What G7 should do in response to sovereign debt crises

Unlike in previous sovereign debt crises, the long-established economic powers can no longer manage the problems on their own. Solutions require that these Paris Club members must involve China and other rising middle-income countries in policymaking. G7 action that serves this purpose is the further development of the G20’s Common Framework on Debt Treatment (CF). 

Lessons from the 1980s

History shows that it is possible to make private creditors accept losses in return for assurances that debtor countries’ ability to repay the rest is restored. That was part of the Brady plan in the 1980s. It was named after Nicholas Brady, then the US secretary of the treasury, to tackle Latin American sovereign debt problems. The plan proved that generosity coupled with the right incentives makes sense. 

From 1989 to 1994, private lenders forgave $ 61 billion in loans. That was roughly one third of the total outstanding debt. The other two thirds were repaid as national economies gained momentum again. However, it took almost a decade to put all the elements of the plan in place. At the time, commercial banks were the main creditors, and before they became willing to accept losses, they had to replenish their capital bases. Otherwise, they would have been at risk of collapse. 

The 18 indebted countries that signed on to the Brady plan agreed to domestic economic reforms that then enabled them to service their remaining debt. The outstanding bonds were relabelled as “Brady bonds” and repayment of their principal was basically guaranteed by the US government with support from international finance institutions. Those guarantees were a strong incentive for banks to take part. The strong ownership of the United States helped to implement the Brady plan successfully. 

Something similar would be useful for resolving current sovereign debt problems. Debt restructuring once again requires strong international cooperation, but also ambitious reform efforts at the national level of indebted countries. Any comprehensive policy menu must include better domestic resource mobilisation (especially tax revenues) and structural reforms (to create fiscal space and flexibility). Without strong financial support, however, indebted countries cannot enact such reforms and their economies will remain stalled. They deserve advice on technical matters too. 

What the G7 should do 

In this setting, the G7 should push for legal reforms. Moreover, international financial institutions like the International Monetary Fund and the World Bank should support collective efforts. Generous provision of climate finance would make sense too. Such action would help to engage China and the other major bilateral creditors that do not belong to the Paris Club. There are several ways for western policymakers to make a positive difference. 

For example, the CF would benefit from law reforms in Britain and New York State. New York City and London are the world’s dominant financial centres. Accordingly, an estimated 52 % of the total outstanding stock of international sovereign bonds was governed by New York law in 2020, and a further 45 % by English law. 

In both places, legal reforms could give a strong majority of private creditors the power to conclude agreements that bind any dissenting minority. A supermajority of two thirds, for example, would be a reasonable option. 

Two recent debt agreements, one pending in Sri Lanka and another agreed last year in Suriname, include clauses that would allow investors to change the location where potential disputes settle. Such clauses are obviously counter-productive. A broad international agreement should close such escape options, and, once again, the Paris Club cannot conclude it on its own. 

More generally speaking, jurisdictions must be coordinated and use harmonised statutes. A new legal regime must codify an international duty for creditors to cooperate in sovereign-debt restructuring. For some commercial banks, after all, participation currently means the risk of breaching fiduciary responsibilities they have towards clients who invested in bonds. Legislation should also prevent the sovereign debtor’s assets from being seized when they are undergoing a good faith restructuring. 

Western policymakers, moreover, should bear in mind that Chinese banks today may well be in a position similar to US banks in the early years of the Brady plan, when they did not want to take losses because they had to safeguard their capital base. If Chinese banks are facing this challenge today, that would explain why China has been so adverse to debt relief in recent restructuring talks, while being rather generous in regard to postponing debt servicing. 

Many indebted countries need debt relief, however. The implication is that other approaches to burden sharing may be needed if the CF is to be enhanced in ways that make it fully fit for purpose. 

José Siaba Serrate is an economist at the University of Buenos Aires and at the University of the Centre for Macroeconomic Study (UCEMA), a private university in Buenos Aires. He is also a member of the Argentine Council for International Relations (CARI). 
josesiaba@hotmail.com