from only 10 percent in 2010, and the cost of servicing private-sector debt8 makes up more than two-thirds of total debt-service payments. Enter New York State lawmakers, who have introduced a series of legislations to compel private-creditor participation in debt restructuring and revitalize the debt-restructuring process.
New York law governs about 50 percent of sovereign-bond issues by emerging markets, totaling about $800 billion in outstanding debt9. If passed, the three active bills introduced by the New York State Legislature will have significant ramifications for global sovereign-debt restructuring. Each bill targets a different aspect of New York law (e.g., banking, judiciary, and debtor and creditor law).
The first bill (A5290/S562310) strengthens protections for governments from litigation by predatory and holdout creditors. Specifically, the practice of vulture funds and other predatory private creditors, who have known histories of purchasing distressed or discounted debt for the sole purpose of bringing legal action to collect on that debt, would no longer be allowed. Further, holdout creditors, who have refused to participate in the consensual debt treatment agreed to by two-thirds of creditors, would be prohibited from suing the government debtholder for repayment. The bill also imposes a “duty” on the government debtholder to participate in restructuring its debt instruments if deemed unsustainable by the IMF.
The second bill (A2970/S474711) limits how much private creditors are allowed to recoup from governments participating in international initiatives for debt relief. This bill would effectively mandate that private creditors comply with “comparable treatment”—a central tenant of the CF that requires a government to obtain equivalent debt relief from other creditor groups.
The third and most far-reaching bill (A2102A/S554212) establishes a comprehensive restructuring mechanism for governments with New York law-governed debt claims. Under this restructuring mechanism, the first step is for the government to file a petition with New York State, self-certifying that its debt is unsustainable and that it would like to seek debt relief. The government must also agree to work with the IMF to restore debt sustainability. Second, the government must submit a proposed plan to its creditors to make its debt sustainable. The country must also self-certify that if the plan becomes effective, its debt will become sustainable, and it cannot file more than one petition to restructure its debt within a 10-year period. Third, if creditors holding two-thirds in amount and more than one-half in number in each class of claims vote in favor of the plan, all creditors are bound by the agreement. The mechanism also requires the appointment of an independent monitor to dismiss a petition for lack of good faith. If the sovereign borrows more money to finance the restructuring, the government must notify all creditors, and it must be approved by creditors holding at least two-thirds in amount of the claims.
Cooperation and coordination with other jurisdictions would be essential to the success of these proposed laws; otherwise, private creditors could switch to debt issued in London under UK law, which governs the other large share of international debt agreements. The notion of cooperation between New York and the United Kingdom has gained traction. The UK International Development Committee (IDC) recommended13 that the UK Government consider similar laws to compel or incentivize private-creditor participation in debt restructuring and engage in talks with New York lawmakers on cooperative legislation. In response to the committee14, the UK Government reaffirmed its commitment to private-sector participation in debt restructuring through comparable treatment but dismissed the committee’s recommendation to consider changes to the laws.
Opponents of the bill argue that it will reduce the liquidity of sovereign debt and increase the cost of borrowing. A key feature of the New York legislation is that it will apply retroactively, overriding any pre-existing contractual protections. Critics have raised concerns about the risks to holders of pensions and mutual funds15,who may see the present value of their debt claims reduced substantially.
Given the size of private-sector debt and its relative importance in the cost of debt servicing, private-sector participation in the debt-restructuring process is critical. At the same time, the approach to private-sector participation should be thoughtful to preserve the countries’ hard-fought access to private financing. One balanced approach is adopting a Brady Plan 2.016 to replace the current private-sector debt with new bonds that have guarantees and, therefore, are cheaper with longer maturities. Private-sector participation in a Brady-like scheme would assure the recoupment of a sizeable share of their investments, as well as the option to exit from their current positions and improve the risk-return profiles of their portfolios. Importantly, it will swiftly restore fiscal sustainability for indebted developing countries and create fiscal space to consolidate economic recoveries and support broader development agendas.
Next year is poised to be pivotal for indebted nations, with payments on emerging-market sovereign bonds expected to total $30 billion17. As international debt-relief initiatives remain lethargic, a wave of sovereign defaults is looming. Now more than ever, it is clear that the global architecture for sovereign-debt restructuring requires revitalization. The New York State Legislature will discuss and vote on the proposed debt-restructuring bills in 2024 when the legislative session reconvenes. At that point, it is possible that all, some or none of the bills could be voted into law. Proponents of the legislations have vowed to push these changes forward, but in the meantime, political buy-in and good-faith participation in debt relief from private creditors could help achieve a legislative compromise.
1 International Monetary Fund (IMF): “List of LIC DSAs for PRGT-Eligible Countries as of June 30, 2023.”
2 Brookings: “Addressing the looming sovereign debt crisis in the developing world: It is time to consider a ‘Brady’ plan,” Brahima Sangafowa Coulibaly and Wafa Abedin, April 3, 2023.
3 United Nations/Regional Information Centre for Western Europe: “Paris Summit for a New Global Financing Pact,” June 19, 2023.
4 Reuters: “Zambia seals $6.3 billion restructuring in breakthrough for indebted nations,” Leigh Thomas, Jorgelina Do Rosario and Chris Mfula, June 23, 2023.
5 International Monetary Fund (IMF) Blog: “The G20 Common Framework for Debt Treatments Must Be Stepped Up: With the debt service suspension initiative expiring and interest rates poised to rise, low-income countries will find it increasingly difficult to service their debts,” Kristalina Georgieva and Ceyla Pazarbasioglu, December 2, 2021.
6 Fitch Ratings: “Zambia’s Debt Deal Paves Way for Next Stage of Restructuring,” June 28, 2023.
7 Euronews Next: “Exclusive-Glencore, Chad creditors agree in principle on terms of debt treatment – source,” Andrea Shalal, November 11, 2022.
8 Brookings/Global Economy and Development: “Addressing the Looming Sovereign Debt Crisis in the Developing World: It Is Time to Consider a ‘Brady Plan’,” Brahima S. Coulibaly and Wafa Abedin, April 2023.
9 The Washington Post: “How a New York Bill Could Help Fix the Sovereign Debt Crisis,” Zijia Song/Bloomberg, June 6, 2023.
10 The New York State Senate: “Assembly Bill A5290, 2023-2024 Legislative Session, Relates to the purchase of claims by corporations or collection agencies,” sponsored by Gonzalez-Rojas.
11 The New York State Senate: “Assembly Bill A2970, 2023-2024 Legislative Session, Relates to recoverability of sovereign debt.”
13 UK Parliament: “Debt relief in low-income countries,” International Development Committee, March 10, 2023.
14 UK Parliament: “Debt relief in low-income countries: Government response to the Committee’s Seventh Report of Session 2022-23,” International Development Committee, June 8, 2023.
16 Brookings: “Addressing the looming sovereign debt crisis in the developing world: It is time to consider a ‘Brady’ plan’,” Brahima Sangafowa Coulibaly and Wafa Abedin, April 3, 2023.
17 Reuters: “Analysis: Debt crunch looms for weaker economies with a wall of bond maturities ahead,” Jorgelina Do Rosario, April 11, 2023.