China's overseas lending has been in the spotlight in the last year over growing fears of debt distress, but how African borrowers will deal with their private sector debt remains controversial and unresolved. Zambia recently announced a suspension of $120 million in interest payments to its Eurobond holders for the next six months.
However, this government request is being rejected by a group of financial institutions holding 40% of Zambian Eurobonds. Zambia now edges ever closer to default (subscription required). There is a pressing need to resolve the question of private sector debt and reform the international architecture, so it can deal with debt crises. The Zambian case is the first African country to signal a private sector debt default, but it may not be the last.
Our experts weigh in on the implications of private sector debt for multilateral initiatives and the international debt architecture for future infrastructure lending, as well as the risks of Zambia facing a financial crisis.
As the largest bilateral lender, China has been castigated for contributing to rising borrowing in Africa. Chinese loans constitute around 17% of African external debt, but greater problems lie elsewhere.
Private sector debt, mostly driven by sovereign borrowing through Eurobonds, makes up 30% of the continent’s total debt. In Nigeria, only 10% of debt service goes to Chinese loans, while 60% goes towards servicing Eurobonds. In Kenya, now at growing risk of debt distress, 40% of debt service goes towards Eurobonds, while Chinese debt constitutes 20-25%. And while Chinese debt might make up a larger proportion of Zambia’s debt portfolio, private sector borrowing comes at a higher cost.
Due in part to its dispersed nature, private debt has not attracted as much media attention as Chinese loans, but having more creditors complicates the restructuring process, as my colleague Shakira discusses below. Comparatively, countries that have borrowed from China may have an easier time in restructuring, and as I’ve previously argued, can leverage a degree of flexibility in renegotiations through their bilateral diplomatic relationship. Angola’s recent restructuring is a case in point.
China's participation in the G20 Debt Service Suspension Initiative (DSSI) was both welcome and necessary for the initiatives' impact and credibility. However, the overall impact of the DSSI remains small compared to what is needed: just 3.65% of debt service for 2020 is covered, and not all Chinese official institutions are included. Moreover, much of these gains may go towards repaying private sector debts, signifying a transfer from bilateral official creditors (largely China) to bondholders in the Global North. This perception has led to recalcitrance among some Chinese creditors (subscription required), who have pushed Zambia to repay its arrears first, essentially deepening the zero-sum game between Chinese, multilateral and private creditors.
The DSSI is not enough. But at the same time, the private sector has not yet provided relief, and private-led initiatives have been lacklustre in impact and wilfully opaque. Without meaningful actions for debt relief by private sector actors, whether in joining the DSSI or by providing other assurances to African governments – such as freezing credit ratings – modest multilateral initiatives will end up meaning very little.
Zambia’s move to suspend interest payments to its Eurobond holders could lead to a financial crisis stemming from heightened risk perception.
First, the lack of resources for debt service will magnify investors’ risk assessment of Zambia’s structural weaknesses – a country with high risk of debt distress, copper-dependent exports, double-digit inflation and dwindling foreign reserves. These factors will make it difficult for the government to mobilise revenues to pay its debt beyond April 2021.
Second, the longer it takes for the Zambian government to find a resolution with creditors, the higher the risk premium would be. Zambian bonds already dropped to half of their face value following the announcement. Since government bonds are a source of 30% (PDF) of Zambia’s banking sector income, bonds’ falling value will negatively affect banks’ balance sheets, posing financial stability risks.
Third, investor uncertainty over the country’s debt restructuring will further weaken the Zambian Kwacha, which may induce a second round of effects including higher import prices, added pressure on inflation, lowered domestic value of remittances, more expensive external debt service and more.
To account for these risks, investors would pull out capital or charge higher interest rates. Zambia’s financial conditions would likely tighten, affected banks may lose substantial income and declare bankruptcy, and cash-constrained governments, firms and households may default on their loans. This can lead to a financial crisis.
Zambia must avoid going down this path since a financial crisis combined with a recession is expected to have lasting economic scars – a GDP decrease by up to 8% (PDF) five years after the onset of the crisis. Thus, the heightened risk perception must be abated as soon as possible. Here are three ways this can be done.
- The government must urgently put a detailed plan in place for its debt management and resolve the issue with its Eurobond holders. Or, at the very least, make negotiations ongoing and transparent.
