A Looming Debt Crunch Demands New Thinking
By Daniel Cash
COVID-19 affects every country, whether developed or developing. But not all have been equally able to respond. Developed countries have managed to lead on vaccination drives, invest significantly in their healthcare, and inject financial resources into their economy. For developing countries and regions, it is a different story.
The international financial community, led by the International Monetary Fund and the G20, has been struggling to develop a response to the dire economic impact of the pandemic on low and medium-income countries, including the question of what to do about the debt burdens that many are now struggling to sustain.
This is a multi-faceted challenge—with the end objective being to ensure conditions for a sustainable recovery, which does not come at the cost of austerity programs or other cost-cutting measures that inflict further damage to social and environmental protections. It is made more complex by the increased dependence of many indebted nations on private, rather than government lending. That has in turn thrust to the fore the currently very negative impact on the process of the private credit rating agencies that evaluate, and in effect put a cost on, a borrower’s ability to pay back debt.
First, a little explanation, with a focus on African countries who make up the majority of participants in the current multilateral IMF/G20 pandemic debt suspension initiatives for vulnerable countries.
Levels of indebtedness have been rising across Africa even before the pandemic, fuelled both by private lenders looking for higher rates of return from high-yield, higher-risk bonds, and by China’s heavy investment in infrastructure and other projects in Africa under as part of its Belt and Road Initiative.
The outbreak of the pandemic upset this increasingly overloaded apple cart, with countries needing to increase expenditure on healthcare, even as revenue-generating economic activity ground to a halt.
With their ability to service and pay back debt curtailed as a result, one option, of course, is to renegotiate that debt.
For so-called “official” lenders, this is not too problematic. Countries and global institutions like the IMF and the World Bank have the capacity and mandate to do this if they wish to. However, for debt held with private creditors—like institutional investors—the same is not so true.
The relationship between private creditors, who often represent the funds of others (like a pension fund for example) are governed by long-established contractual-based laws like those housed in New York or London (predominant centers for private creditor contractual arrangements); so, they arguably have duties to the holders of those funds who they represent. They are also are connected to the credit rating process.
Credit rating agencies such S&P Global, Moody’s, and Fitch use scales to assess issuing countries and debts—from AA for the U.S. government to CCC+ for Argentina to D for "defaulted." If an agency downgrades an issuer, because its debts may not get paid back in full, the interest rate the market expects to receive for holding that debt will go up—in effect increasing the costs to the debtor.
The rating agencies are required to act proactively, transparently, and without conflict to produce ratings that represent the chance of a private investor receiving the return on their initial investment on time and in full.
Unfortunately, that means that the “big three” have all declared that any attempt by a country to renegotiate its debt arrangement with private creditors will be regarded as a reason for an automatic downgrade.
Many of the affected countries are dangerously close to the ranking of ‘in default’ anyway and any such downgrade would massively impact their access to the credit markets – with a rating of “in default,” many investors cannot invest at all.
What does all this mean for the current crisis?
The G20, in collaboration with the IMF and the World Bank, developed two initiatives to suspend debt servicing requirements due to pandemic stress. However, African countries could only renegotiate with one category of lender—the official creditors—because, quite simply, the threat by the credit rating agencies led to an absolute lack of renegotiation with private creditors, who collectively are one of the biggest lenders to the continent. That problem has been dubbed the credit rating impasse.
In our new research report, we at the Credit Rating Research Initiative have tried to find a solution, with a three-stage seed-bed proposal. We start with the idea of a waiver from private creditors, to allow the next stage of the proposal, which is for the credit rating agencies to develop and implement a “rating overlay” that is temporary, but particular to the affected countries and the multilateral initiatives at play.
This overlay would sit on top of the current rating scales and as long as several multilateral initiative-related objectives are met, the country in question could technically renegotiate with their private creditors without, necessarily, being downgraded on the core rating scale. Finally, we propose that a committed and particular advisory service be established for affected countries so that they can take part in the credit-rating process in a much more progressive manner.
Are our proposals simple to implement? No. Are there more practical proposals being made? Perhaps. Our main objective is to drive new ideas and collaborations—because it is clear that something needs to be done.
Affected countries in Africa and elsewhere need help now, but also in the future. It cannot be the case that the financial cycle continues to develop and leave, as almost a natural consequence of high finance, poorer countries at the bottom. The pandemic has revealed several ingrained and systemic fractures on the global scene, and the harshness of high finance is one of them.
The financial architecture can be developed to allow for systemic growth across the globe if there is enough genuine will to do so—one place to start is with the ultimate resolution of this credit rating impasse.
The Credit Rating Research Initiative is a grantee of the Open Society Foundations.