Debt relief: the state of play and what’s next - Capital Economics
Africa Economics

Debt relief: the state of play and what’s next

Africa Economics Focus
Written by Jason Tuvey

There has been much less progress towards debt relief for African economies than many had hoped. And governments’ diverse array of creditors means that the “Common Framework” recently unveiled by the G20 to help debt distressed EMs will struggle to gain traction. Most governments are likely to have to live with higher debt burdens, which will come at the cost of austerity and weak growth. The few that find themselves in severe stress in the future may follow Zambia down the path of a disorderly default.

  • There has been much less progress towards debt relief for African economies than many had hoped. And governments’ diverse array of creditors means that the “Common Framework” recently unveiled by the G20 to help debt distressed EMs will struggle to gain traction. Most governments are likely to have to live with higher debt burdens, which will come at the cost of austerity and weak growth. The few that find themselves in severe stress in the future may follow Zambia down the path of a disorderly default.
  • The coronavirus crisis shone the spotlight on to debt risks across Sub-Saharan Africa. In aggregate, sovereign debt in the region has steadily increased as a share of GDP, from less than 30% at the start of the 2010s to more than 50% last year. It will, of course, rise even further due to the current crisis. What’s more, governments have relied heavily on borrowing from abroad.
  • In an effort to provide some respite to governments, the IMF and the World Bank have attempted to coordinate action on debt relief. These have centred on two main initiatives. The first is the IMF’s Catastrophe Containment and Relief Trust, although this is aimed at the very poorest economies and only covers debts owed to the IMF. The second is the Debt Service Suspension Initiative (DSSI) endorsed by the World Bank and the G20, which provides relief on bilateral debt payments.
  • So far, though, progress on debt relief has not been as swift or encompassing as many officials had hoped. There are a few reasons for this. The first is that governments have been worried about the negative consequences of signing up to the DSSI. Second, China has played hardball (although a deal between Zambia and China’s Exim Bank to defer debt repayments within the DSSI framework suggests that Beijing may be softening its stance). And third, the DSSI has failed to open the door to private sector participation.
  • Failure to get China and private creditors on board has already pushed Zambia into default. Debt problems are building in Nigeria and South Africa, although immediate debt fears are more likely to be centred on Ghana, Ethiopia and Kenya – the IMF considers all three countries at “high risk of debt distress”. Political upheaval in Ethiopia and upcoming elections in Ghana are potential flashpoints.
  • Some steps are being taken to try to push debt relief along. An extension to the current debt relief initiatives was recently approved and there have been proposals for an African “Brady Plan”, moving towards debt cancellation, and overhauling the international debt “architecture” to lower debt payments or suspend debt servicing in the event of natural catastrophes. A new “Common Framework” unveiled by the G20 last week outlines ways to reduce the net present value of debt.
  • While the “Common Framework” is a step in the right direction, there are reasons to be sceptical that it will lead to much. One key point is that the diverse array of creditors to African governments makes broad debt relief programmes difficult to achieve – and much more so than in the past. So long as China prefers a bilateral approach, it will be difficult to convince private investors that China’s loans are being treated equally. And since bilateral loans are now a relatively small part of governments’ external debt, the incentive provided by bilateral lenders for private creditors to join a restructuring is smaller than before.
  • The upshot is that, across much of Sub-Saharan Africa, we suspect governments will probably end up living with higher debt burdens. This will come at the cost of the need to pursue austerity, resulting in weak economic growth. But there will inevitably be some countries that run into trouble servicing their liabilities.
  • One lesson we can draw from recent developments is that, so long as private creditors are suspicious of China and China continues to play hardball in negotiations, governments may ultimately be forced to up the ante in order to try to secure debt restructuring deals. As Zambia’s experience shows, however, that brings with it the increased threat of disorderly defaults, prolonged legal battles, a higher reputational cost for the sovereign and potentially a longer-lasting country risk premium.

Debt relief: the state of play and what’s next

  • There has been much less progress towards debt relief for African economies than many had hoped. And governments’ diverse array of creditors means that the “Common Framework” recently unveiled by the G20 to help debt distressed EMs will struggle to gain traction. Most governments are likely to have to live with higher debt burdens, which will come at the cost of austerity and weak growth. The few that find themselves in severe stress in the future may follow Zambia down the path of a disorderly default.

What’s the current state of play?

