Finance Covid-19 Relief and Recovery, Not Debt Buybacks

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR: In July, the UN Secretary-General warned that a “series of countries in insolvency might trigger a global depression”. Earlier, the United Nations Conference on Trade and Development (UNCTAD) and the International Monetary Fund (IMF) had called for a US$2.5 trillion coronavirus crisis package for developing countries.

Debt distraction

In the face of the world’s worst economic contraction since the Great Depression, a sense of urgency has now spread to most national capitals and the Washington-based Bretton Woods institutions. Unless urgently addressed, the massive economic contractions due to the COVID-19 pandemic and policy responses to contain contagion threaten to become depressions.

Nevertheless, many long preoccupied with developing countries’ debt burdens and excessive debt insist on using scarce fiscal resources, including donor assistance, to reduce government debt, instead of strengthening fiscal measures for adequate and appropriate relief and recovery measures.

Most debt restructuring measures do not address countries’ currently more urgent need to finance adequate and appropriate relief and recovery packages. In the new circumstances, the debt preoccupation, perhaps appropriate previously, has become a problematic distraction, diminishing the ‘fiscal space’ for addressing contagion and its consequences.

Buybacks no solution

One problematic debt distraction is the renewed call for debt buybacks from private creditors, through an IMF-managed Brady Plan-like multilateral bond buyback facility funded by a global consortium of countries. The historical evidence is clear that bond buybacks are no panacea and neither an equitable nor efficient way to reduce sovereign debt.

The contemporary situation is quite different from the one three decades ago when US Treasury Secretary Brady’s plan successfully cut losses for the US commercial banks responsible for most debt to Latin American and other developing country governments. Hence, prospects for a comprehensive arrangement involving all creditors are far more remote now. Unsurprisingly, debt buybacks have been rare since the mid-1990s.

Furthermore, private bond markets have changed significantly from what they were during the Brady era when there was last a comparable effort involving many debtor countries. Importantly, the new creditors largely consist of pension and mutual funds, insurance companies, investment firms and sophisticated individual investors. Also, today’s creditors have less incentive to participate in sovereign debt restructurings.

Many of today’s creditors are now represented by powerful lobbies, most significantly, the International Institute of Finance (IIF). Unlike before, when their efforts focused on OECD developed economies, the IIF now actively works directly with developing country finance ministers and central bank governors.

Voluntary scheme problematic

But the debt buyback proposal, to be underwritten by a multilateral donor consortium, can inadvertently encourage hard bargaining by powerful creditors who know that money is available, while retaining the option of threatening litigation. Hence, resulting buybacks are likely to cost more. The evidence shows that a country’s secondary market debt price is higher when it has a buyback programme than otherwise.

Such an approach can also encourage trading in risky sovereign bonds promising higher returns, inadvertently sowing the seeds for another debt crisis. Private investment funds are more likely to buy such bonds if there is a higher likelihood of selling them off, while still making money from the high interest rates, even when the bonds are sold at large discounts.

The proposal’s voluntary feature also creates incentives for creditors to ‘free-ride’ by ‘holding-out’, thus undermining the likelihood of success. If the scheme is expected to effectively restore creditworthiness, then each existing creditor would hold on to the original claims, expecting market value to rise as new creditors provide relief.

Maintaining a good credit rating undoubtedly enables access to international funds at relatively lower interest rates. But low-income countries typically have poor access to international capital markets, and only get access by paying high risk premia, due to poor credit ratings.

Compared to near zero interest rates in major OECD economies, African governments pay 5~16% on 10-year bonds, while Kenya, Zambia and others pay more. Borrowing costs for developing countries issuing Eurobonds more than doubled due to high interest rates.

Also, many, if not most contemporary creditors are not primarily involved in lending money. They are therefore unlikely to respond to government requests for new loans needed to grow out of a debt crisis.

New obstacles include the greater variety of powerful creditors, the unintended incentives for free-riding inherent in voluntary debt reduction, problematic precedents as well as perverse incentives for both governments and bondholders. Perhaps most importantly, debt reduction by purely ‘voluntary’ means -- like buybacks, exit bonds, and debt-equity swaps – is unlikely to be adequate to the enormity of the problem.

