Many of the world’s low-income countries have been pushed to the brink of default on their loans to foreign creditors by the COVID-19 pandemic. The Debt Service Suspension Initiative (DSSI), agreed jointly by the Paris Club and the G20 Finance Ministers and Central Bank Governors in April 2020, provided debt relief in the form of a suspension of debt-service payments falling due from these countries in the period May-December 2020.1The G20 members are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, United States, and the European Union. This suspension has been extended to the end of 2021.
China is not a member of the Paris Club but is a major creditor to quite a few of these countries and is the largest creditor to several of them. Naturally, the Paris Club members don’t want to forego payments that will make it easier for these debtor countries to meet their payment obligations to China. Consequently, they worked within the G20 process to obtain China’s agreement to join the suspension.
It will be necessary, however, to convert this payment suspension into sustainable debt relief arrangements—including debt reduction—for at least some of these low-income countries.2In this essay, debt relief is defined to include all actions that modify the payment obligations (principal and interest) of a country. These actions include debt rescheduling with no change in net present value and debt reduction that involves forgiving of net present value. As used here, debt relief is synonymous with debt restructuring. In November 2020, the G20 Finance Ministers and Central Bank Governors agreed on a “Common Framework” for implementing such arrangements that is closely aligned with Paris Club principles and practices. The Paris Club is the obvious place in which to negotiate these conversions, but China’s non-membership creates an interesting policy challenge for both China and the Paris Club members.
In this essay, we examine the problem and suggest how it will play out.
Paris Club Membership
In the 1950s, Western creditors, led by France, created a process for rescheduling their loans to defaulting countries. It came to be called “the Paris Club.”
The Paris Club is an informal institution with no legal foundation. It emerged at a time when there was little international lending to low-income/developing countries. Virtually all of the lending to these countries was from government agencies (foreign aid agencies and export credit agencies) in the high-income countries. There was very little lending to these countries by commercial banks because they were deemed to be uncreditworthy. There was virtually no debt owed by these countries to private-sector investors in the form of bonds floated in the international capital market because of the history of bond defaults earlier in the 20th century.
There are only two requirements to be a Paris Club member. One is to be a country with a substantial amount of outstanding loans from its government agencies to borrowers in foreign countries. The other is to fully accept “the main principles and rules of the Paris Club.”
Today, the Paris Club has 22 Permanent Members.3The Permanent Members are Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Italy, Japan, South Korea, the Netherlands, Norway, Russia, Spain, Sweden, Switzerland, the United Kingdom, and the United States of America. They are all members of the Organisation for Economic Cooperation and Development (OECD—the Paris-based forum of the countries with the most advanced free-market economies), except for Brazil and the Russian Federation.
In addition, there are 14 “Ad hoc Participants” in meetings of the Paris Club, notably including China, India, Saudi Arabia, and South Africa.4The other Ad Hoc Participants are Abu Dhabi, Argentina, Czech Republic, Kuwait, Mexico, Morocco, New Zealand, Portugal, South Africa, Trinidad and Tobago, and Turkey. These countries are invited to participate in negotiations with a debtor country to which they have substantial loan exposure. They sign the Agreed Minute for the negotiations in which they participate, and they are bound by it.
There are also three categories of Observers that participate in Paris Club meetings but not in the actual negotiations with debtor countries. These are: (1) representatives of nine international financial institutions, starting with the IMF and the World Bank;5The others are four lending institutions (the InterAmerican Development Bank, Asian Development Bank, African Development Bank, and European Bank for Reconstruction and Development) and three non-lending forums (Organization for Economic Cooperation and Development-OECD, UN Commission for Trade and Development-UNCTAD, and the European Commission). (2) representatives of Permanent Members that have no debt owed by the particular debtor country seeking debt relief; and (3) representatives of other countries with debt owed by the particular country seeking relief but are not in a position—generally for political reasons—to sign the Agreed Minute.
Paris Club Principles
The Paris Club website lists six principles.
Case-by-case means that each debtor country is treated separately. This principle was formalized in the 1970s when there were calls for generalized debt relief for developing countries in the UNCTAD-led “North-South Negotiations.”
Solidarity is working together respectfully. Implicit here is the notion of nondiscrimination: all members in their bilateral implementing agreements will adhere to the terms of the Agreed Minute.
Consensus means that all participating members in a negotiation must support the terms in the Agreed Minute.
Information sharing is the commitment of members to fully disclose their loan exposures in borrowing countries with each other, and with the IMF and World Bank, on a confidential basis.
Conditionality is the most controversial principle for the borrowing countries. It links the debt relief provided by members to countries that are: (a) in default or facing imminent default; (b) committed to reforms that will restore their creditworthiness; and (c) implementing a policy reform program supported by the IMF. It is controversial because low-income countries in the UN’s developing country G-77 caucus have sought unconditional debt relief (debt relief on demand) since the 1970s.