  • The coronavirus crisis shone the spotlight on to debt risks across Sub-Saharan Africa. In aggregate, sovereign debt has steadily increased as a share of GDP, from less than 30% at the start of the 2010s to more than 50% last year. (See Chart 1.)

Chart 1: Sub-Saharan Africa Gross General Government Debt (% of GDP)

Sources: IMF, Capital Economics

  • Since 2010, Angola, Zambia and Mozambique have recorded the steepest jumps in debt-to-GDP ratios and the trio now have the highest debt ratios in the region. (See Charts 2 & 3.) And the effects of the crisis mean that debt ratios will rise again this year, by more than 15%-pt in some of the worst cases such as Zambia and South Africa.
  • What’s more, governments have relied heavily on borrowing from abroad, which has pushed overall external debt burdens across the region up from less than 25% of GDP in 2010 to more than 45% of GDP last year. (See Chart 4.) These external debts are mainly denominated in foreign currency. This leaves economies vulnerable to exchange rate swings and shifts in the external financing environment.

Chart 2: Change in Gross Government Debt
(2010 – 2019, % of GDP)

Sources: IMF, Capital Economics

Chart 3: Gross Government Debt (2019, % of GDP)

Sources: IMF, Capital Economics

Chart 4: Sub-Saharan Africa External Debt
(% of GDP)

Sources: IMF, Capital Economics

  • As the coronavirus crisis escalated earlier this year, many countries were faced with acute balance of payments strains as exports and tourism receipts slumped, capital inflows dried up and external borrowing costs jumped. That, combined with limited foreign exchange reserves, created difficulties for governments in making external debt payments. The foreign currency needed to make these could otherwise only be generated by supressing demand and imports to improve current account positions.
  • In an effort to provide some respite – particularly given the simultaneous need of governments to spend more to counter the health and economic costs of the pandemic – multilateral institutions such as the IMF and the World Bank have attempted to coordinate action on debt relief. These efforts have centred on two main initiatives.
  • The first is the IMF’s Catastrophe Containment and Relief Trust (CCRT). This was set up in 2015 but was overhauled as the current crisis unfolded to expand the qualification criteria to provide immediate relief for up to two years on debt owed to the Fund. It’s worth noting, though, that the CCRT only applies to the very poorest economies – among the 15 countries that we cover on our Africa service, only Rwanda and Ethiopia are eligible.
  • The second major debt relief programme is the Debt Service Suspension Initiative (DSSI), endorsed by the World Bank and G20. As part of the DSSI, G20 governments have allowed the suspension of the repayment of official bilateral credit until June 2021.
  • The suspension does not result in a reduction in the net present value of the payments; repayments will take place over a period of five years, with a grace period of a year. The potential relief provided by the DSSI is quite large – the latest estimates from the World Bank show that, globally, it could result in savings of just over $12bn. Of the African countries that we cover, the largest benefits potentially accrue to Angola and Mozambique. (See Chart 5.)

Chart 5: Potential DSSI Savings (% of 2019 GDP)

Sources: World Bank, Capital Economics

What are the hurdles to debt restructuring?

  • These initiatives, coupled with multilateral financing and a recovery in risk appetite and commodity prices, have reduced the risk of a slew of sovereign defaults. But budget positions across many African economies are still under strain, limiting governments’ ability to provide much-needed economic support. Indeed, direct fiscal stimulus has been limited across the region (see Chart 6) and this raises the risk of scarring effects from the crisis that hold back economic recoveries. Debt relief would help to free up vital resources.

Chart 6: Direct Fiscal Support (% of GDP)

Sources: IMF, Capital Economics

  • So far, though, progress has not been as swift or as encompassing as many officials had hoped, especially given that the IMF considers many governments across Africa to be at high risk of debt distress. (See Table 1.) Angola is the only country to have successfully secured a debt restructuring. Globally, only 44 of the 73 eligible countries have so far participated in the DSSI. Take up has been proportionally better among the 11 eligible countries that we cover on our Africa service. But major economies such as Nigeria, Kenya and Ghana have not signed up.
  • There are a few reasons for this. First, governments have been worried about the negative consequences of signing up to the DSSI. Potential participant countries have been deterred by the terms of the DSSI, which include refraining from issuing new non-concessional debt during the suspension period – effectively shutting them out of international capital markets. There are also concerns that seeking debt relief from official creditors may raise fears among private investors about creditworthiness, risking higher borrowing costs, ratings downgrades and potentially trigger cross-default clauses. Kenya’s government has rejected the DSSI for many of these reasons.

