Check out the fourth episode of our podcast series, TwentyTwenty; Your Podcast for (Un)Precedented Time, here! Find us also on Spotify, Apple
Check out the fourth episode of our podcast series, TwentyTwenty; Your Podcast for (Un)Precedented Time, here! Find us also on Spotify, Apple Podcasts and Google Podcasts
Elizabeth Dysktra-McCarthy: Unprecedented times. Such has been the clarion call of this year. But just how unprecedented are these times? Whilst a global pandemic might not be an annual issue, many of the crises we are facing, from the erosion of civil liberties to debt crises, or from fears around technology to the shifts in geopolitics as major powers flex their muscles, these other products of trends and concerns we know only too well in which a state of global emergency has amplified. Even the pandemic itself was no surprise to those in the know. So what are these trends? Where have they come from? And what kind of path can we expect them to put us on?
This is TwentyTwenty Vision, and I’m Elizabeth Dykstra-McCarthy with a podcast, brought to you by Foreign Brief in partnership with the Fletcher School, about how this year has accelerated global trends and the state of global crisis has made them that much more visible.
EDM: Over the last year, countries around the world have been digging into their coffers, turning to international bodies for loans and piling up debt. The fiscal response to the COVID-19 pandemic, from additional health care spending to increased unemployment benefits, or furlough schemes and PPE budgets, have driven countries that were already teetering on the edge to the brink of financial ruin: a sovereign debt crisis.
Now, buckle up, here comes the mini macroeconomics lessons you never knew you wanted. When governments borrow beyond their means, they increase their sovereign debt. Let’s say a country, Debtlandia, wants to fund a big new infrastructure project, but can’t pay for it solely with whatever revenues it gains from taxes. Debtlandia might seek funding from private, domestic, or foreign sources: creditors. Those creditors give money by purchasing bonds from the Debtlandian government. Basically, I Owe Yous with the knowledge that they will be paid back the principal amount plus interest down the road. This is a critical source of funding for high, medium and low-income economies alike. All governments borrow, and many, such as the US, borrow heavily, but they can because creditors trust the government to pay them back. But borrowing does come with risks. Let’s say Debtlandia owes more to creditors than it can reasonably make payments on; it has run itself into a sovereign debt crisis. Often this will end in a default, a situation where the government says it cannot and will not pay what it owes. It’s a bit like a country declaring bankruptcy. Why does this matter? Well, let’s say Debtlandia goes into default. It doesn’t pay back the creditors it owes, which might help it financially in the short term, but creditors are now unlikely to trust it last year, and will punish it for defaulting by locking it out of credit markets, basically not purchasing any more of its bonds. As a result, Debtlandia will likely experience a good deal of economic pain, as foreign investment is a huge source of growth and economic activity in many economies. Beyond not being able to launch any new fun infrastructure projects, the Debtlandian government will likely also need to cut funding for critical social services, such as education, health care, or transportation, as it now receives no money from creditors. It has become a lonely financial pariah that no international creditor would touch with a 39 and a half foot pole.
EDM: Defaults can happen for a number of reasons: violent conflicts, a crash in the price of a country’s main source of revenue, or just hypothetically, a worldwide recession induced by the worst global pandemic in the last century. All of these can play the match for an impending sovereign debt explosion.
EDM: Not since the 2008 recession has the issue of sovereign debt been more prevalent. Since the Fiinancial Crisis, high, medium, and low income countries alike has borrowed exorbitant sums of money to promote development and growth. Since 2007, global government debt has more than doubled, having reached about 70 trillion US dollars as of 2019. With COVID-19 slamming on the brakes of economies around the world, countries are finding it increasingly difficult to muster the funds to pay back what they owe. And the situation is becoming more and more dire, especially for emerging market economies. In the last few months, and in the coming months, many nations have been and we’ll be faced with the choice: to service their people or their debt. Should they default, they will likely be locked out of credit markets for years to come, hamstringing any chances of a post COVID recovery. However, paying creditors will likely come at the expense of funding critical social welfare programs. This will have dire implications for public health. And as citizens become more and more frustrated, for political stability. So lesson over, hopefully you’re still with me. But are we on the brink of the worst sovereign debt crisis in recent history? How can we mitigate such a reality? And how can emerging market countries that have historically struggled with sovereign debt issues, like Argentina, emerge from this crisis intact?