Comparable treatment means that debtor countries accepting Paris Club debt relief commit to providing no better treatment to non-member bilateral official creditors (e.g. China) and commercial creditors (commercial banks and bondholders). This has been a highly contentious principle because private-sector creditors always want to be “bailed out” by their governments. Private creditors argue that they provide “non-political” financing and therefore their loans should have seniority over official creditors in the sovereign debt restructuring process. Official creditors argue that they should have seniority because they often provide new financing when private creditors refuse to and because private creditors charge higher interest rates to reflect default risk. The comparable treatment principle does not extend to bank and bond debt owed by private-sector borrowers in defaulting countries.
The Paris Club Process
A Paris Club debt relief negotiation begins with a request from a debtor country to the Paris Club Secretariat within the Finance Ministry of France. Such requests generally follow informal conversations between the Secretariat and the lead ministry in the debtor country to make sure its request will be accepted. The sticking point at this stage is often the conditionality requirement of having a policy reform program supported by the IMF.
The IMF’s support of countries in default has a technical element and a financing element. The technical element specifies policy measures that will be implemented by the country over the next 1-3 years designed to restore its creditworthiness. The measures are always a combination of macroeconomic reforms (budget and monetary policy) and structural reforms (such as removing trade and investment restrictions). The financing element is in the form of quarterly disbursements of funds that will close the country’s external financing gap. The size of this gap is determined by the IMF’s “debt sustainability analysis”, which assumes a fixed amount of debt relief by the country’s foreign creditors. This assumption is made in consultations with the Paris Club Secretariat and is guided by precedents set in other cases. It has the effect of defining to a large extent the amount of debt relief the Paris Club creditors will provide and, via the comparable treatment principle, the amount other official and private creditors will provide.
Upon receipt of a well-crafted formal request, the Paris Club Secretariat will fix a date for a meeting between representatives of the country in default or facing imminent default and representatives of the Paris Club members (a mix of finance ministry, foreign ministry, and export credit agency officials). The negotiations are usually concluded in one or two days and are formalized in an “Agreed Minute” that sets forth new terms for specific debt service obligations (arrears and principal and interest payments) falling due in a specified period of time.
Agreed Minutes have no legal status. They are not binding on the participants. Each of the participating creditor countries is committed, however, to negotiate a legally binding bilateral agreement with the debtor country that incorporates the terms in the Agreed Minute. The debtor countries are committed to obtaining from non-participating bilateral official creditors equally favorable relief, and to obtaining comparable treatment from their private creditors.6The distinction between bilateral and multilateral official creditors is important. See below. While the treatment of the long-established multilateral agencies is clear, the treatment of newer agencies with more limited membership is an open issue. These newer agencies range from the European investment Bank to the African Exim Bank and could include the Asian Infrastructure Investment Bank and the New Development Bank.
A typical Paris Club meeting includes a session restricted to members and Observers in which views are exchanged on countries likely to be seeking Paris Club debt relief. These sessions also provide an opportunity to review the principles of the Paris Club and problems of implementation that arise from time to time.
Paris Club History
The rash of debt problems that led to the birth of the Paris Club in 1956 was related to borrowing by developing countries from export credit agencies in the high-income countries. Arguably, the export credit agencies had overlent to this group of countries in a competitive race to win export business. In its debt relief operations during the ensuing two decades, Paris Club debt relief was entirely in the form of rescheduling: combining arrears and payments falling due in the coming year or two and having them repaid in full over some period in the future.
In the 1980s, a group of mostly Latin American countries that had borrowed heavily from commercial banks experienced severe debt-servicing difficulties in an episode often referred to as “the Latin American debt crisis”. The principle of comparable treatment with commercial banks was nailed down at this time, although the first case where the principle was established was with Zaire in 1976. At the end of the 1980s, the Paris Club accepted the necessity of writing down/reducing the debt of countries where debt sustainability could not plausibly be restored without it. It was at this time that commercial banks were required to participate in debt reduction for the first time, in parallel with Paris Club debt reduction operations.
In the 1990s, a group of mostly African low-income countries accumulated unsustainable debts to the World Bank and other multilateral agencies and had to be bailed out to avoid default. From its earliest days, the Paris Club treated these agencies as “preferred creditors”, meaning they would never be required to reschedule or write down debt owed to them.7See Addendum. To preserve this status, the main foreign aid donors provided special grants to this group of debt-distressed countries through the “Heavily-Indebted Poor Country (HIPC)” Initiative to meet their payment obligations to the multilateral agencies. Most of the Paris Club creditors at this time had shifted largely from making loans to making grants to support economic growth in low-income countries. As needed, they wrote off debt owed to them in conjunction with HIPC operations.
