China as a creditor

Sovereign debt restructuring has become tricky

One of the most anticipated components of the Spring Meetings of the World Bank and the International Monetary Fund (IMF) in Washington DC this year was a global sovereign debt roundtable meant to revitalise the under-performing system to restructure public debt. This is because the world is going through a severe sovereign debt crisis, and one which the international financial architecture has by and large failed to effectively address. The effects of the pandemic and relief spending, along with the worldwide inflationary environment created largely by big Western stimulus packages and the Russian invasion of Ukraine, have resulted in sharply higher interest rates and affected government finances in multiple developing countries. As IMF Managing Director Kristalina Georgieva has noted, about 15 per cent of low-income countries are in distress, while another 45 per cent are facing high debt vulnerabilities. Existing systems, however, were not able to respond to this crisis because of structural changes to the sovereign debt system since the restructuring systems were first designed in the 1980s.

One major change is the rise of China as a creditor nation. This has caused complications because, to begin with, China is not part of the existing Paris Club of creditors that closely coordinate on how to bail out distressed debtors. Beijing has been a problematic creditor for various other reasons. For one, it has insisted lending through its development banks, which the rest of the world views as bilateral government-to-government lending, be treated instead as private commercial lending and thus receive seniority in repayments as opposed to bilateral lending from other countries. In addition, the internal systems within the People’s Republic to authorise a haircut are not well developed.

It has been reported in fact that each individual haircut in sovereign debt restructuring cases would have to be cleared at the highest level by the State Council of the People’s Republic. Thus, there is naturally a disincentive to enter the restructuring process in the first place, and even once entered, there is a bottleneck on decision-making that the Chinese system will need to solve. The Chinese thus tend to offer to roll over debt rather than cancel it or write it down. Finally, there are concerns that Beijing is refusing to recognise the convention that the IMF and the World Bank itself are “super-senior”, in that they are not required to take a haircut in a bailout when everyone else is. The leadership of these institutions remains convinced that this status is essential in order for them to retain their enviable credit ratings, which allows them to tap a wide set of funding sources.

Some reports have emerged that the Chinese, after being relatively isolated at the sovereign debt roundtable, are willing to retain the special status of the multilateral development banks in sovereign debt restructuring if the World Bank also steps up lending to distressed debtors through its International Development Association funding line, which hands out concessional loans and grants to countries with prohibitive credit risk. It remains to be seen whether this quid pro quo will wind up subsidising Chinese bondholders out of global public funds in a roundabout way. If so, it will likely prove unacceptable. Finance Minister Nirmala Sitharaman has prioritised the reform of sovereign debt restructuring as part of the Finance Track in India’s G20 presidency. This is wise prioritisation, and an equitable and efficient solution to the problem would be seen as a big achievement of the presidency.