Successful buybacks?

Only banks definitely gained from the Brady deals. Benefits were unclear for most debtors other than Mexico and Argentina, and particularly ineffective for Uruguay and the Philippines, where gains were paltry, if not negative.

Positive effects for economic growth were very small, as most buybacks failed to improve either market confidence in or the creditworthiness of debtor countries. Hence, even if private creditors participate, there is no guarantee that debtor countries will benefit significantly at the end of the long and complicated processes envisaged.

The 2012 Greek bond buybacks, backed by the European Commission, the European Central Bank and the IMF ‘troika’, effectively bailed out the mostly French and German banks owed money by Greece. Celebrated as a success, it neither restored Greece’s growth nor reduced its debt burden.

While bond buybacks can always be a debt restructuring option for consideration, Ecuador’s in 2008-2009 are probably the only one regarded as favourable to the debtor country. Wall Street observers suggest that Argentina’s recent initiative may also have a positive outcome.

Also, after successfully restructuring its commercial debt, the country is now better able to negotiate with its official creditors, particularly the IMF. These ‘successes’ have been exceptional, led by the countries themselves and ultimately settled on their terms, taking advantage of opportunities presented by global crises for comprehensive national debt restructuring.

Importantly, neither creditor consortia nor multilateral financial institutions were involved in coordinating or underwriting both restructurings, and hence could not impose onerous policy conditionalities. Thus, when able to take advantage of favourable conditions for negotiating strategic buybacks, debtor countries may be better able to benefit from them.

Urgent financing needed

Despite her earlier reputation as a ‘debt hawk’, new World Bank Chief Economist Carmen Reinhart recognizes the gravity of the situation and recently advised countries to borrow more: “First fight the war, then figure out how to pay for it.” Hence, in these COVID-19 times, donor money would be better utilized to finance relief and recovery, rather than debt buybacks.

Multilateral development finance institutions should resume their traditional role of mobilizing funds at minimal cost to finance development, or currently, relief and recovery, by efficiently intermediating on behalf of developing countries. They can borrow at the best available market rates to lend to developing countries which, otherwise, would have to borrow on their own at more onerous rates.

Debt hawks detract from urgently needed fiscal recovery efforts

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY & KUALA LUMPUR: Developing country debt has continued to grow rapidly since the 2008-2009 global financial crisis (GFC). Warnings against debt have been reiterated by familiar prophets of debt doom such as new World Bank chief economist, Carmen Reinhart, once dubbed the ‘godmother of austerity’.

Growing debt burden

Falling commodity prices, dwindling foreign reserves, slower global growth and weakening currencies have made it harder for developing countries to meet external debt payments.

This has involved economies of all income categories, reaching historical highs even before the pandemic. By early May, more than 100 countries had asked the International Monetary Fund (IMF) for help.

Developing countries’ government debt is likely to worsen with the pandemic induced recessions, triggering appeals for urgent debt standstills, cancellations and restructuring. While accumulated debt is undoubtedly problematic, debt phobia is now limiting fiscal options for coping with the worst economic downturn since the Great Depression.

In March, the United Nations called for a US$2.5 trillion package for developing countries to cope. By May, IMF Managing Director Kristalina Georgieva warned that the need is far greater.

While the Trump administration blocked the latest IMF Special Drawing Rights (SDRs) initiative, other debt relief initiatives, e.g., by the G20 and the IMF, are quite inadequate. Even David Malpass, the Trump nominated World Bank president, has criticised the G20 for falling short on debt relief, insisting “more needs to be done”.

Debt buybacks hardly novel

Surprisingly, rather than seeking to finance stronger fiscal responses to Covid-19 recessions, Joseph Stiglitz and Hamid Rashid have joined the chorus to address “catastrophic debt crises”, offering no evidence they are “impending”.

They discuss various options for debt relief and restructuring, and offer guidelines for bond buybacks, without mentioning April proposals by the UN, UNCTAD, the African Union and the UN Economic Commission for Africa.

