INTERNATIONAL POLICY ANALYSIS Making the Global Financial System More Resilient A Regional / Group-wise Approach to Sovereign Debt Workouts JÜRGEN KAISER May 2017 n More countries in the Global South are heading towards a new debt crisis due to low global interest rates and low commodity prices. Thus far, there have been no innovative approaches for a possible debt workout with regard to the new crisis. n Regarding the next crisis, there is something to learn from the HIPC/MDRI initiatives of the 1990s and 2000s: overcoming political deadlocks by designing debt relief exclusively for a limited group of countries. n Such a limited debt relief scheme could then imply procedural innovation that could remedy weaknesses of the HIPC/MDRI schemes and debt restructuring mechanisms at large, by making them more comprehensive and impartial. JÜRGEN KAISER | MAKING THE GLOBAL FINANCIAL SYSTEM MORE RESILIENT Contents 1. The Next Sovereign Debt Crisis: A Global Problem with Differentiated Characteristics �������������������������������������������������3 2. Shortcomings of the Global Sovereign Debt Workout Regime in the Face of the Next Crisis . .4 3. Difficulties in Designing a Global Debt Workout Mechanism ...................5 a. »This Time is Different« ���������������������������������������������������������������������������������������������������6 b. Costs . .6 c. Co-ordination Problems ���������������������������������������������������������������������������������������������������6 4. The Global / National Dilemma in the Design of a New Debt Relief Regime and the Case for a Third Approach between the Two �������������������������������������������������7 a. A Global Approach: Proposals and Political Deadlocks �����������������������������������������������������7 b. The National Approach: Moving Forward from a Weak Position . .8 5. Learning from the Process that Led to HIPC: Limited Target Group, Limited Relief and a Sort of Comprehensiveness . .9 6. Beyond HIPC: Where a New Regional Approach Needs to Be Different . 11 7. Below the Level of a Global Statutory Insolvency Regime: A Debt Relief Option for Regionally or Thematically Defined Country Groups . .12 a. The Logic of Sub-groups for Debt Relief . 13 i. Regional Groups: The Caribbean as an Example ��������������������������������������������������������� 13 ii. A Thematic Group: Debt Vulnerabilities in Countries Affected by Climate Change �����14 b. How it Would Work . 15 c. Debt Relief under the Regional and Thematic Schemes and their Financial Implications �����15 8. How It Could Be Brought About . .16 9. A Pragmatic First Step: Establishing a »Debt Workout Institution« �������������������������17 10. The Political Way Forward . .18 Annex . .20 Caribbean Group . .20 Climate Change Group ...................................................21 Debt Risk Matrix . .22 JÜRGEN KAISER | MAKING THE GLOBAL FINANCIAL SYSTEM MORE RESILIENT 1. The Next Sovereign Debt Crisis: A Global riphery had already caused the hard awakening: a per- Problem with Differentiated Characteristics sistent risk, such as debtor-creditor imbalances, requires a structural response that addresses crises whenever Since 2005, the Multilateral Debt Relief Initiative (MDRI) they occur. has concluded in large part the debt relief process for the poorest countries, which started under the aegis of Regarding the beneficiaries of the debt relief efforts of the International Monetary Fund (IMF) and World Bank the 1990s — i. e. low- and middle-income debtor coun- with the first Heavily Indebted Poor Countries (HIPC) tries in Asia, Africa, Latin America, and the European Initiative in 1996. External debt owed to commercial, periphery — indicators did indeed start to rise again bilateral official, and multilateral creditors was substan- from 2009 onward. And that rise became increasingly tially reduced and debt indicators of the poorest coun- dynamic. Based on figures from World Bank’s Interna- tries decreased dramatically. Most of the middle-in- tional Debt Statistics database,3 the annual analysis at come and »emerging market« countries in debt distress erlassjahr.de showed 83 countries with one, several, or had achieved some external debt relief — albeit less all indicators in critical ranges for end-2013, and the lat- dramatic — a few years earlier under the Brady Plan, est available data for end-2015 show a rise to 116 coun- which reduced their exposure to their private creditors tries.4 Even beyond the present data, the trend is all too only. clear: for every two improved debt indicators between 2011 and 2015, there were seven that had worsened by Policymakers were tempted to consider sovereign debt at least 10 per cent; one year earlier, i. e. for the 2010– crises — of the type that occurred after