Points To Ponder On Debt Restructuring And Cancellation – Analysis

While there could be debt reduction or cancellation in specific cases, across-the-board reduction or cancellation will reduce capacity to give grants or concessional aid, the IMF and World Bank have said. 

Given debt-ridden Sri Lanka’s difficulty in getting creditors to agree to haircuts and the problem it has in meeting the IMF’s onerous conditions, the subject of debt servicing has gained public attention across the world. Recently, a group of 182 international academics issued a statement on the question of Sri Lanka’s foreign debt restructuring. Among its key observations were (1) the unsatisfactory performance of international institutions like the IMF and the World Bank; (2) the opacity of debt negotiations; (3) profiteering by private creditors holding International Sovereign Bonds (ISB).  

Though international financial institutions like the World Bank and the IMD were set up to assist funds-strapped countries reach financial stability and provide resources for development, they have not been ot living up to these responsibilities. 

“They have been slow to respond to the crisis, and are apparently requiring onerous policy and fiscal conditionalities, such as moving to a primary fiscal surplus in a very short time, even as the economy continues to plunge. The implications are already evident in the recent Budget of the Sri Lankan government, which has unrealistic revenue assumptions that are unlikely to be met. Revenue shortfalls would then necessitate further austerity and likely cuts in essential public spending. The Budget also proposes public asset stripping and privatization of strategic lands, marine resources, energy, transport and telecom infrastructure and public enterprises. These policies will harm the most vulnerable groups in Sri Lanka, exacerbate poverty and inequality, and lead to further economic decline,” the statement said.

“Instead the focus should be on legal and regulatory changes to stem the illicit outflow of capital through transfer pricing and trade mis-invoicing over the past 15 years, which is estimated to be far more than the aggregate foreign debt of Sri Lanka, and on taxation of wealth and consumption of the super-rich,” the academics added.

They also said that the current debt crisis in Sri Lanka (and other such countries) is partly due to the lack of transparency in the debt negotiation process and in the accountability of the holders of ISBs. There had been risky lending to corrupt politicians, leading to what is now recognized as “odious debt”. And such ‘odious debt’ has been  a significant factor generating the current debt crisis. 

Private Creditors

The signatories observed that private creditors owned almost 40% of Sri Lanka’s external debt stock, but given the higher interest rates at which they had lent, they would receive over 50% of external debt repayments.

“Over the last decade of liquidity expansion and low-interest rates in the world economy, private lenders provided loans to low and middle-income countries at higher interest rates than for advanced countries. These higher rates were purportedly due to greater risk exposure that could make debt repayment more difficult in such countries. That risk has now materialized, firstly through a global pandemic, and then the price shocks and interest rate increases of 2022,” the academics pointed out.  

Therefore, lenders who had benefitted from higher returns because of the risk premium, must be made to take the consequences of that risk, the statement suggested. Apart from revealing the identity of ISB holders, it is also important to disclose how the ISB funds were used.

Turning to the big bilateral creditors they said: “Instead of geopolitical manoeuvring all of Sri Lanka’s creditors must ensure debt cancellation sufficient to provide a way out of the current crisis.” Since debt negotiations in Sri Lanka are now at a crucial stage, all lenders—bilateral, multilateral, and private—must share the burden of restructuring, with assurance of additional financing in the near term. 

Debt Restructuring/Cancelling

As many Third World countries are in deep debt and unable to repay, debt restricting and cancellation are suggested by some. Writing in The Guardian on May 17, 2003, Bob Geldof said that annual debt payments by 26 countries were cut by 40% , thus  freeing-up money to be spent  on health and education. However, simultaneously, the rich creditors also slashed aid and rigged trade. Total resource flows in terms of aid to the 53 countries identified as highly indebted, fell sharply.

Debt relief had come with conditions, Geldof pointed out.  “G7 leaders required countries to jump impossible economic hurdles. “Open up your markets” they said, “but don’t expect us to do the same!”. “Structurally adjust your economies – but don’t expect the same of us – even though we are living well beyond our means!”. “Lower the prices of your commodities, but don’t expect us to lower the prices of our exports!”. “Get out of commodities – but God help you if you try and compete with our value-added industries!”. 

It’s a dreary tale: the age-old story of the playground bully, picking on the weak and vulnerable, Geldof comments. 

But the IMF/WB has defended their funding policies. In a joint note dated November 30, 2022, under the title: Debt Relief Under the Heavily Indebted Poor Countries (HIPC) Initiative they said that, to date,  debt reduction packages under the HIPC Initiative was approved for 37 countries, 31 of them in Africa, providing $76 billion in debt-service relief over time.

In 2005, to help accelerate progress toward the United Nations Sustainable Development Goals (SDGs), the HIPC Initiative was supplemented by the Multilateral Debt Relief Initiative (MDRI). The MDRI allows for 100 percent relief on eligible debts by three multilateral institutions—the IMF, the World Bank, and the African Development Fund (AfDF)—for countries completing the HIPC Initiative process. In 2007, the Inter-American Development Bank (IaDB) also decided to provide additional (“beyond HIPC”) debt relief to the five HIPCs in the Western Hemisphere.

But a condition was that the beneficiary country should have established a track record of reform and sound policies through IMF- and World Bank–supported programs; and should have developed a Poverty Reduction Strategy Paper (PRSP) through a broad-based participatory process in the country.

In a July 2001 paper, the IMF and World Bank Staff had said that a recipient country should have the capacity to deliver on social policy, better expenditure management, and the many other elements of economic, social, political and institutional reform. 

On the role of the international community, the paper said that they must respond by providing more official development assistance on appropriate terms, opening markets for poor countries, assisting with building capacity, and providing well-targeted debt relief. 

“The agreements in place for the 23 countries envisaged reduction of  their total debt by two-thirds, and bringing their indebtedness to levels below the average for all developing countries. Cash debt service savings in these countries were about US$1.1 billion annually for the next three years. Debt service payments as a percentage of exports, GDP and government revenues would fall dramatically,” the paper said.  

It further said that debt reduction under the HIPC Initiative should be seen as a “one-time action”, as the first step toward enabling the HIPCs to stand on their own feet. Their growth and poverty reduction strategies need financial support, which for many will mean a need for a much higher level of concessional official aid for many years to come. 

“In time, they will be able to gain access to private international capital, including both direct investment and further borrowing,” the note said.

Rejecting calls for total debt cancellation, the paper said that those who call for 100% cancellation for the HIPCs must recognize that this would be inequitable for other poor countries. Across-the-board debt cancellation will reduce the capacity of the richer countries to give grants or aid on concessional terms, the paper pointed out.