While recognizing some limitations, the duo insist “bond buy-backs present a highly attractive solution, offering substantial debt relief at a relatively low cost”, which “has not received sufficient attention”.

They urge the IMF to use its New Arrangements to Borrow to buy debt at a discount, supplemented by funds from donors and multilateral institutions, but offer no convincing evidence why debt buybacks should now be prioritised over fiscal resources for recovery.

Brady debt buybacks

Under a US-led debt buyback initiative, named after then Treasury Secretary Nicholas Brady, indebted developing countries purchased US Treasury bonds to collateralize more than US$160 billion in replacement ‘Brady bonds’ from 1989.

The scheme restructured the debt of 18 developing countries long after sovereign debt crises began in 1981, following the US Fed’s sharp increase of interest rates to kill inflation. Thus, governments helped banks take defaulted loans, trading for small fractions of their face value on illiquid secondary markets, off their books.

Some banks took ‘haircuts’, but still got much more than what was available in secondary markets. Unlike in the current era, US interest rates were high, and thus, countries bought the Treasury zero-coupon bonds at an attractive discount.

Bloomberg’s Sydney Maki argued on 5 May that a second Brady plan is unlikely to work. The Brady plan transformed commercial bank loans, many in default, into collateralized bonds, but government debt today is owed to more diverse creditors including New York hedge funds, Gulf sovereign wealth funds and Asian pension funds.

Maki doubts that fund managers’ fiduciary duties would allow them to be lenient, even if so inclined. Terms of many deals cannot be legally changed without approval from most bondholders.

Debt buybacks for whom?

As some have noted, the plan undoubtedly relieved “pressure on Wall Street”, saving large US commercial banks which had pushed loans to developing countries in the 1970s. Stock prices of US commercial banks with significant developing country loan exposure rose 35% by US$13 billion after countries accepted the deal.

Jeremy Bulow and Kenneth Rogoff noted that “when highly indebted countries retire their deeply discounted debt, either through buy-backs or ‘debt-equity’ swaps, they may simply be using their scarce resources to subsidize their creditors”.

For them, buybacks and debt-equity swaps “are by themselves a boondoggle benefiting … creditors”. Stiglitz and Rashid dismiss this as just a “possibility”, citing the 1988 Bolivian debt buyback and the 2012 Greek bond buyback as two “good examples” of success stories.

In fact, when Bolivia bought back US$308 million in debt at face value in 1988, the price rose to 11 cents from 6 cents on the dollar, lowering the market value of the remaining debt (US$362 million at face value) to US$39.8 million.

As the earlier market value of its total bonds (US$670 million at face value) was US$40.2 million, the buyback only reduced its debt by US$400,000. This miniscule reduction cost donors US$34 million, which Bolivia would have been better off investing otherwise.

Furthermore, debtor countries participating in the Brady plan were required to deregulate, liberalize and privatize, i.e., implement structural adjustment, to qualify for Fund-Bank money to supplement their own foreign currency reserves for buybacks.

Greek tragedy

Financed by European taxpayers, the Greek buyback experience was no better. The price of 10-year benchmark Greek bonds also rose, as yield fell 147 basis points following announcement of the buyback.

Former Greek Finance Minister Yanis Varoufakis observed, “rumours of a debt buyback have pushed these bond prices to above 43%”; “its effect will be a net debt reduction 40% less than the Eurogroup’s stated target”, constituting “a reward to hedge funds and a ruthless,… massive involuntary haircut for Greece’s embattled banks”.

The New York Times agreed that the “bigger winners were hedge funds, which pocketed higher profits than many had expected”, while Moody’s Analytics correctly predicted that the “bond buyback will not end Greece’s debt woes”.

Greece was forced into excruciating austerity, plunging it into economic depression. As the economy contracted by 24%, unemployment hit 26%, the highest in the euro zone, by September 2009, less than a year later. Thus, debt buybacks may well help financial markets, litigious funds and global finance, rather than indebted countries.