Mexico’s default 2014, period this relationship had been 1:2. in 1982 — to be a thing of the past. Logically, it is un- deniable that individual debt relief operations can never There can be no doubt that many more countries are rule out future over-indebtedness. Politically, however, heading for a new sovereign debt crisis, and if we look global debt problems were treated in this manner during at the global economic conditions under which this cri- much of the financing for development discourse. It was sis emerges, we see stunning parallels to the build-up too tempting for policymakers, such as the G8, to look of sovereign over-indebtedness ahead of Mexico’s 1982 instead at development finance from the positive angle default: extremely low interest rates in the advanced of resource mobilization, ignoring that debts are the in- economies (caused by the ultra-liberal monetary policies evitable downside of any loan flowing into the Global of central banks and the capital oversupply due to rising South or the European periphery. The 2030 investment oil prices and recycled petro-dollars), combined with a agenda, the German G20 Presidency’s »Compact with slump in global commodity prices (caused by a reduction Africa«,1 and even a veritable »Marshall Plan for Africa« of global demand, which leads to drastic reductions in propagated by the German Development Ministry are hard currency incomes of commodity exporters). Political the most recent expressions of this one-sided under- circumstances also show increasing parallels: in the past, standing of capital flows into infrastructure and other many military and authoritarian governments in debtor economic development projects. Some even take the countries provided the loan pushers of the time with a form of mega-projects, such as the Chinese »One Belt, seemingly stable environment, which would guarantee One Road« initiative.2 repayments regardless of the social costs, which an un- sustainable debt service might cause. Today, we see that In reality, the global financial crisis of 2007/2008 and the wave of democratization of the 1990s has been ex- the subsequent sovereign debt crisis in the European pe- hausted and is giving way to more and more autocratic and authoritarian regimes in debtor countries. On global 1. F. Mabera / N. Monkam (2017): Germany’s G20 Presidency and the capital markets, this again encourages capital transfers Africa compact: what now for the G20 Africa partnership? available at: http://blogs.die-gdi.de/2017/01/31/germanys-g20-presidency-and-the- without too much emphasis on due diligence on the africa-compact-what-now-for-the-g20-africa-partnership/ (last accessed on 14.3.2017). 3. World Bank: International Debt Statistics 2017; available at: http://data. 2. For a short description see: T. Jianchen (2016): ›One Belt and One Road‹. worldbank.org/data-catalog/international-debt-statistics (last accessed on Connecting China and the World (July 2016); available at: http://www. 12.3.2017). mckinsey.com/industries/capital-projects-and-infrastructure/our-insights/ one-belt-and-one-road-connecting-china-and-the-world (last accessed on 4. erlassjahr.de / Misereor (2017): Schuldenreport 2017; English: Sover- 14.3.2017). eign Debt Monitor 2017. 3 JÜRGEN KAISER | MAKING THE GLOBAL FINANCIAL SYSTEM MORE RESILIENT creditor side.5 Rather, the confidence, which prevailed protracted and piecemeal back-and-forth negotiation in the 1980s that »states do not go bankrupt« is once process over debt restructuring and eventually debt re- again driving creditor behaviour. lief with ongoing enforced payments from insolvent sov- ereigns, in fact would ultimately be more expensive for What is new, however, is that the debt relief operations everybody.7 For instance, the debt of the 36 countries, under HIPC/MDRI have indeed provided fiscal space for which ever since have obtained HIPC debt relief, stood at meaningful infrastructure investment through external 78.8 billion US dollars in 1982. Despite some piecemeal loans or bond financing. Nevertheless, the distinction debt and debt service relief through the various frame- between meaningful investment and corrupted white works of the Paris Club, that debt rose to 118.5 billion US elephants, as well as between sustainable and unsus- dollars in 1997 at the onset of the HIPC-I initiative. The up tainable debt, is as difficult to make now as it was 20 to 90 per cent debt relief, which HIPC/MDRI combined years ago.6 provided, would have implied fewer nominal losses for the creditors — or less relief would have been required There are further novelties in the crisis currently emerging: in the first place — had it come immediately after Mexi- n the broad-based shift from loan to bond financing on co’s 1982 default. Additionally, a