In 2001, Argentina’s government defaulted on a large volume of bonds issued in the international capital market and held by private sector investors (individuals and firms, notably including hedge funds). Argentina’s debt workout was exceptionally complicated because there was no precedent for including bondholders in debt relief negotiations and it proved impossible to appoint a single representative for all bondholders. The Paris Club adapted its procedures in this case and other cases where “haircuts” on bond debt were deemed necessary to restore creditworthiness. In the wake of the Global Financial Crisis of 2007-08, Greece became the first high-income, OECD-member country to require debt relief. This case was addressed by the European Union without any explicit debt reduction and without any Paris Club involvement.
The COVID-19 pandemic that erupted in 2020 has exacerbated the debt vulnerabilities being experienced by an unprecedented number of countries. It is impossible to know in April 2021 how far this problem will spread and what kinds of adaptations the Paris Club will have to make to play its part in restoring the creditworthiness of these countries.
China’s Participation in Paris Club Operations
There is no official statement from China explaining why it has not yet decided to become a member of the Paris Club. Several possible reasons can be deduced from China’s policies over the past 2-3 decades.
One reason is that, since the revolution that culminated in the founding of the People’s Republic of China in 1949, it has maintained a “brotherly” relationship with developing countries, notably in the UN context where it remains a member of the G-77 developing nation caucus, opposed to the advanced “imperialist” countries. China now legitimately claims superpower status, but it takes advantage of its years of developing country status when this helps to advance its foreign policy and economic objectives.
Another reason is the close working relationship the Paris Club has with the IMF and the World Bank, which are dominated (and arguably controlled) by the United States and other high-income countries with democratic political systems. China prefers to make its own rules rather than adopt the rules of others. This same reason keeps China out of the OECD.
One narrow but crucial reason for remaining outside the Paris Club is China’s discomfort with the information sharing (transparency, disclosure) principle of the Paris Club. It prefers bilateral deals with debtor countries over multilateral procedures not of its own making.8There is an interesting but obscure sentence in the Communique from the 7 April 2021 meeting of the G20 Ministers and Governors. In connection with implementation of the Common Framework, it notes in positive terms a set of “Voluntary Principles for Debt Transparency” produced by the Institute of International Finance, the private sector association for the global financial industry.
Nevertheless, China has increased its engagement with the Paris Club progressively over the past twenty years. The Paris Club members welcome the participation of China as an Ad Hoc Participant in meetings with countries where it has substantial credit exposure.
China’s Bilateral Debt Relief Deals
It is impossible to get a clear picture of debt relief provided by China due to the government’s policy of not disclosing comprehensive information about the dozens of cases where it has rescheduled or reduced debt owed by defaulting countries or provided other forms of relief such as balance-of-payments loans that could be used to meet contractual debt-service obligations.9A peer reviewer noted that the contracts for Chinese loans typically restrict sovereign borrowers from revealing the terms of these loans and sometimes require the existence of the loans to be kept secret.
A working paper by Horn et al. looks at “140 external debt restructurings and debt write-offs with governments and public entities of developing and emerging countries.”10Sebastian Horn, Carmen M. Reinhart, and Christoph Trebesch, “China’s Overseas Lending.” NBER Working Paper 26050, July 2019, https://www.nber.org/papers/w26050. These can be divided into two periods. One is in the early 2000s when Chinese development loans were written down in the context of the HIPC Initiative. The other is the past decade when the restructurings involved a broader range of defaulting countries.
As is true for any creditor, China is not restructuring or writing down its international loans because it wishes to be generous. It is doing so because otherwise it would have to accept larger losses: the borrowing countries in question are unable or unwilling to pay their debt service obligations in full. When it began writing down loans to low-income countries, China often wrapped these actions in the rhetoric of solidarity and brotherhood.
One issue related to China’s approach to debt relief has been a particular problem for the Paris Club. China has taken the position that loans from the China Development Bank and some from the Export-Import Bank of China are “commercial loans,” not “official” loans.11China categorizes the Export-Import Bank of China as an official creditor but excludes “cofinancing loans with private creditors” and possibly other loans “on commercial terms” from debt relief under the DSSI program. Both of these lending agencies are owned by the Chinese government, which puts them in the “official category” under the practices of the Paris Club.12A peer reviewer noted that the China Development Bank is the 16th-largest bank in the world and has five times the assets of the World Bank. Its two largest shareholders are China’s Ministry of Finance and a state-owned investment company. The Paris Club members apply the same debt relief terms to loans from their market-based lending agencies as they apply to their “soft” concessional loans.13In the Paris Club context, concessional loans are loans that qualify as Official Development Assistance, because of their high grant element, by the standards of the OECD.