Bond buybacks no panacea

Undoubtedly, debt buybacks may sometimes work in favourable circumstances when well planned as part of a broader financing strategy. Ecuador’s 2008-2009 bond buybacks were part of its external debt restructuring to secure relief from illegitimate ‘odious debt’.

With no pressure from acute financial stress, Ecuador repurchased over 90% through financial intermediaries, at 35 cents on the dollar, as its bond prices fell during the GFC.

Jeffrey Sachs agreed with Bulow and Rogoff that debt buybacks are “not necessarily a panacea for heavily indebted countries” unless “part of a comprehensive arrangement” for reduction of all debt with the full participation of all creditors involved.

Writing before Brady, he doubted the feasibility of such debt reduction as the US had previously blocked such arrangements in the interest of US banks. The political influence of US financial lobbies has only grown in recent decades. And, as Maki notes, a comprehensive arrangement involving all creditors is an even taller order now as they are more heterogenous.

Furthermore, it was reasonable then to assume that debtors only had a certain amount to repay, with other prices adjusting accordingly. However, bond market prices today easily ‘overshoot’, while debt restructurings are rarely sufficient, often delayed and very costly.

Promoting buybacks, backed by institutions like the IMF, also runs the risk of encouraging holdouts in future debt restructurings.

Instead of using scarce financial resources to buy back bonds, multilateral institutions and donors should help developing countries retrieve fiscal space to urgently prevent Covid-19 recessions becoming depressions.

Multilateral Bank Intermediation Must Help Developing Countries' Recovery

Jomo Kwame Sundaram, Anis Chowdhury

SYDNEY and KUALA LUMPUR, Aug 07 (IPS)  - International Monetary Fund (IMF) Managing Director Kristalina Georgieva has warned that developing countries would need more than the earlier estimated US$2.5 trillion to provide relief to affected families and businesses and expedite economic recovery.

With their limited fiscal capacities, developing countries will need to borrow more, increasing their often already high public debt burdens. Developing country debt has grown rapidly since the 2008-2009 global financial crisis (GFC), reaching historical highs even before the pandemic.

A deep pandemic induced depression may also require governments to take over huge private debt liabilities. All this has increased calls for urgent debt relief, cancellation and restructuring, and for new IMF and World Bank lending lines, including new IMF special drawing rights (SDRs).

Not enough debt relief

On 13 April, the IMF approved debt service relief for 25 eligible low-income countries (LICs), estimated at US$213.5 million, for six months, i.e., from 14 April until mid-October 2020.

On 15 April, G20 leaders announced their ‘Debt Service Suspension Initiative for Poorest Countries’ from May to the end of 2020 for 73 primarily LICs. The G20 initiative would cover around US$20 billion of bilateral public debt owed to official creditors by International Development Association (IDA) and least developed countries (LDCs).

Such steps are welcome, providing some temporary relief, but far short of the eligible countries’ long-term public and publicly guaranteed external debt of US$457 billion in 2018.

UNCTAD estimates that in 2020 and 2021, middle- and low-income countries face debt service repayments between US$700 billion and US$1.1 trillion, while upper middle-income developing countries expect to pay US$2.0~2.3 trillion.

The G20 initiative is already seen as merely kicking the can down the road. It does not cancel any debt, which is to be repaid in full over 2022–2024, as interest continues to grow. Hence, it is quite unlike the Heavily Indebted Poor Country (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI).

Furthermore, money saved from debt relief “can be used to pay the private creditors on time and in full”, i.e., prioritizing private over public creditors. The G20 initiative only applies to a limited number of countries, and does not impact the US$8 billion owed to private lenders and the US$12 billion debt to multilateral creditors.

An Oxfam report estimated that eligible countries are still required to pay at least US$33.7 billion for debt servicing this year, or US$2.8 billion monthly, “double the amount Uganda, Malawi, and Zambia combined spent on their annual health budget”.

Furthermore, the initiatives presume that Covid-19 shocks to developing economies will be short and swift, and that developing countries can make debt repayments over the next 3-4 years.

