(Bloomberg Opinion) — The Covid-19 pandemic and the accompanying economic lockdowns have deepened inequality both within national borders and across the globe. Many low-income countries have suffered a severe economic contraction that has derailed budgets and created urgent financing needs. This has exacerbated debt-sustainability concerns, which were already high on the eve of the pandemic.
Today, more than half of low-income countries eligible for relief under the Group of 20’s Debt Service Suspension Initiative are either in debt distress or at high risk, doubling in the last decade.
Since (at least) the founding of the League of Nations in 1920, a recurring preoccupation of the international community has been the cycles of boom and bust in indebtedness, particularly external indebtedness. Proposals to “fix” the global financial architecture usually intensify with the severity of the problems. These have ranged from the broadly encompassing, such as the Bretton Woods Agreement at the end of World War II, to the more targeted, such as the re-introduction of collective action clauses in sovereign debt contracts in the early 2000s (already used in the 19th century).
Changes to the global financial architecture are easy to propose and difficult to implement. But progress can be made incrementally as well as with great leaps. The growing focus on transparency in finance, debt statistics and contracts is a case in point. Global leaders, as well as G-7 and G-20 communiques, stress transparency as a priority. In connection with the DSSI, the International Monetary Fund and the World Bank have taken important steps to disclose more data on the creditor composition of each country. In the private sector and civil society, the call for greater transparency has also escalated, as highlighted by a recent Group of 30 report. The Institute for International Finance finally agreed on voluntary principles for debt transparency, although it remains to be seen whether there will be effective implementation by private creditors.
Given the scale and complexity of social, climate, economic and political challenges facing the global economy, why is debt transparency important and why now?
Let’s be clear. Boom-bust cycles in international debt have been around for centuries. Transparency on debt and financial flows alone will not change that. Transparency can, however, play a critical role in mitigating the severity of these cycles, helping to avoid setbacks in poverty reduction and other development objectives. Covid-19 constitutes a major setback: The World Bank estimates that the global poverty rate has increased in 2020 for the first time since 1998.
Inadequate debt disclosure undermines debt-sustainability analyses and poses serious challenges for macroeconomic surveillance work. As some low-income countries, such as Zambia, began to issue Eurobonds, investors underpriced risk in nations with opaque debt structures — contributing to the unsustainable buildup of debt. Since early detection of possible problems is the cornerstone for pre-emptive policy action, transparency is critical.
During the period of high global commodity prices and relative prosperity that lasted until around 2014, many low-income countries accumulated significant debts to a number creditors from outside the Paris Club, including China, and relatively new in this marketplace. A substantial share of these debts went unrecorded in major databases and was not on the radar screen of credit-rating firms. External borrowing by state-owned (or guaranteed) enterprises, which have very uneven reporting standards, also escalated. Public domestic debt, which was a minor issue in the 1980s debt crisis in developing countries, is much larger now, and data availability lags its external counterpart (particularly on ownership).
Now that a growing share of countries has entered the bust phase of the cycle, the need for transparency has become urgent. The DSSI has played an important role in freeing up resources from debt service, so governments gain fiscal capacity to cope with the pandemic; by design it is a temporary measure. The Common Framework for Debt Treatments, endorsed by the G-20 late last year, recognized that short-term measures alone are not able to address unsustainable debt. The framework seeks comparable treatment from all official bilateral creditors, both Paris Club and non-Paris Club, and private creditors. Three countries have applied for debt relief under it (Chad, Ethiopia and Zambia), and the resolution of these test cases will probably shape future restructurings.
The common framework faces (at least) three major challenges. The first has been around since time immemorial: Creditors — governments, commercial banks and bondholders alike — have often been reluctant to offer significant debt relief quickly. This helps explain why debt-restructuring cases stretched out over a decade during the 1980s (and also during the 1930s). Second, the resolution of past debt crises has often been delayed by uncertainty about the willingness or ability of debtor governments to commit to a credible multiyear action plan.
Third, an obstacle of more modern vintage is that many developing countries (including some of the applicants to the framework) face a more complex and varied group of creditors than the Paris Club and commercial banks of the 1980s. This can complicate a coordinated response.
Transparency cannot overcome all the challenges, but it can go a long way to increasing the success of the common framework by increasing trust among creditor groups, which at present is rather low. Conversely, the framework can be a powerful tool to enhance transparency, as accurate and shared information is needed to get the negotiations on a speedier track. Disclosure must come from all creditors and debtors, as multilaterals continue to expand their coverage of data gaps in existing databases while building more encompassing ones, and revise their lending policies to enhance disclosure requirements.
All this will take time and requires a coordinated effort. Transparency is a global public good. The IMF and the World Bank will continue to support this important agenda through their functions such as surveillance and through their policies to support debtors and creditors in achieving greater debt transparency.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ceyla Pazarbasioglu is the International Monetary Fund’s director on strategy, policy and review.
Carmen M. Reinhart is vice president and chief economist of the World Bank Group.