Another issue arising in the case of China’s loans, which has become clearer in recent years, is that some Chinese loans are collateralized.14Sebastian Horn, Carmen M. Reinhart, and Christoph Trebesch , “How Much Money Does the World Owe China?,” Harvard Business Review, February 26, 2020, https://hbr.org/2020/02/how-much-money-does-the-world-owe-china. This means that, in the event of a default, repayment is secured by some other asset, such as deliveries of oil or other resources from the defaulting country. Collateralization of official lending in this fashion is normally not done by Paris Club members.
While borrowing governments appreciate that China’s debt relief usually does not involve the policy reform conditionality of the Paris Club, its lending practices have been a political headache for some countries.
While borrowing governments appreciate that China’s debt relief usually does not involve the policy reform conditionality of the Paris Club, its lending practices have been a political headache for some countries. One often-mentioned case is the construction of a port at Hambantota in Sri Lanka that opened in 2010. It is not easy to reconcile different accounts of this case. A Chinese source mentions a $300 million loan from the Export-Import Bank of China for this project and subsequent payment difficulties in 2017 that were resolved with a large financing commitment from the IMF. At this time, Sri Lanka entered into a 99-year lease with the Chinese port operator. The lease payments were used to “bolster its foreign [exchange] reserves, but not to pay off debts.”15“Debt-trap narrative around China-financed projects only well-told lie: scholars,” Xinhua, February 9, 2021, http://www.xinhuanet.com/english/2021-02/09/c_139732853.htm. An American source reports that Sri Lanka “defaulted on its loans.”16Lauren Frayer, “In Sri Lanka, China’s Building Spree Is Raising Questions About Sovereignty,” NPR, December 13, 2019, https://www.npr.org/2019/12/13/784084567/in-sri-lanka-chinas-building-spree-is-raising-questions-about-sovereignty. A recent Japanese source mentions a $1.2 billion loan from China Development Bank to help Sri Lanka meet its external debt obligations, raising the possibility that Chinese financing might be used “to repay Western creditors.”17Marwaan Macan-Markar, “Sri Lanka turns to China rather than IMF to avoid default,” Nikkei Asia, October 12, 2020, https://asia.nikkei.com/Politics/International-relations/Sri-Lanka-turns-to-China-rather-than-IMF-to-avoid-default.
Another closely followed case is Venezuela. Between 2007 and 2017, the Financial Times found that China loaned $60 billion to Venezuela. This exposure is now part of Venezuela’s $150 billion stock of defaulted debt.18James Kynge and Jonathan Wheatley, “China pulls back from the world: rethinking Xi’s ‘project of the century’,” Financial Times, December 11, 2020, https://www.ft.com/content/d9bd8059-d05c-4e6f-968b-1672241ec1f6. A standard debt restructuring deal is not possible because Venezuela’s Maduro government is uninterested in negotiating a policy reform program that the IMF can support.
The Financial Times story also reported that China engaged in debt relief negotiations with 18 countries in 2020, but negotiations with 12 countries on $28 billion of loans had not been completed as of September. These negotiations presumably go a long way toward explaining why Chinese overseas lending by the China Development Bank and the Export-Import Bank of China dropped precipitously in 2019: to $4 billion from $75 billion in 2016.19Matthew Mingey and Agatha Kratz, “China’s Belt and Road: Down but not Out,” Rhodium Group, January 4, 2021, https://rhg.com/research/bri-down-out/.
Debt Owed to China Now
One technical problem in getting a handle on debt owed to China by foreign countries is that information on commitments is easier to get than information on disbursements and repayments. A country’s outstanding debt to a foreign creditor at any point in time is, of course, the sum of the disbursements received less the principal repayments it has made.
Determining which country owes the most debt to China also depends on how debt is defined. For example, when China purchases bonds issued by foreigners, this represents debt that the issuing country owes to China. By this definition, the country with the most debt owed to China is the United States, because of China’s large holding of U.S. Treasury bonds. In addition, China’s central bank has established “swap lines” with a number of central banks in other countries.20A recent news report lists swap arrangements entered into by China with 41 countries between 2009 and 2020. Generally created for a 3-year period, most have been renewed, with the active number peaking at 33 at the end of 2016, slipping to 27 at the end of 2019. See: CP Chandrasekhar and Jayati Ghosh, “Bilateral swaps’ role in China’s rising global footprint,” The Hindu BusinessLine, December 14, 2020, https://www.thehindubusinessline.com/opinion/bilateral-swaps-role-in-chinas-rising-global-footprint/article33330279.ece. When these lines are activated (i.e. the partner country exchanges its currency for China’s renminbi), this represents debt owed to China. Another form of debt is short-term debt, which consists of obligations having an original maturity of one year or less. A lot of the financing of international trade falls in this category. It is excluded from most sovereign debt workouts to avoid disrupting trade that supports economic growth.