Lee Buchheit: I wish more thought might be given to how the longer-term consequences of debt stocks at this level are going to be managed. And while I fully appreciate we’re in a crisis and we need to devote all our energies to dealing with it, someone should be thinking about how this is addressed in the future.
EDM: Unless this is your particular niche in international finance or law Lee Buchheit is likely one of the most important people you’ve never heard of. Described by the New York Times as “The Philosopher King” of sovereign debt lawyers, Professor Buchheit has kept nearly every bankrupt country since the 1980s afloat, from Mexico to Mongolia, Guatemala to Grenada, Iceland to Iraq, Buchheit has built the field of sovereign debt, a field of which, in the words of the US Treasury advisor Adam Lerrick, everyone is a DOB: a disciple of Buchheit, whether they like it or not.
LB: We have seen sovereign debt crises since the Latin American crisis, but they were localized and the rest of the world economy was churning on and that balanced things out. Here we’re talking about potentially a situation in which the economies of both the developed countries like the United States and emerging markets are all hit at the same time.
EDM: There have been many localized sovereign debt crises over the years, and Lee is drawing a pretty critical distinction between those and the global sovereign debt dilemma that we could find ourselves in: a potential sovereign debt crisis precipitated by the COVID-19 pandemic, which could be the worst he’s ever seen.
LB: The last time we had a truly systemic sovereign debt crisis was in the 1980s. It afflicted countries as far field as Poland and the Philippines.
EDM: That debt crisis was caused by the creation of OPEC, the coalition of oil-producing nations that trebled the price of oil in the middle of the 1970s.
EDM: The price hike was a boon for commodities exporters, often emerging market countries like Venezuela and Saudi Arabia, who shipped out vast quantities of oil. It was less than ideal for developed economies, which were hamstrung by recession. Naturally, banks lent money to countries that were doing well, the emerging market nations who are profiting off inflated commodity prices. These countries began accumulating massive amounts of debt, but as their economic indicators remained high, the party continued. However, such high oil prices caused a spike in inflation in the US without any accompanying economic growth. And the party quickly came to a close for many of these highly indebted states.
LB: The reaction to the recession, and the double digit inflation in this country, was significantly to raise interest rates to the point that, in early 1981, LIBOR, the London interbank offered rate, topped out at 22% per annum. Now that rendered the debt stocks of 25-27 countries–unsustainable almost overnight.
EDM: At the snap of the finger, hundreds of billions of dollars in loans to emerging market countries were suddenly un-payable and mass defaults ensued. We’re seeing a worryingly similar accumulation of debt today.
LB: What we have seen in the last 12 years, since the onset of the Financial Crisis in 2008, is an astonishing run-up in the size of the debt stocks of most countries, both in the developed world and the developing emerging markets, to inject stimulus into the economies after the Financial Crisis of 2008. But the fact of the matter is that we are entering potentially a period of sovereign debt distress when debt stocks are unprecedentedly high.
EDM: And of course, the stimulus measures that each country has passed will steepen that debt trajectory. The entire world is feeling the effects of this crisis. The US’ GDP shrank by nearly 33% in the second quarter of 2020, the worst drop since the Great Depression. Still short of Argentina and Lebanon, we haven’t seen any sovereign defaults, even though dozens of countries are in grave debt distress. What strategies have kept these countries from defaulting?
LB: The only technique seems to be a willingness on the part of those countries who can afford it to borrow and spend for economic stimulus or put in place monetary policy where the central banks are buying vast amounts of debt in order to frankly manipulate the market interest rates on that debt to allow the countries to continue to borrow.
EDM: But most emerging market economies don’t have the ability to just lower interest rates to continue borrowing, maintain access to bond markets, and with them, credit to fund critical services. Instead, they’ve been relying on a trickle down of monetary stimulus from high-income economies who have kept interest rates low, making it easy for these emerging market countries to pay off the relatively low interest on their bonds.