Table 1: DSSI Participation & IMF’s Latest Assessment of Risk of Debt Distress

Country

DSSI Participation?

Risk of external debt distress

Risk of overall debt distress

Angola

Yes

n/a

n/a

Côte d’Ivoire

Yes

Moderate

Moderate

Ethiopia

Yes

High

High

Ghana

No

High

High

Kenya

No

High

High

Mozambique

Yes

In distress

In distress

Nigeria

No

n/a

n/a

Rwanda

No

Moderate

Moderate

Tanzania

Yes

Low

Uganda

Yes

Low

Low

Zambia

Yes

High

High

Source: Capital Economics

  • A second reason is that China has played hardball. China has become an increasingly important creditor to African governments over the past decade and, in Ethiopia, Zambia and Angola, now accounts for more than 30% of outstanding public sector long-term external debt. (See Chart 7.)

Chart 7: Public Sector Long-Term External Debt by Creditor* (2019, % of Total)

Sources: World Bank, Capital Economics

  • While the actual sums involved are small for China, Beijing appears to be taking a selective approach with its interpretation of the G20 deal. In particular, the government has deemed lending by Chinese state-owned banks (which account for the vast bulk of what is commonly considered to be Chinese bilateral lending) as commercial debt, so it is not subject to the DSSI.
  • Admittedly, Angola secured an agreement in September with major creditors, believed to be Chinese state lenders, to restructure its debts. And a deal between Zambia and China Exim Bank to defer debt repayments within the DSSI framework suggests that Beijing may be softening its stance. But Angola’s talks with Chinese lenders were reported to have been at an advanced stage back in June, suggesting that Beijing is proving to be a tough negotiator. 
  • What’s more, reports suggest that China does not want to renegotiate loans made under the Belt and Road Initiative, which accounts for a large but unknown amount of lending to African sovereigns. And Beijing seems to have a preference for bilateral deals, which increase its leverage. For example, debt relief provided to Angola was negotiated on a loan-by-loan basis (and in an opaque way).
  • A third and final reason for the lack of progress is that the DSSI has failed to open the door to private sector participation. The Institute of International Finance has drawn up terms of reference for voluntary private sector participation in the DSSI. And G20 governments have put intense pressure on private creditors to partake in debt relief efforts, arguing that providing debt service suspension now is in their long-term interest.
  • But private bondholders seem to be insisting on fair treatment across all creditors, rejecting the idea of a one-size-fits-all approach and preferring to negotiate on a case-by-case basis. Perhaps emboldened by Angola’s ability to get concessions from China, private investors first refusal of Zambia’s request to defer interest payments on Eurobonds came after the government revealed that it had only sought relief from commercial creditors (and not China). In a recent piece in the Financial Times, Ghana’s finance minister said that investors may be hesitant to provide relief “for fear that that released resources will simply be transferred to Beijing”.

Which countries need help most?

  • Zambia has stood out as a default risk for some time on account of its poor public finances and it’s not a major surprise that events have come to a head there. Last Friday (13th November) marked the end of the grace period on the Eurobond coupon payment that was missed last month and failure to pay means that the country is now formally in default, the first in Africa to be triggered by the coronavirus crisis.
  • Elsewhere in Sub-Saharan Africa, our initial fears of a wave of defaults have not materialised. The health costs of COVID-19 have, thankfully, generally been less severe than we had initially feared. But the indirect economic effects remain grave. Many economies are still suffering from low commodity prices and depressed tourism revenues. And while borrowing costs on global capital markets have declined from their levels earlier this year, they remain elevated. (See Chart 8.) Yields in Kenya, Ethiopia and Ghana are above 6%, a level at which governments tend to be reluctant to issue dollar debt.

Chart 8: JP Morgan EMBI Dollar Bond Yields (%)