Setting aside these three forms of debt, the size of a country’s debt to China can be measured in two ways: the outstanding U.S. dollar amount of debt and the ratio of this amount to the borrowing country’s GDP. Another important distinction is between the total amount of a country’s outstanding debt at a point in time (debt stock at year-end) and the sum of payments (principal and interest) a country is scheduled to make during a period of time (debt-service flow during a calendar year).
A number of non-Chinese organizations and scholars have labored to compile records of China’s international loans from debtor-country records, press releases, and other sources. The most complete and up-to-date source of debt owed to China is arguably the World Bank, which has been reporting developing country debt (debt owed to external creditors by its borrowing countries) for many years. One drawback is that the World Bank’s Debt Tables are not easy to use to extract debt owed to China by all of the countries covered. There are a number of other drawbacks. In particular, it is based on debt reported to the World Bank by the debtor countries. It is well known that some countries are not reporting certain debts (debts related to the purchase of military equipment are an obvious case). There are also cases where the debt reported by individual borrowing countries does not match the claims reported by its creditors.
There is, however, a special series of World Bank debt data that is useful in this context.21World Bank, “Debt Data 2021: International Debt Statistics,” World Bank, accessed April 15, 2021, https://datatopics.worldbank.org/debt/ids/. It presents disbursed debt and related debt service owed by the 73 countries in the G20’s Debt Service Suspension Initiative (DSSI) and breaks it down by major creditors, including China.
This series yields the following results for these 73 countries:22These numbers are constantly changing as the World Bank gets new disbursement and payment information. The numbers presented here were found at the beginning of February 2021.
- Total debt owed (stock) for all 73 countries at year-end 2019: $524 billion
- of which, owed to agencies of the Chinese government: $102 billion
- of which, owed to other Chinese lenders: $6 billion (mostly China Development Bank and Export-Import Bank of China)
- Subtotal owed to China: $108 billion (20.7 percent)
- Among these 73 countries, the ones with the most debt owed to China are Pakistan ($22 billion), Angola ($16 billion), Ethiopia ($8 billion), Kenya ($7 billion), and Lao PDR ($5 billion).
- Total debt-service payments due (flow) from all 73 countries in 2020: $46 billion
- of which, owed to agencies of the Chinese government: $10 billion
- of which, owed to other Chinese lenders: $1 billion
- Subtotal owed to China: $12 billion (rounded up, 25.5 percent)
A second database compiled by scholars at Boston University focuses on the years between 2008 and 2019.23Rebecca Ray, Kevin P. Gallagher, William Kring, Joshua Pitts, and B. Alexander Simmons, “Geolocated Dataset of Chinese Overseas Development Finance,” Boston University Global Development Policy Center, accessed April 15, 2021, https://www.bu.edu/gdp/chinas-overseas-development-finance/. This source only tracks loan commitments from the China Development Bank and the Export-Import Bank of China to 93 countries, yielding a cumulative commitment total of $462 billion. The six countries benefitting from the most commitments are Venezuela ($58 billion), Pakistan ($37 billion), Russia ($37 billion), Angola ($30 billion), and Brazil ($28 billion). The total outstanding debt at the end of 2019 related to this set of loans is substantially lower due to undisbursed amounts and repayments of principal.
A third database for 152 countries that have received loans from China between 1949 and 2018 has been created by the authors of a recent NBER Working Paper.24Horn, Reinhart, and Trebesch, “China’s Overseas Lending,” NBER Working Paper 26050, July 2019. Htttp://www.nber.org/papers/w26050. This database includes loans to both public-sector and private-sector entities in the borrowing countries. China’s total commitments in this 69-year period come to $530 billion. The authors made adjustments to arrive at current outstanding amounts and to scale them against GDP. They arrived at a figure of $370 billion for outstanding debt owed to China at the end of 2017, which is 50 percent more than the $246 billion that was owed in aggregate to the 22 members of the Paris Club by the same group of countries.
The NBER authors found that the countries with the highest ratios of outstanding debt to GDP at the end of 2017 were: Djibouti (100%), Tonga (45%), Maldives (35%), Republic of Congo (35%), Kyrgyzstan (30%), and Cambodia (30%).
The NBER authors sum up their findings with respect to low-income countries as follows: “The footprint of China is particularly large among low-income countries, where Chinese lending flows have surpassed total capital flows from multilateral creditors such as the IMF or the World Bank, as well as flows from private creditors.”25The methodology used by the NBER authors has been questioned by the IMF, but not this particular conclusion. See: “The Evolution of Public Debt Vulnerabilities in Lower Income Economies,” IMF Policy Paper, February 2020, Text Box 2, page 17.