EDM: The managing director of the IMF and the president of the World Bank, at the end of March, put out what they called a “Call to Action,” asking the G20 countries to suspend debt service on their loans to the world’s poorest country.
These 73 of the world’s poorest countries are faced with unexpectedly large humanitarian expenditures as they navigate this crisis. Luckily, this call has been heeded. But still, this doesn’t represent a systemic change in the way debt crises are handled. And it’s unclear if the IMF and the World Bank will alter the way in which they approach the question of sovereign defaults in the future.
LB: Right now, none of us knows whether we are on the cusp of a systemic sovereign debt crisis. The IMF in response to the crisis opened a so-called rapid financing facility under which it is prepared to lend modest amounts of money to member countries who requested it to help with the COVID problem. More than 90 countries have requested it. That’s more than half the membership of the IMF. Are we on the cusp of a systemic sovereign debt crisis? None of us knows. But if we are, the official sector is probably going to have to come up with some mechanism by which this can be done in a reasonably quick and orderly way.
EDM: But these developing cash strapped countries are in a bit of a bind. Any renegotiation of their debt payments needs to be done in a sustainable way that doesn’t lead to a decade of litigation with dozens of individual creditors.
LB: We’re in the middle of a pandemic and the theory is that these countries don’t have the luxury of being able to renegotiate the terms of their debt instruments on a bespoke basis with each individual creditor for each individual instrument.
EDM: So what are their options?
LB: There is one proposal that a group of economists and I, a legal colleague, put forward which would essentially say that the sovereign’s money that they’re scheduled to pay in interest this year to their private creditors, diverted into a central credit facility opened and administered by a multilateral development bank, it could be the World Bank, it could be the Asian Development Bank, African Development Bank, and then those funds are able to be drawn by the country for crisis amelioration purposes.
EDM: This would give heavily indebted countries some breathing room to spend on critical services for their citizens. But a mechanism to monitor the use of these funds is key to ensure they’re not misused.
LB: Importantly, the multilateral development bank wouldn’t be responsible for monitoring the use of proceeds of those drawings to make sure they’re going for that purpose. Each of the private sector creditors who had been expecting to receive the interest payments would, in lieu of the interest payments, now receive an interest in this central credit facility and the central credit facility would be repayable with interest over a reasonably short period of time. That would be a technique that I think could be implemented very quickly. But as of right now, that’s not the way the official sector is going. It is not clear whether or how the private sector will participate in this call for a standstill on debt service payments this year.
EDM: And it seems debtor countries have little ability to force the issue, scared that any requests for debt relief would affect their credit ratings, and perhaps shut them off from the ability to borrow in the bond market and future. This leaves them in a highly unenviable position of vulnerability.
LB: That is where we are right now. It could change just as quickly as it did last spring. If the markets begin to think that this pandemic will indeed be more durable than I think many of them hope, and if they think the effect on the world economy could be as serious as the IMF is predicting it will be, we could see the markets turn arthritic, and pull back from lending. That would quickly exacerbate a debt crisis for many countries. It could catapult us into another systemic sovereign debt crisis.
EDM: And sovereign debt crisis does have the word crisis in it, but it’s hard to imagine what the real life implications of that would be.
LB: I fully appreciate we’re in the middle of a crisis, and that requires extraordinary steps and they’re taking them. But we will exit the crisis, I hope sometime in the reasonably foreseeable future, and the residual of the crisis, as it relates to sovereign debt will be enormous debt stocks, how are they to be handled?
EDM: How are they to be handled? If central banks raise interest rates, the debt of many emerging market economies will be unpayable. But if they don’t raise rates, they risk rising inflation and a diminished toolbox with which to address any future crises.
LB: With debt stocks of the colossal size that many countries will be carrying, that would quickly make the situation supportable, you would have to divert resources from other government uses–social safety net, education, military, whatever–to service external debts. And the same is true of many developing countries. There are a number of developing countries today that are spending 50 to 60% of their government revenues on external debt service. Now, the effect of that is to beggar every other possible use of government money, education, health and so forth.
