The World Bank’s chief economist has called for an urgent overhaul of the system for dealing with unsustainable debts, as the institution warns of a coming wave of sovereign defaults by developing countries.
A surge in global borrowing costs, along with the strong dollar and high inflation, have made it hard for some developing countries to meet repayments on both foreign and local currency debts.
Indermit Gill, chief economist of the Washington-based organisation, said in an interview with the Financial Times that the existing framework for dealing with unsustainable debt burdens was no longer fit for purpose and “needs to change”.
“We are applying a restructuring model that was devised for another time,” Gill said, adding that the current system was “too little, too late” for countries in danger of default and “too lopsided” in favour of commercial creditors.
The World Bank has warned countries are increasingly struggling under soaring debt servicing costs and the strains on public finances caused by multiple crises, including the pandemic and Russia’s war in Ukraine.
Poor global growth makes it even more urgent to tackle the issue now, he said. “Our best forecast for next year is a third lower than it was a few months ago, and 2024 doesn’t look a lot better,” he said, adding that debt restructurings “could be a train wreck”.
Critics say efforts to deal with mounting debts have moved too slowly in cases such as Zambia, Sri Lanka and Ghana, which this week became the latest developing economy to default.
“You can have long periods [between problems arising and being resolved] in which very bad things can happen,” Gill said. It took Zambia almost two years after defaulting to secure an IMF loan.
Gill blamed the lack of a set of globally-agreed standards for the delays, and said dealing with defaults and restructurings on a case-by-case basis was creating “the same problem five years down the road”.
“We absolutely need a uniform approach,” Gill said. “Otherwise you are just tinkering and hoping that growth will resume and the problem will go away.”
Relief, he said, should be significant enough to put debtors on a sustainable path to growth and mean all creditors share an equal burden.
Today’s approach to debt workouts was devised during the emerging market debt crises of the late 20th century, when creditors were largely western governments and commercial banks.
Since then, however, China, India and Saudi Arabia have become increasingly important players in financing poorer countries. The banks involved in the past, meanwhile, have been replaced by thousands of bondholders.
Governments have also increasingly turned to domestic institutions as sources of finance. In both Ghana and Sri Lanka, about half of government debt is owed to domestic lenders. In other troubled debtors such as Egypt and Pakistan, the proportion is much greater. Any default risks causing chaos in domestic banking systems.
Standard procedures for debt workouts involve the IMF and World Bank conducting a debt sustainability analysis to assess the scale of the problem, before calculating the amount of debt relief needed to restore sustainability and put the debtor on a path to economic growth. Creditor governments then agree how much relief they will provide — a step which typically unlocks an IMF bailout. The process ends when the debtor government is tasked with securing the same terms from its commercial creditors as those offered to the official sector.
The big asset managers that represent bondholders want to be involved earlier in the talks.
An attempt to break the dominance of western governments in the debt resolution process came early in the pandemic from the G20 group of large economies that includes China, India and Saudi Arabia. But their Debt Service Suspension Initiative failed to gain traction, with only three countries — Zambia, Ethiopia and Chad — signing up to the framework built from the initiative.
Gill said the biggest mistake of the new framework was to introduce the possibility that commercial creditors would remain outside any debt relief process — an error which risked cutting off governments’ access to foreign capital markets.
A new system for debt workouts would, he said, need to recognise that “countries have market access” and would need to “continue to have it”.