China’s Participation in the November 2020 Common Framework adopted by the G20 Finance Ministers and Central Bank Governors
On 15 April 2020, the G20 Finance Ministers and Central Bank Governors met virtually and reached agreement on steps to address the impact of the COVID-19 pandemic on the global economy.“26Virtual meeting of the G20 finance ministers and central bank governors,” G20 Research Group, University of Toronto, accessed April 15, 2021, http://www.g20.utoronto.ca/2020/2020-g20-finance-0415.html. A key decision was to implement the Debt Service Suspension Initiative (DSSI). Under DSSI, the debt-service payments to bilateral official creditors from 73 low-income/least-developed countries falling due between May 1 to the end of 2020 were suspended with repayment scheduled over three years following a one-year grace period.
As a G20 member, China participated in and is committed to implementing DSSI. The other G20 members that are not members of the Paris Club are Saudi Arabia, Turkey, Mexico, India, Indonesia, South Africa, and Argentina. Among these, however, only Saudi Arabia has substantial foreign lending exposure. The DSSI program also called on multilateral agencies and private creditors to provide comparable relief.
At their 13 November 2020 virtual meeting, the G20 Ministers and Governors extended DSSI to 30 June 2021. At their 7 April 2021 virtual meeting, the G20 Ministers and Governors further extended DSSI to the end of 2021. Hopefully, it will be the last extension.
At the November 2020 meeting, the G20 Ministers and Governors also endorsed a “Common Framework for Debt Treatments Beyond DSSI.” The Common Framework is needed because of the world’s inability to slow the spread of the COVID-19 virus and the expectation that its impact on many economies is sharply increasing the number of countries requiring some debt relief beyond payment suspension in the form of debt reduction.
Significantly, the Paris Club is explicitly recognized as agreeing to both DSSI and the Common Framework. This agreement was presumably not hard for the G20 to obtain because the principles for debt treatment in the Common Framework correspond closely to Paris Club principles.
As with all Paris Club deals, debt restructuring under the Common Framework requires: (a) a case-by-case approach initiated by a request from the debtor country; (b) an economic reform program supported by the IMF; (c) full disclosure by the debtor country of “all public sector financial commitments”; and (d) comparable relief provided by other official creditors and by private-sector creditors. The multilateral agencies are recognized as preferred creditors who will continue to provide countries with financing that helps restore their creditworthiness.27See Addendum.
As of March 2021, Chad, Ethiopia, and Zambia had formally requested debt relief under the Common Framework. At their 8 April 2021 meeting, the G20 Ministers and Governors announced an imminent “first meeting of the first creditor committee” to begin negotiating a debt reduction deal under the Common Framework.“28Italian G20 Presidency: Second G20 Finance Ministers and Central Bank Governors meeting,” Ministry of Finance of Japan, accessed April 15, 2021, https://www.mof.go.jp/english/international_policy/convention/g20/g20_210407.pdf. The expectation is that most countries benefiting from DSSI will obtain debt relief in 2021 or 2022 under the Common Framework. The odds of more debt problems in 2021 are especially great because the flow of new financing from official sources is unlikely to increase and the net flow of financing from private sources may all but dry up.
China is now committed through the Common Framework to follow most of the fundamental principles of the Paris Club in the implementation of the DSSI. This should include treating the China Development Bank and the Export-Import Bank of China as official creditors, but it does not.China has taken the position that loans from the China Development Bank are not official credits but are commercial credits subject to debt relief according to the comparable treatment provision of the Common Framework. The main reason why China is unlikely to become a full-fledged Paris Club member is geopolitical: it would be a “rule-taker” in the Paris Club, and it prefers to be a “rule-maker.”
The main reason why China is unlikely to become a full-fledged Paris Club member is geopolitical: it would be a “rule-taker” in the Paris Club, and it prefers to be a “rule-maker.”
A key issue related to the Common Framework is the treatment of debt-distressed countries beyond the low-income countries benefiting from DSSI. Two non-DSSI countries of particular interest are Sri Lanka and Venezuela, where China is the creditor country with the greatest exposure. It is conceivable that a Common Framework-like approach will be applied to these countries, but no official statement suggesting that possibility has yet emerged.
The Biden Administration’s Approach to Unsustainable Debt Owed to China
In his campaign and in the period after the election up to his inauguration, Biden did not give any clear signals about how his Administration would address the growing number of countries at risk of defaulting on their external debts. Glimpses of an evolving Administration position came in connection with the virtual meetings of the G7 Finance Ministers and Central Bank Governors on 12 February 2021 (chaired by the UK), the G7 leaders on February 19 (chaired by the UK), and the G20 Finance Ministers and Central Bank Governors on February 26 (chaired by Italy).