EDM: Borrow now to pay back later. Of course, the funds have been absolutely critical this year. From emergency health spending to investment in contact tracing, citizens have been more dependent on their government financially than ever before. But as the year drags on, many have been questioning at what cost. As the debt is repaid, how will we fund it? And will it come at the cost of long term investment in public health, education, infrastructure–all the elements that make our societies function?
LB: Choose your metaphor. We have the tiger by the tail or the wolf by the years. We can’t let go. But we can’t safely hang on forever. And that’s the dilemma they’re facing.
EDM: So, the fiscal strategy pursued to enable countries to survive the COVID-19 storm may have potentially devastating implications for sovereign debt. Many countries out there are almost entirely reliant on foreign investment: Lebanon and Zimbabwe, Venezuela and Iran. Last month, Ecuador negotiated with its creditors over its $17.4 billion debt, capping off a successful set of talks with a fat loan from the IMF to get its battered economy back on track. Nor is it just our traditional bogeyman. In 2016, China’s debt at 250% of GDP, was a huge cause for concern, sparking fears that defaults could trigger a systemic crisis. The strides that it has taken since then to reduce its debt have been threatened by the debt incurred this year because of the pandemic.
EDM: The Republic of Argentina has earned its reputation as a serial defaulter, having defaulted on its debt nine times, three of which have come since the turn of the millennium. Historically, the country has poor relations with creditors, in part because the austerity measures implemented to make payments have caused an immense amount of pain within the Argentine population. This, coupled with the countries being locked out of credit markets for the better part of two decades, have hamstrung the government’s ability to attract the foreign investment desperately needed to sustainably fund development projects and social services.
EDM: In January of this year, Argentina entered into negotiations with bondholders to restructure more than $65 billion in debt: equivalent to Luxembourg’s GDP. After numerous deadline extensions, an agreement was finally reached on August 4, where investors agreed to drop their defaulted bonds for new bonds, which will be paid at 55 cents on the dollar, a huge jump from Argentina’s first offer of about 38 cents on the dollar. Buenos Aires also agreed to adjust clauses, making it more difficult for Argentina to reach future restructuring deals with a separate subset of creditors locking itself in.
Miguel Kiguel: So Argentina is unique. The creditors don’t trust Argentina’s statistics.
EDM: Dr. Miguel Kiguel has served as the President of Banco Hipotecario S.A, as a Deputy General Manager at the Central Bank of Argentina, Undersecretary of Finance and Chief Advisor to the Ministry of the Economy of Argentina, and Principal Economist World Bank and the Institute for International Economics in DC. One would be more than hard-pressed to find a better authority on Argentine monetary policy and financial markets. So what motivated Buenos Aires’ decision to settle now? What was the advantage of taking this deal?
MK: The truth is, Argentina doesn’t want the deviation. Argentina doesn’t want the bondholders to litigate. Maybe the chances of collecting the money are small. It’s complicated for Argentina, because you always have a risk of embargo, injunctions…So clearly, it’s going to be a headache. If Argentina remains in default, it will not be able to reap the gains from an agreement. The main advantage of agreeing with the bondholder for Argentina is a reduction in the country’s risk.
EDM: It’s not that Argentina’s government was afraid that if the bondholders demanded their money back that they would actually have to hand over the cash, but that the collateral damage might be enormous. Gambling that they won’t be put under a financial embargo is a bit too risky in an already risky business. For example, before the agreement was reached on the 4th, Argentina had no access to the credit markets, which was a major problem.
MK: The fact that Argentina is in default complicates access for the private sector, complicates across border lines, for banks or for corporations. The private sector suffers whenever they need to roll over any type of debt, the provinces cannot roll over their debt.
EDM: When Argentina defaulted, the effects were felt by the private sector and by the local government. The government might need to roll over the debt, extending the date by which they needed to make payments. But that wasn’t an option for Argentina’s provinces, leaving them cash strapped and without options. This made it hard for local governments to receive desperately needed funds to cover social services and infrastructure projects and deprive private firms of critical investment
MK: So it creates a lot of headaches for Argentina to remain in default. And Argentina really needs money, because it has a large fiscal deficit around 6% of GDP, which is part of the problem of the pandemic. Not having access to the market means that all that deficit has to be money financed where there’s a big risk of inflation. So clearly, the government has the political will to reach a deal.