IMF and World Bank falling short

The World Bank has put in place a US$14 billion fast-track package to meet immediate health and economic needs, envisaging financial support of around US$160 billion during 2020-2021.

The IMF has doubled access to its Rapid Credit Facility and Rapid Financing Instrument to meet greater expected demand for emergency financing of about US$100 billion, without requiring “a full-fledged program in place”. By mid-June, various IMF facilities had committed around US$300 billion.

Although these financing instruments involve fewer conditionalities and faster approval, eligibility still depends on familiar — and, in current conditions, very restrictive — criteria. These include, inter alia, having to satisfy the ‘revamped’ joint Bank-Fund debt sustainability framework, which critics deem “obsolete”.

Therefore, actual urgent liquidity support falls far short of the IMF’s US$1 trillion lending capacity while the attempt to issue new SDRs for Covid-19 has been blocked by the Trump administration.

Debt reduction wrong priority now

The UN warned of the dire consequences of the Covid-19 pandemic in April, and in May, argued that without bold policy action, the pandemic would set back the SDGs.

Facing the greatest economic crisis since the 1930s, many developing countries have little choice but to borrow to create fiscal space, rather than focus on complicated, time-consuming long-term debt restructuring, workouts or buybacks.

Instead of obsessing over debt, some developing countries are tapping global debt markets to meet Covid-19 financing needs. When governments can borrow on reasonable terms to invest in projects needed for sustainable development, debt may even be desirable, if not necessary, especially in resource-poor countries.

For some, in a low interest rate environment, it is reasonable for developing countries to borrow more, even raising their debt/GDP ratios to levels previously regarded as dangerous, to fund recovery. This time, it is really different as debt costs are lower and are expected to stay low for some time to come.

Furthermore, the consequences of fiscal inaction, so as to not take on debt, can be disastrous for the developing world, paradoxically making current stock of debt unsustainable. On the other hand, new borrowing to mitigate the negative impact of the pandemic on growth can make debt sustainable.

However, most non-investment grade developing countries have to pay substantially higher risk premiums, due to the prejudices and biases of market finance, even when their macroeconomic ‘fundamentals’ are sound.

Pandemic emergency financing fiasco

After the 2014 Ebola epidemic in West Africa, the Bank launched the Pandemic Emergency Financing Facility (PEF) in July 2017, using insurance-like ‘catastrophe bonds’ and derivatives to raise private sector money for LICs’ pandemic responses.

The PEF promised to “blend the best of the public and private sectors, helping to keep 1.6 billion people safe” while “transferring [financial] risk [from governments] to international markets”.

To draw investors, the PEF has stringent and controversial rules on when and how much to pay-out. To make them attractive to investors, PEF bonds were designed to reduce the probability of paying out.

Due to its complicated approval process the PEF had not paid out a single dollar until the end of March, although the World Health Organization designated the Covid-19 outbreak a “public health emergency of international concern” on January 30, and a “pandemic” on 11 March. The pay-out decision was only made on 27 April; as of 27 July, only a paltry US$146.5 million had been “transferred to support” 48 countries — “too little, too late”, even for The Wall Street Journal.

Meanwhile, its “cash window” – funded by donors – has not been replenished after being used up for the Ebola outbreak in the Democratic Republic of Congo in 2018-2019.

In April 2019, Larry Summers, former World Bank chief economist and US Treasury Secretary, described the PEF as “an embarrassing mistake” and “financial goofiness”, noting that the programme was “loved” for promoting private sector involvement.

Intermediation role required

With preferred creditor status, the Fund and the Bank can borrow ‘cheaply’, i.e., at the much lower interest rates available to them. By intermediating, they can enable developing countries, especially LICs and LDCs, to borrow cheaply for their relief and recovery.

A first step would be to ditch the last Bank president’s now discredited ‘mobilizing finance for development’ (MFD) framework to use public funds, including official development assistance (ODA), to leverage private finance for public-private partnerships (PPPs).

As with the PEF, the MFD approach has failed to leverage billions in ODA into trillions of development finance, as promised, mobilizing only US$0.37 of additional private capital for LICs for every US$1 of public money invested.

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