The UK Chancellor of the Exchequer’s statement at the conclusion of the February 12 meeting included this commitment: “The G7 must ensure that International Financial Institutions have the right tools to equip and enable vulnerable countries to respond to the pandemic, and the Chancellor called on private-sector creditors to play their full part to help ensure sustainable debt treatments for the poorest countries, paving the way for a truly global recovery.”29“Chancellor Prioritises Climate Change and Urged Support for Vulnerable Countries in First UK G7 Finance Meeting,” G7 Research Group, University of Toronto, accessed April 15, 2021, http://www.g7.utoronto.ca/finance/210212-finance.html.
The formal G7 leaders’ statement issued at the end of their February 19 meeting included this commitment: “We will work through the G20 and with the International Financial Institutions to strengthen support for countries’ responses [to the COVID-19 crisis] by exploring all available tools, including through full and transparent implementation of the Debt Service Suspension Initiative and the Common Framework.”30“G7 Leaders’ Statement: 19 February 2021,” Government of the United Kingdom, February 19, 2021, https://www.gov.uk/government/news/g7-leaders-statement-19-february-2021.
The statement issued by the Italian Finance Minister at the end of the February 26 G20 meeting included this commitment: “The Ministers and Governors reaffirmed their support for the most vulnerable countries, especially those facing an unsustainable debt burden. Key milestones in the near future include the effective implementation of the G20 Common Framework on Debt Treatment and of the Debt Service Suspension Initiative. They also called on the international financial institutions to explore additional tools to meet long-term global financing and reserve needs; the IMF should formulate a proposal for a general SDR allocation.”31“First meeting of the G20 Finance Ministers and Central Bank Governors,” G20, February 26, 2021, https://www.g20.org/first-meeting-of-the-g20-finance-ministers-and-central-bank-governors.html.
The Biden Administration’s position on these matters became clear in comments made by Treasury Secretary Janet Yellen in the runup to the April 2021 Spring Meetings of the IMF and World Bank and are reflected in the statements and communiqués issued in connection with this set of meetings.32James Politi and Jonathan Wheatley, “Yellen backs fresh financial support for low-income countries,” Financial Times, February 25, 2021, https://www.ft.com/content/8535e507-eac7-4b4e-b3dd-f78b06dffac4. In particular, the Biden Administration has fully embraced—as a member of the International Monetary Committee of the IMF—a $650 billion allocation of Special Drawing Rights, the extension of DSSI to the end of 2021, and implementation of debt reduction agreements under the Common Framework.33“Communiqué of the Forty-third Meeting of the IMFC,” International Monetary Fund, April 8, 2021, https://www.imf.org/en/News/Articles/2021/04/08/communique-of-the-forty-third-meeting-of-the-imfc.
The U.S. Treasury Department will have the lead in crafting the government’s position on further steps to implement the Common Framework or new initiatives to head off a catastrophic global debt crisis. The National Security Council, the National Economic Council, and the Office of Management and Budget will have important voices in the policymaking process. Any new initiative will have to be acceptable to the U.S. Congress, which can be counted on to constrain the Biden Administration’s options because of strong political sentiment favoring domestic (including military) spending over foreign spending.
Four instruments the Biden Administration can deploy to address any worsening of the debt vulnerability of other countries do not involve any change in the international financial architecture:
- Bilateral financing in the form of on-budget grants and loans from USAID, the Millennium Challenge Corporation, the new International Development Finance Corporation, and several other agencies. There is unlikely to be a breakout here in the short term because of budget constraints.
- Multilateral financing has the advantage of leveraging any U.S. government participation in a general capital increase for the World Bank and the regional development banks. As long as the pandemic is raging, it seems likely that the Administration will be able to obtain Congressional support for modest capital increases for some if not all of these banks.
- Generous debt relief under the Common Framework for countries with large amounts of debt owed to the U.S. government could pose difficulties because all such debt relief has to be covered by Congressional appropriation. The Administration will have some flexibility here but the amounts “needed” could exceed the amount that the Congress considers tolerable.