EDM: And it has that political will, because the situation is a bit desperate. It can’t go back to where it was before. And with that background, the pandemic has surely affected Argentina’s ability to make payments on its debt in the medium term, say for the next two to three years.
MK: COVID-19 has clearly added some stress to the whole thing. Argentina wasn’t going to have a deficit of 6% of GDP. So that’s a new issue. Which means Argentina has in fact less capacity to pay especially in the next two to three years, precisely because the deficit has gone out of control for good reasons. I mean, there was no alternative to having a bigger deficit. Argentina had, first of all, a drop in GDP this year that we expect is going to be close to 13%. In that situation, tax revenues collapse or the deficit increases because of the loss in revenues.
EDM: It’s the double whammy a lot of governments have faced this year. As productivity has dropped, so have taxes. But as the lockdown has dragged on, so has government expenditure.
MK: At the same time, the government in Argentina had to assist all the people that lost their employment, they lost jobs, people all of a sudden fell into poverty. And you know, there’s no way that Argentina cannot assist those people, even if it means printing money, even if it means an increase in inflation, you have to save lives. Okay, so in this emergency, no one is against the fiscal deficit in Argentina. The question is, how is it going to be corrected in the future and if the government will have the political will to do it in an environment especially where the economy is likely to be in recession for at least for some time, where the economy is going to see increases in the level of poverty that we’ve not since the great depression that Argentina suffered in 2001.
EDM: During the 2001 crisis, the country’s poverty rate hit 55%. While the situation Argentina is in now is a way aways from that, the poverty rate, due to COVID-19 slowdowns has topped 40%. In the interest of both short-term recovery and long-term fiscal sustainability, Argentina will need open access to liquidity, to credit markets. It will need to borrow at reasonable rates to keep its public services going. But a historical barrier to that has been its poor creditworthiness. Creditors simply don’t trust Buenos Aires.
MK: Argentina’s default in many ways is unique. When I say that, I mean that typically countries default when they’re completely insolvent, where their debt ratios get to a very, very high levels, say 100% percent or more. For instance, last time that Argentina defaulted in 2001, the debt to GDP ratio was over 100%.
EDM: Greece, for example, when it restructured its domestic debt, had a debt to GDP ratio close to 200%.
MK: Argentina’s net debt today stands at around 50% of GDP, the total interest burden is not more than 3% of GDP, probably closer to 2.5% percent of GDP. So that’s not clearly an insolvent country. Argentina at the moment has a paradox or puzzle as why it got into the fault with numbers that many countries would never have gotten into the fault. If you look at any country in the world that has the ratio of debt to GDP of around 50%, and interest payments in the range of 2.5% percent of GDP, none of those countries would default.
EDM: So what happened?
MK: Argentina basically lost credibility when the previous government, Macri, lost the primaries, and it became clear that he was going to lose the general election. At that point, everyone wanted to get money out of Argentina. There were no capital controls, so it was very easy for people to get money out of the country. So in a way, it was a complete loss of confidence, in part because of our past.
EDM: This credibility concern that exists today stems from a historical precedent of defaulting. The government that defaulted in 2014 was one led by Cristina Kirchner. And it is the same party in power today, a party bondholders don’t trust and viewed as hostile to creditors because of that 2014 default.
MK: The concern that the government that was coming in was the same that defaulted in the 2001–Argentina lost credibility. If Argentina had had credibility, all along, having a government that made a clear statement that was willing to pay the debt, not just saying that it was going to pay the debt, but taken all the actions in terms of fiscal policy and others, in order to ensure the payment of the debt, then Argentina wouldn’t have defaulted at all. But Argentina defaulted. And once you default, you lose credibility.
EDM: And if you lose credibility the first time, doing it three times in the last two decades probably doesn’t help the image.