Sources: Refinitiv, Capital Economics

  • Many will point to South Africa and Nigeria as being the most high-profile African countries suffering from debt problems. But we suspect that these are medium-term rather than short-term issues. In both cases, the bulk of public debt is denominated in local currency (and held domestically). Governments are likely to resort to financial repression policies including, in Nigeria’s case, outright deficit monetisation, to tackle the problem. We will explore these issues in more detail in forthcoming pieces.
  • Instead, immediate debt fears are more likely to be centred on Ghana, Ethiopia and Kenya – the IMF considers all three countries at “high risk of debt distress”. (See Table 1 again.) All have high public debt-to-GDP ratios, a large share of which is external (and denominated in foreign currency), and limited foreign exchange reserves.
  • It’s difficult to pin down the timing of when governments might run into trouble and so, instead, it’s worth looking at potential flashpoints. In Ethiopia, the recent escalation of political tensions and growing threat of civil war (see here) is currently weighing heavily on investor sentiment towards the country and sovereign dollar spreads have widened by more than 100bp since tensions flared up. (See Chart 9.) Meanwhile, concerns about the government’s debt burden is a recurring theme in the campaigning for next month’s elections in Ghana.
  • Aside from political developments, upcoming debt repayments could prompt governments to consider whether default is a palatable option. Ethiopia, Kenya and Ghana should be able to get through the next few years but large FX debt repayments lie in store from the middle of this decade. (See Chart 10.)

Chart 9: JP Morgan Ethiopia EMBI Index

Sources: Refinitiv, Capital Economics

Chart 10: Foreign Currency Principal Debt Repayments (% of 2019 GDP)

Sources: Bloomberg, Capital Economics

What’s next in store?

  • In a bid to push debt relief efforts along, some steps are being taken or have been proposed. At the IMF and World Bank meetings in October, officials approved an extension to the current debt relief initiatives. The DSSI will now run until the middle of next year (it was previously slated to finish at the end of this year), when policymakers will decide whether to extend it for a further six months. But this actually disappointed hopes in some quarters – the IMF and the World Bank had originally called for the DSSI to be made available until the end of next year but leaders could only agree to another review before the latest extension expires. In any case, many of the issues with the DSSI outlined above have not been addressed. Those countries that have already secured debt relief under the DSSI will clearly benefit, but it’s difficult to see many more eligible countries signing up to the agreement.
  • Other ideas have also been floated. The African Union and the United Nations have previously proposed a programme similar to the Brady Plan that helped countries in Latin America to emerge from their debt crises in the 1980s. The Brady Plan is the only example of a coordinated approach to writing off the private sector debt of a large group of countries and was widely heralded as helping Latin America return to strong economic growth. (More details on the Brady Plan can be found here.)
  • There is also some discussion that debt relief should move towards outright debt cancellation. This has long been advocated by the Jubilee Debt Campaign and appears to be sparking the interest of World Bank President David Malpass. However, some G20 governments seem reluctant to extend and broaden the current arrangements, let alone go so far as to cancel debts altogether.
  • In addition, the IMF has recently proposed an overhaul of the international debt “architecture”. As well improving transparency and agreeing on a common approach among the G20 countries to bilateral debt relief, the Fund has proposed including clauses in bond contracts that allow lower debt payments or suspend debt servicing in the event of natural catastrophes. While these proposals are promising and will probably make more headway, they will only help in the event of the next crisis not the current one.
  • Perhaps the best hope so far in trying to help those countries that have been left with unsustainable debts as a result of the crisis is the “Common Framework” unveiled by the G20 and Paris Club members last week. More details can be found in Box 1 but the key point is that it will try to tackle sovereigns’ solvency, rather than liquidity, problems.

Box 1: What is the “Common Framework”?

  • Known officially as the “Common Framework for Debt Treatments Beyond the DSSI”, the agreement was endorsed at this month’s G20 Finance Ministers and Central Bank Governors’ Meeting. The key difference between the original DSSI and the “Common Framework” is that the latter paves the way for reductions in the net present value (NPV) of debt, whereas the DSSI was NPV-neutral.
  • The need for a debt reduction will be based on debt sustainability analyses undertaken by the IMF and World Bank as well as the collective assessment of official creditors. All G20 and Paris Club creditors have agreed to participate in principle. Eligible debt will include all public and publicly guaranteed debts which have an original maturity of more than a year.
  • Any agreement between debtor countries and G20 and Paris Club creditors will outline three key parameters: (i) the change in nominal debt service over the period of an IMF programme; (ii) where applicable, the reduction in the net present value of debt; and (iii) the extension of the duration of the treated claims.
  • Once an agreement has been struck, the debtor country will be required to seek debt relief with other bilateral and private creditors on terms that are at least as favourable (from the debtor’s perspective). Regular updates will need to be provided to official creditors on the progress of these negotiations.
  • The “Common Framework” is clearly a step in the right direction. After all, the willingness of bilateral lenders to take a haircut on their loans means that the losses borne by private creditors will be smaller than would otherwise have been the case.
  • But one important point in all of this is that the varied nature of creditors across African economies makes broad debt relief programmes difficult to achieve (and much more so than in the past). The composition of creditors has shifted markedly over the past decade. In 2010, the vast majority of the debts of those African countries eligible for the DSSI were owed to multilateral and bilateral creditors other than China. (See Chart 11.) But the tables have turned dramatically over the past decade, with the majority of debts now owed to China and private creditors.