- The most controversial option for the Biden Administration is a new allocation of SDRs from the IMF to its members. Since 1969, the IMF has had the ability to, in effect, create money in the form of “Special Drawing Rights” allocated to IMF members in proportion to their “quota share” (capital subscription) in the IMF. There have been four SDR allocations so far. The most recent was in 2009, as one of the measures to recover from the Global Financial Crisis. Appeals to have a new allocation to address pandemic-induced debt problems have come from numerous sources. The U.S. government is authorized to agree to a global allocation equivalent to around $680 billion without Congressional approval. Accordingly, the new allocation in the process of being finalized is capped at $650 billion. While there has been pressure from some advocacy groups for a larger allocation, the political capital the Biden Administration would have to expend to obtain Congressional support pretty much rules it out. This SDR allocation option is also complicated because the low-income countries needing the most debt relief will get relatively small allocations. Thus, some arrangements will be made to reallocate to low-income countries some portion of this new allocation received by high-income countries.
So far, the Biden Administration has not singled out China in the context of addressing countries with debt vulnerability due to the COVID-19 pandemic. It is taking a relatively hard line with China on human rights issues, but its positions on international trade and finance issues are evolving slowly as the Administration focuses on urgent domestic issues.
Pressures on China to align its policies and practices on debt relief for defaulting countries with those of the Paris Club are likely to intensify as pandemic-related debt relief operations move from temporary suspension of debt-service obligations to formal debt reduction. Still, it remains unlikely that China will become a Paris Club member in the next few years.
As long as China associates itself with the G20’s Common Framework, however, the debt relief it provides in the coming period is likely to be closely aligned to the relief provided by Paris Club members because of the “comparable treatment” principle incorporated in the Common Framework.
About the author: Lex Rieffel was the Paris Club desk officer in the U.S. Treasury Department from 1977 to 1984. While working at the Institute of International Finance between 1994 and 2001, his primary focus was the prevention and resolution of financial crises in emerging market and developing countries, which often involved debt relief in some form. He is the author of “Sovereign Debt Restructuring: The Case for Ad Hoc Machinery” (Brookings Institution Press, 2003), which stands as the most comprehensive description of the debt restructuring process as it evolved in the last half of the 20th century and largely shaped the debt relief operations that have taken place in the first two decades of the 21st century.
The Treatment of Debt Owed to Multilateral Agencies
By tradition and not by any treaty or similar obligation, the Paris Club creditors regard the multilateral lending agencies as “preferred creditors.” This limited group of agencies consists of the IMF, the World Bank, and four regional development banks.34InterAmerican Development Bank, Asian Development Bank, African Development Bank, European Bank for Reconstruction and Development.
Preferred creditor status means that these agencies do not reschedule or write down the debt service obligations of their borrowers. The main reason for this practice is simply that their ability to borrow on favorable terms from the international capital market to fund their operations depends on this preferential treatment in cases of country default. With this preference comes an expectation that these agencies will continue lending to debtor countries obtaining debt relief before their creditworthiness has been restored.
One consequence of the preference is that the high-income countries have had to “bail out” multilateral agencies when borrowing countries were unable to meet their payment obligations to these agencies despite obtaining debt relief from other creditors.
There is also an issue about which multilateral agencies merit this preferential treatment. A small number of multilateral lending agencies that have limited membership (in Latin America and the Middle East) are not recognized by the Paris Club as preferred creditors. The status of the China-led Asian Infrastructure Investment Bank (established in 2015 with open membership) and the New Development Bank (established in 2015 by Brazil, China, India, Russia, and South Africa) is under discussion.
The treatment of debt owed to the mainline multilateral agencies is an issue that could be as difficult to resolve in the coming year as debt owed to China. For the 73 low-income countries eligible for DSSI relief (see below), $14 billion of the $43 billion in payments of principal and interest falling due in 2020 were owed to these multilateral agencies.35Jonathan Wheatley, “Debt dilemma: how to avoid a crisis in emerging nations,” Financial Times, December 20, 2020, https://www.ft.com/content/de43248e-e8eb-4381-9d2f-a539d1f1662c. It may not be easy for the high-income countries to come up with this amount of new grant financing to bail out these low-income countries, in part because they will need help to meet payments owed to the multilateral agencies in 2021 as well and possibly several additional years.
The Treatment of Debt Owed to Private Creditors
Private-sector lending across borders currently takes many different forms and its treatment has made debt workouts increasingly complex over time. Before the 1970s, there was a negligible amount of international lending beyond the industrial countries by the private sector because developing countries were considered uncreditworthy. A history of bond defaults in the preceding decades in particular discouraged private-sector lending.
The explosion of commercial bank lending to developing countries in the 1970s led directly to the Latin American debt crisis in the 1980s and a hardening of the Paris Club’s principle of “comparable treatment.” The explosion of bond lending to developing countries in the 1990s led to Argentina’s historic default in 2001 and then to other cases where debt relief by bondholders was necessary.
The workouts for countries defaulting on their debt to foreign bondholders have yielded different forms of “private sector involvement” in debt relief operations and some fundamental changes in bond contracts in order to facilitate collective action.