MK: Really creditors are worried when they look at Argentina. They don’t look at Argentina the same as other countries because they see Argentina as a serial defaulter, as a country that doesn’t want to honor the debts, or doesn’t care about honoring the debts. They put other priorities ahead of paying the debt. And creditors don’t like that. You know, creditors are looking at Argentina with concern. But you know, Argentina has the capacity to pay. So Argentina has time to regain confidence, to show its commitment to fiscal discipline. But predators are always looking at Argentina with concern because of our past.
EDM: So, the problem is much more political and economic: about perception, rather than reality. This contradicts the impression that Argentina isn’t capable of paying its debts, that rather it has a reputation as a country more likely to prioritize other commitments over repaying its debts, whether or not that’s true. Regardless, Argentina will have to make huge adjustments to its fiscal accounts next year in order to regain this lost confidence.
MK: Most countries have debts like Argentina, but they roll over the debts. Brazil, for instance, has debt of over 80% of GDP, has interest payments that probably exceed 5% of GDP. And yet they pay, because you know, when they go to the market, everyone is willing to lend and a very low rate.
EDM: In 2018, the International Monetary Fund and Buenos Aires very controversially agreed to a $57 billion loan package: the largest in the IMF’s almost 100 year history. The terms of the loan stipulate that it must be paid back by 2023. Although that’s obviously unlikely in the context of COVID-19. There has been talk of the IMF forgiving debt for many emerging markets, is that a possibility for Argentina? interactions between the two have historically been hostile to say the least, what will they look like moving forward?
MK: Everything I’ve seen in terms of debt forgiveness is essentially for the very low-income countries. But they’re not talking about that forgiveness or debt relief for middle-income countries. What they could do for Argentina, what the IMF could do for Argentina, is not debt relief but essentially lending more to Argentina, increasing the exposure to Argentina. And I think that if Argentina’s government goes to the fund and says we need more money because we need to solve the issue of the debt, we have a lot of social problems in Argentina that we need to deal with because of COVID-19, we need, you know, $10 billion more.” The IMF probably would say, “Yes, and we’re willing to lend.” But, if the IMF were to lend more to Argentina, they will come, and they will ask, “Okay, how are you going to repay me?” And they will say, “Argentina, we have to show the efforts you’re willing to make on the fiscal side to reduce the fiscal deficit, and whether they weren’t willing to do and the central bank in terms of reducing inflation in order to improve the business climate and improve investments so Argentina can grow, and it’s going to come the typical conditionality.” So I think the IMF will be willing to lend, but it’s not going to be willing to lend with no conditionality. It’s probably not going to be a tough conditionality, but there’s got to be some conditionality. And probably that’s not what the government wants.
EDM: So just how screwed are we? No one knows for sure, but the outlook appears far from rosy. What we do know, however, is that the state of sovereign debt was precarious, even before COVID-19. Now as borrowing has increased to fund recovery efforts, debt levels will be higher than ever. In reality, Argentina is lucky. Yes, we’ve painted a pretty painful picture, as for Argentina its debt to GDP ratio is 50%. For other governments, they’re almost entirely reliant on foreign investment. If it becomes clear that some of these governments can’t pay back their debt. What’s going to happen to them? Will they get the debt relief that they will doubtless ask for? Or will creditors simply shut up shop, refuse to loan any more money to these risky recipients? If the latter, it is unlikely these countries will achieve any semblance of a post-COVID economic recovery, the reliance on foreign investment can be extreme. During this year, Lebanon has relied on it for basic food and medical imports. Without it, taxes around the world will rise and services will be cut. Should this burden become too onerous on these countries’ populations? social and political unrest could very well ensue: riots, populist backlashes, even governmental collapse could all be on the cards–all three of which Argentina experienced under similar circumstances in 2001.
EDM: Though not the most glamorous issue, the question of sovereign debt is ubiquitous, and it influences decisions that affect our everyday lives. And we don’t yet have an answer to how we’ll keep these countries solvent. So buckle up.
This episode was researched and written by Max Klaver and Bryan Campbell Romero. The Associate Producers were Jonathan Regnier and Max Klaver, the Studio Assistant Rachel Carp, and the series TwentyTwenty is produced and presented by me, Elizabeth Dykstra-McCarthy. Thanks for listening, and until next week, goodbye