Chart 11: Public Sector Long-Term External Debt by Creditor* ($bn)

Sources: World Bank, Capital Economics

  • That introduces several complexities. First, there is simply a wide array of creditors to negotiate with in any debt restructuring, which is likely to make the process longer and more arduous. In contrast, the last major debt relief for Africa in the mid-2000s, involved a write-down on debts owed to a much smaller array of creditors. Multilateral lenders and governments of advanced economies accounted for around 85% of their outstanding long-term public sector external debt at the time.
  • The average length of sovereign debt restructurings across emerging markets since 1970 is about seven years. History also suggests that there is often a narrow window for a quick deal. In cases where a year has passed, talks can often take more than a decade. And the recent lesson from Argentina and Ecuador is that securing debt relief quickly requires large concessions on the part of governments to investors. (See here.) Angola’s recent debt restructuring appears to be similar to those of Argentina and Ecuador in that it mainly involved re-profiling debt repayments, rather than a large write-down on outstanding principal.
  • Second, it’s hard to see the mutual suspicion between China and private creditors going away. Private creditors are likely to remain concerned that debts owed to China are not being transparently recorded. And so long as China appears to be preferring a case-by-case approach to debt negotiations and being selective over its interpretation of debt relief initiatives, it will be difficult to convince private investors that China’s loans are being treated on a level playing field.
  • And finally, since bilateral lending is now a relatively small part of governments’ external debt, the incentive provided by bilateral lenders for private creditors to join a restructuring is smaller than it once would have been.

Impasse raises threat of disorderly defaults

  • The upshot is that, across much of Sub-Saharan Africa, we suspect governments will probably end up living with higher debt burdens. As the height of the crisis has passed, some of the potential benefits from defaulting, notably freeing up resources to spend in other areas, may no longer outweigh the costs in terms of a loss of investor confidence, ratings downgrades and being locked out of international capital markets.
  • That said, living with higher debt will come at the expense of tighter fiscal policy and weak economic growth. Indeed, it’s worth noting that, historically, debt relief initiatives have led to a pick-up in growth. The Brady Plan helped growth in Latin America to strengthen in the 1990s. And debt write-downs in sub-Saharan Africa in the mid-2000s may have helped to sustain strong growth rates in the subsequent years.
  • There will inevitably be some countries that struggle to cope with a higher debt burden and run into trouble servicing their liabilities. Zambia is already in default. As we mentioned earlier, the debt risks in the rest of Africa are perhaps greatest in Ethiopia, Kenya, and Ghana.
  • One lesson we can draw from recent experience is that, so long as private creditors are suspicious of China and China continues to play hardball in negotiations, governments may ultimately be forced to up the ante in order to try to secure debt restructuring deals. Governments will generally want to try to maintain cordial relations with China and so they may try to push a greater share of losses on to private bondholders. But, as Zambia has found out, that brings with it the increased threat of disorderly defaults and prolonged legal battles.
  • The implications of this are somewhat nuanced. The best gauge of potential recovery rates in any eventual restructuring tends to be the size of public debt as a share of GDP around the time of default, rather than the type of default. (See Chart 12.) Based on this, recovery rates on Zambian debt are likely to be in the region of 40%.

Chart 12: Recovery Rates in Restructurings & Public Debt-to-GDP Ratios

Sources: Moody’s, Refinitiv, Capital Economics

Chart 13: Premium on Sovereign EMBI US$ Spreads After Defaults (bp)

Sources: Various academic papers, Capital Economics

  • The type of default may matter for the government’s reputation, which could lead to a higher country risk premium. Historically, governments usually only lose market access during the debt restructuring phase – the more disorderly the default, the longer that is likely to last. In terms of borrowing costs, academic research suggests that the “defaulters’ premium” is sizeable initially but fades to about 100bp after five years or so. However, that premium might last longer if a government’s tactics lead to an erosion of faith among investors. (See Chart 13.)

Jason Tuvey, Senior Emerging Markets Economist, jason.tuvey@capitaleconomics.com