A new era of debt distress

Before the pandemic, African debt was high and finances tight. As a result of COVID-19 and Russia’s invasion of Ukraine, the situation has gotten much worse. With international attention elsewhere, we ignore debt issues at our peril.

The reality is that international efforts have failed to deliver a solution. The G20’s Debt Service Suspension Initiative (DSSI) offered limited breathing room for select countries struggling with the aftershocks of the pandemic. Its successor, the G20 Common Framework for Debt Treatments, is yet to prove that it can offer an effective solution to resolving debt crises at the scale or speed required. Whilst leaders blame each other for the Common Framework’s failure, citizens in debt-distressed countries are suffering.

What’s different about this debt crisis?

The last debt relief effort in the early 2000’s under HIPC and MDRI canceled over $100 billion of bad debt that had built up since the 1980s. Huge amounts had been borrowed on cheaper terms from traditional bilateral ‘Paris Club’ lenders, as well as multilateral institutions like the IMF and World Bank. With fewer lenders, it was relatively easier to agree to debt relief. Yet debt buildup in the last decade has been different, with new bilateral lenders such as China and Saudi Arabia, and diversified private sources like bonds and commercial loans. These new sources lend at commercial or less concessional rates, making the new debt profile more expensive and complex.

The COVID-19 pandemic sharply increased the need for financing. Simultaneously, it decimated the ability of countries to generate or attract it, creating two years of hardship for most countries and eroding financial buffers. The war in Ukraine has led to greater global instability, and had knock-on effects on key commodities, food supply and prices, global supply chains, and inflation. As a result, the US and other advanced economies have had to increase interest rates sharply. Higher global interest rates mean a higher cost of borrowing foreign currency, harming Africa more than other countries and driving up inequality.

Debt service is eating away African finances

African debt service payments have increased substantially in the past decade, in part due to higher interest payments on private loans. Africa’s external debt service will increase to $74 billion in 2024. 59% of the 2023 Nigeria’s revenue to be spent on external and domestic debt service; over twice as much as will be spent on health and education combined. Even before the pandemic, 32 African countries spent more on debt service than on healthcare. 

The higher cost of debt is also driven by an unfair system, where poorer countries that need more finance are charged more to access it. The cost of private finance (bond yields) for emerging markets doubled between 2020 and 2022. The risk and associated cost is driven by Credit Ratings Agencies, and it is estimated that Africa has lost more than $74.5 billion from unfair credit ratings, due to excess interest and forgone funding. This is more than all aid to the continent in 2021.

Challenges aren’t going away

The currency depreciation and inflation that increased the cost of debt will remain high, even if it stops rising. Declines in the price of oil will help the many countries who import it. But for those who rely on it for export earnings, falling prices will put a dent in revenues. Similarly, with commodity prices falling for the first time since the start of the pandemic, many countries will see a fall in revenue as the value of their exports fall.

Some countries will try to grow their way out of debt unsustainability, but sluggish global growth rates could put this at risk.

Chinese lending and investment in Africa has already slowed dramatically, dropping 90% from its $35.6 billion annual average of between 2008-2021, to $3.7 billion in 2021, as countries struggle to repay. For private finance, many African countries are likely to remain locked out of capital markets as interest rates are expected to remain at least at their current levels throughout 2023, whilst banking sector challenges deter investment in riskier markets.

What’s worse than a wave of defaults?

Defaults are catastrophic for countries, for a long time. It takes at least 5 years to recover from a debt default, which can wipe out a decade of economic and social progress. Access to finance is immediately cut, as lenders are reluctant to lend money that might need to be restructured. Even afterwards, countries may find it harder and more expensive to borrow.

The economic impact is also great, with strong evidence of negative impact on growth, investment, trade, and other macro indicators. Politically, default can also be challenging, as countries in default are forced to rely on an IMF programme, requiring painful reforms before any new money comes in. 

However, avoiding default could be worse for longer. Before COVID-19, countries could refinance debt more easily, borrowing new money to pay off old. New debt from capital markets used to be a fast and affordable way to do this, but the premium for private finance is now too high for many.

Second, they could look to restructure bilaterally, adjusting terms on a creditor by creditor basis. China historically preferred this method, but it came at a price for some. Unfortunately, as these options run out, countries must instead make cuts elsewhere. As default draws nearer, countries have no choice but to reduce spending, making cuts to social sectors that are already severely underfunded just to buy time with the hope that the economy and exports will grow sufficiently to avoid default entirely. The long term impacts of underinvestment in social sectors and more loans on unfavorable terms will make the fallout from eventual default worse, and fixing it harder. 

Treating debt before a crisis minimises negative outcomes, in turn maximising repayment, growth, and future financing for debtors and creditors alike. To work, this treatment needs to be fast, predictable, and perceived as fair for all creditors.

Despite the scale of the problem, leaders are failing to act

The G20’s Common Framework—meant to bring together all of a distressed country’s creditors to agree a resolution—is not working. Since its creation in 2020, four countries have applied. One country, Chad, has completed a treatment under the framework, which offers no debt reduction unless oil prices drop. Two years after applying, Zambia has secured a deal with bilateral creditors that could see significant reductions in the value of debt, yet the country continues to negotiate a comparable deal with its private lenders.

The first post-pandemic countries that defaulted, like Sri Lanka and Zambia, were left in limbo for years, seeing their citizens suffer. Securing agreement on a prerequisite IMF programme is taking hundreds of days, against the 55 day average over the last decade. And Paris Club lenders, China, and private lenders have struggled to agree to comparable treatment. As a result, other countries are hesitant to apply, instead doing everything they can to avoid a default—but at their country’s peril. 

Leaders failed after the last crisis to institute the checks and balances necessary to prevent unsustainable debt accumulation in the good times, and a fast, effective and fair system to resolve it in the bad. They must now act fast to prevent a lost decade of development.

Urgent action is needed from leaders

G20:  Prove that the Common Framework is worth keeping

• Provide a debt standstill from all creditors immediately upon application
• Clarify the process, to foster good faith negotiation, promote accountability and quick resolution
• Expand eligibility to Middle-Income Countries

IMF and World Bank: Provide support for countries facing debt challenges

• Increase concessional lending through Multilateral Development Banks
• Ensure that the Global Sovereign Debt Roundtable includes a wide range of views and inputs
• Reform the Debt Sustainability Framework to be fit for purpose, better reflecting changes in the global environment, debt composition and financing needs, enabling faster treatment with improved outcomes. 

G7 countries: Take responsibility for their Private Creditors

• Ensure private creditors participate fairly in negotiations and restructurings, exploring legislative options supporting this
• Continue to implement innovation in contracts through state contingent clauses, such as pandemic and climate clauses
• Support borrower countries to coordinate and effectively negotiate for their interests