The urgency to solve the sovereign debt crisis in developing countries continues to increase. As global temperatures rise and the threat of irreversible damage to the planet looms, debt burdens are preventing many low-income (GDP) countries in Africa and other regions from investing in climate action. Attempts to find answers using the common G20 framework for dealing with debt are hampered by disputes between creditors, which undermine any possibility of a timely and meaningful resolution.
The question of whether multilateral development banks (MDBs) will share in the losses along with other creditors is particularly discussed. The G20 asked the multilateral development banks to develop cost-sharing formulas, but no systematic plan was developed. China insisted (unlike the Paris Club of sovereign creditors) that MDBs accept debt relief, but then softened its stance at this year's spring meetings of the World Bank Group and the International Monetary Fund. But at the recent summit of the BRICS group, the call for the participation of the MDBs was reiterated.
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And it's a legitimate request. As we show in a new report, MDB involvement in sovereign debt restructuring is not only feasible but also necessary to resolve the current impasse. First, at least half of all external debt of 27 over-indebted countries, many of which are low-income countries (GDPs) or small island developing States (SIDS), is owed to multilateral creditors. Even by canceling all bilateral and private debt, some of the world's most vulnerable countries will not achieve a full recovery unless multilateral development banks participate in the restructuring.
Second, perceptions are important. If all external creditors (including MDBs) are involved in the restructuring, any perception of unfairness (or “others will pay the costs”) is eliminated. This in turn increases the willingness of bilateral and private creditors to negotiate.
Third, debt relief through cost sharing would be consistent with the MDBs' core mission of supporting sustainable economic development and eradicating extreme poverty. Without a solution to the crisis, over-indebted countries will be unable to make progress towards the United Nations Sustainable Development Goals, let alone achieve them before 2030. The only way for affected governments to invest in high-priority areas is if they have more fiscal space.
Finally, a prolonged debt crisis will be very costly for the concessional credit arms of MDBs: as GDP distress indicators rise, the concessional part of MDB support also rises. Take, for example, the International Development Association (IDA), the World Bank agency charged with lending to the poorest countries. By our calculations, IDA's debt-sustainability-based grants increased from $600 million in 2012 to $4.9 billion in 2021, or from 8% to 36% of its commitments. Therefore, accelerating the search for a solution to the debt problem will benefit multilateral development banks.
However, MDBs offer loans on more favorable terms than other creditors. Therefore, to ensure a fair distribution of losses, comparative fair treatment rules must be applied that take into account the cost of the loan.
Using these rules, we estimate that providing $55 billion (39%) of debt relief to 41 over-indebted countries and SIDS with access to IDA funds would result in a loss of $8 billion for the MDBs and $27 billion US dollars for private creditors. This scenario would cost the IDA $2 billion, much less than it currently spends on donations that depend on indicators of the debt crisis. With a more generous cut of 64% (similar to the Heavily Indebted Poor Countries Initiative), the total losses to the MDBs would be $25 billion.
And if the MDBs were to participate in broader debt relief, covering 61 countries with serious debt problems (including some middle-income countries such as Egypt, Nigeria and Pakistan), a reduction of 39% would cost them 37, with fair comparison rules for treating them Billion dollars. It's not a supporting character. However, by accepting this loss, the MDBs would enable a total of $305 billion in debt relief (including $209 billion from private creditors). That means every dollar donors donate through the MDBs would translate into a total of seven dollars in debt relief, a staggering multiplier.
It is possible to share losses without jeopardizing the MDBs' high creditworthiness or their privileged access to low-cost capital. Previous sovereign debt restructurings suggest that multilateral development banks can cover their costs by relying on donor contributions and internal resources. They can also revive institutional arrangements such as the World Bank's Debt Relief Fund (DRTF) and leverage their precautionary balance sheets as they receive fresh capital injections.
If we really want to solve the growing debt crisis in the global south, the MDBs must be prepared to accept a debt haircut. This is the only way progress can be made in debt restructuring. However, in order for the losses to be distributed fairly, comparability rules for fair treatment must be applied, taking into account the cost of the loan and the degree of benefit. Debt relief comes at a price, but it is worth paying to put vulnerable countries and the world at large on the path to climate resilience and sustainable development.
Ulrich Volz He is Director of the Center for Sustainable Finance and Professor of Economics at the School of Oriental and African Studies (SOAS) at the University of London, senior researcher at the German Institute for Development and Sustainability and co-chair of Debt Relief for a Green and Inclusive Recovery . Marina Zucker-Marques She is a postdoctoral researcher at SOAS and research leader for the “Debt relief for a green and inclusive recovery” project.
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