- International financial institutions should immediately assist Zambia before worsening conditions spiral into economic and financial crises that can trigger capital flight from other countries of similar profile. Crises and spillovers would be more costly for the domestic and international community to resolve.
- Zambia’s case highlights the need to address long-standing issues around government debt management and restructuring. How much are governments exposed to not only official but also private debt? Is there a need for a global debt restructuring framework covering all creditors if the root of debt distress is beyond government control?
These issues are more important now than ever. As the adverse growth impact of past debt restructurings have shown, we must avoid getting to the point where the global community acts too little, too late for low-income countries.
Zambia’s challenges with interest repayments are bad, but not breaking, news. After having benefitted from the Heavily Indebted Poor Countries (HIPC) Initiative for debt relief in 2005, Zambia started borrowing heavily again in 2012, and was classified by the International Monetary Fund as at high risk of debt distress by 2017. All of this was compounded by Covid-19, as the government needed to allocate funds towards the pandemic response, while at the same time facing lower revenues. ODI research (PDF) estimates a drop of around 10% in Zambia’s exports.
Unfortunately, Zambia may not be an isolated case. Many countries borrow heavily, in particular to pay for infrastructure. External debt is one of the few tools they have at their disposal to fill their infrastructure financing gap, estimated to be around $68 – 108 billion per year for African countries. Earlier this year, Kenyan MPs called for a renegotiation of the debt repayment and the operating costs of the Standard Gauge Railway, which was built to connect Mombasa and Nairobi. Similarly in Laos, changes in ownership of its national power grid seem to be connected to the country’s inability to service its obligations. This has caused some real issues, and the country has even been downgraded by rating agencies.
Many have pointed fingers at China, the lender, for many large infrastructure projects in low- and middle-income countries, but the reality is much more complex than this. Countries already on the verge of debt distress can be tipped over the edge by many factors, as the Zambia case demonstrates. Large infrastructure projects are complicated as they raise technical and political challenges, and are also very complicated to manage. Cost overruns are very common in North America and Europe too.
The lesson I draw from Kenya and Laos is that countries need to think a lot more carefully and comprehensively about what they borrow – and why. Understanding infrastructure projects and their impact on the host countries’ economies is not just about disentangling their financial setup. It is also about assessing how (if) they can promote economic transformation in host countries. As I have pointed out elsewhere, making sure that infrastructure is planned more strategically in the future is a necessary (but not sufficient) condition to avoid future disasters.
Even before Covid-19, it was widely recognised that the international system was woefully equipped to deal with a wave of countries defaulting on their debt service obligations, particularly to private creditors. In an ideal world, a sovereign borrower unable to repay its creditors would have recourse to a bankruptcy code (similar to that in the corporate world), allowing it to renegotiate with its creditors without the threat of creditor litigation before an agreement is reached. Unfortunately, to the detriment of the borrower and its creditors alike, no such bankruptcy regime exists for over-indebted countries.
Consequently, restructuring sovereign debt remains an unpredictable process that can be derailed by a minority of private sector creditors. This is known as the “holdout” problem, where instead of participating in a debt restructuring and accepting a loss, holdout creditors often seek to recoup the debt's full value through aggressive litigation. This results in less debt relief and discourages creditor participation.
Despite the adoption of innovative clauses in bond contracts to mitigate this problem, there are still gaps in the international system that could lead to difficult restructurings. These include large outstanding stock of international sovereign bonds missing these clauses, as well as other types of debt instruments that limit the ability of debtors to defer payments resulting from the involvement of collateral.
Given the growing risk of a Covid-19-related systemic sovereign debt crisis, the focus now needs to be on mobilising political support for bold – yet practical – solutions that address these gaps.
- Laws in the United Kingdom and United States (which govern most emerging market sovereign bonds) should be amended to stop litigious creditors from filing lawsuits against countries where the International Monetary Fund certifies that debt service is onerous in light of a crisis.
- International finance institutions should use their resources to incentivise creditors to participate in a restructuring.
- Given the high level of uncertainty, all debt restructurings should include state-contingent features in new bond contracts to protect the sovereign from future risks by automatically adjusting debt service payments to commodity prices or natural disasters.
These solutions will require tough trade-offs, but they are critical if we are to avoid a protracted economic crisis that results in significant hardship for the most vulnerable.