Default risk at hand

22 Jul, 2022

Around end of March, in a World Bank published article ‘Are we ready for the coming spate of debt crises’ it was pointed out that ‘In recent weeks, Russia’s invasion of Ukraine has exacerbated global economic risks.

There is a fourth element, however, that could make the mix combustible: the high debt of emerging markets and developing economies. These economies account for about 40 percent of global GDP. On the eve of the war, many of them were already on shaky ground.

Following up on a decade of rising debt, the Covid-19 crisis expanded total indebtedness to a 50-year high — the equivalent of more than 250 percent of government revenues. Close to 60 percent of the poorest countries were already in debt distress or at high risk of it. Debt-service burdens in middle-income countries were at 30-year highs. Oil prices were surging. And interest rates were rising across the world. …’

It is strange then that little reported effort was made by the International Monetary Fund (IMF), for instance, to get relocated special drawing rights (SDRs) from last August, which in the first place should not have been distributed on the usual principle of how much each country contributed to the pool of resources of the IMF.

At the same time, given the composition of debt of developing countries shifting more in terms of proportion to private lenders, and that the debt restructuring mechanisms available with multilateral forums, had little capacity in this regard, it was important that the IMF and World Bank, along with treasuries of major economies, should have worked in this direction to improve the restructuring frameworks, and engaged China and private lenders, and overall provided needed debt moratorium/relief to countries high on the list of default risk like Sri Lanka, El Salvador, Ghana, Tunisia, Pakistan, among others.

A Bretton Woods Committee report was highlighted in a Financial Times (FT) article ‘Argentina’s IMF deal offers a warning on emerging market debt’. According to it, ‘…the old Paris Club framework should be overhauled to give China a proper seat at the table.

Finally, it calls for private sector lenders to be incorporated into negotiations at a much earlier stage.’ Having said that, the recent G7 Summit in Germany had not much of a discussion reportedly in terms of meaningful consequence of SDR relocation, and improving debt restructuring effort.

A recent FT article ‘The world isn’t prepared for a wave of sovereign debt defaults’ highlights the rising risk of default for many countries, and it’s very challenging nature for the global economy in the following words: ‘It’s not wildly surprising that we’re on the brink of a string of defaults.

The end of a long period of super-low global interest rates, the blow to growth from the pandemic, the huge uncertainty arising from Russia’s invasion of Ukraine, particularly the shock to net commodity importers from rocketing fuel and food prices, and the rise in the dollar have rapidly increased the burden of dollar-denominated debt. … Apart from Russia itself, Zambia and Sri Lanka among others have already defaulted…’

Moreover, the same article pointed towards significant weaknesses in the current debt restructuring, relief-providing framework, whereby it indicated the ‘The Paris Club played a key role in resolving episodes like the HIPC debt relief initiative, but has always struggled with compelling private sector creditors also to write down sovereign debt.

Twenty years ago, the IMF heroically tried but failed to set up an official bankruptcy procedure (the sovereign debt restructuring mechanism) to bail in private investors. Borrowers have increasingly added clauses to sovereign bond contracts to ease restructuring, but they have imperfect coverage and effectiveness.

Sovereign bankruptcies with official bailouts and private creditors are still worked out ad hoc, sometimes with rival creditor committees. Resolution can get particularly protracted when litigious distressed debt investors get involved. …The G20 of leading economies created a Common Framework for Debt Treatments during the pandemic in 2020, but it’s too vague to provide certainty.’

In the meantime, since February for instance, Sri Lanka has already defaulted, and according to a recent assessment of Fitch rating agency, Pakistan default risk rating was downgraded to ‘negative’, and was projected to be fourth on the list of countries likely to default.

In their rating action commentary ‘Fitch revises Pakistan’s outlook to negative; affirms at “B-”’, published on July 18, 2022, it pointed out in this regard: ‘The Revision of the Outlook to Negative reflects significant deterioration in Pakistan’s external liquidity position and financing conditions since early 2022. We assume IMF board approval of Pakistan’s new staff-level agreement with the IMF, but see considerable risks to its implementation and to continued access to financing after the programme’s expiry in June 2023 in a tough economic and political climate. … Renewed political volatility cannot be excluded and could undermine the authorities’ fiscal and external adjustment…’

Hence, in addition to lukewarm support by major bilateral and multilateral donors, which require better allocation of SDRs, and bringing to table a meaningful debt restructuring/relief-providing framework, default risks in the particular case of Pakistan, also have roots in both political-, and economic instability causes and concerns, and require a broader settlement from main stakeholders of the political and economic arena.

Copyright Business Recorder, 2022

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