Restarting Development Finance to Handle Debt Distress in the COVID-19 Era

By Ying Qian

The COVID-19 pandemic has levied a brutal force on many emerging and low-income countries: not only their public health systems, but their economies have also suffered from severe contractions, which derailed revenue generation and budget execution. The onslaught of the pandemic has exacerbated the triple crisis of public health, rising poverty and inequality and climate disasters.

In September 2021, the Boston University Global Development Policy (GDP) Center hosted a virtual workshop on “Debt Distress and Development Finance in the COVID-19 Era” that included participants from the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, the United Nations Conference on Trade and Development (UNCTAD), as well as individuals from across the world. The workshop was divided into two sessions, with the first analyzing how debt sustainability can be measured in a more precise manner so policymakers can better understand and design effective investment and development strategies by rethinking and reforming the International Monetary Fund’s Debt Sustainability Analysis (DSA). The second session featured discussions of debt restructuring proposals that would allow key creditor and debtor countries to work together to reduce debt burdens in a fair and equitable manner, enabling emerging markets and developing countries to have the fiscal and policy space to invest in sustainable growth and development. Researchers presented six working papers, followed by animated discussions with global experts on financial stability and development finance. Attendees exchanged ideas on topics of debt distress, as well as China’s role in financing development and Chinese approaches to debt restructuring.

A new policy brief summarizes the discussion and outlines key policy recommendations.

The DSA framework, first initiated in 2002 and subsequently revised in 2017, has played a key role in assessing countries’ debt vulnerabilities and examining alternative debt-stabilizing policy paths in cases of distress. The IMF and other international financial institutions (IFIs) have helped countries hit by the COVID-19 pandemic avoid debt crises and uphold the Group of 20’s (G20) Common Framework and Debt Service Suspension Initiative (DSSI). But the scope of the DSA is limited to debt repayment capability, not on how debt contributes to or hinders economic transformation. Moreover, the DSA does not comprehensively consider climate or other sustainability risks nor account for crucial investment needs for climate adaptation and the UN 2030 Sustainable Development Goals (SDGs). Critical revisions should be made in the direction of including productive public assets in the DSA and adopting a framework for the long-run solvency where fiscal austerity, structural transformation, the SDGs and climate scenarios move in sync in various development scenarios.

Refinancing for sustainable growth is a must for any distressed debt restructuring measure moving forward. At the workshop, experts suggested “asset+ based refinancing”; linking debt relief with climate resilience; and adopting an initiative similar to the Brady plan deployed during the Latin American debt crisis of the 1990s. Specifically on linking debt and climate action, the creation of a “Guarantee Facility for Green and Inclusive Recovery”, with policy and technical support and financial leverage from IFIs, could help debtor countries build national visions, strategies and plans along with a set of key performance indicators and a spending plan. The Facility would ensure recovery is in line with the SDGs and the Paris Agreement. Distressed debt buyback programs could be linked with conservation and climate adaptation programs where sufficient technical assistance could be offered by donors to reform policies, develop capacities and build project pipelines.

During the workshop, experts agreed that multilateral institutions and IFIs need to offer more leadership and assume more supportive roles in debt restructuring. This can be done through the DSA framework and policy dialogues at the macro-level, donor and creditor coordination on the mezzo-level and selection of the most appropriate transaction structure for debt restructuring at the micro-level. In debt restructuring negotiations, debtor countries’ perspectives need to be fully considered. While benchmarks and monitoring mechanisms are necessary, these must be established in a way that respects debtor countries’ sovereignty and uses agreed-upon international best standards, linking with “pro-development conditionalities” in areas of public asset management, sustainable development and green finance. Lowering debt burdens should be accompanied with commitments towards the SDGs and the Paris Agreement. Proven and innovative approaches can be considered, such as leveraging public assets, Brady bond-like debt restructuring, utilizing natural hedges through state-contingent instruments, debt buy-backs with green and climate finance, debt-for-nature swaps and various forms of credit enhancements. Effective use of these tools will require creditor countries and development partners to help debtor countries improve their policy frameworks, technical know-how and financial market infrastructure.

Lending from China in recent years has bridged crucial development finance gaps for many low-income countries and as much as 80 percent of China’s loans to African governments and state-owned enterprises have been to infrastructure sectors. China also became an important player in sovereign debt restructuring, where tailored solutions have frequently been sought on a project-by-project basis. However, amid the systemic crisis, experts at the workshop suggested China needs to adopt a more systematic approach to debt restructuring. China could designate a targeted share of its official development aid (ODA) to a level that is commensurate with its per capita income and count debt relief as part of its ODA. China could also work with the IMF, multilateral development banks and financial authorities of major creditor countries on coordinated actions and innovative solutions on debt restructuring for sustainable growth of debtor countries.

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