Ridge walking on the debt mountain

Article as analysis
Many poor developing countries are suffering under a huge mountain of debt. Consequently, the UN is at long last discussing a regulated debt restructuring procedure. Switzerland is slowing things down.

The sovereign debt of European countries in particular has lately been causing quite a stir. Front and centre of the discussion is managing the Greek debt crisis. Contrastingly, there is hardly any talk of the debt mountain of developing countries. One may well have the impression that the debt problems of the poorest countries were a thing of the past.

In its report entitled "An international framework for restructuring sovereign debt" of September 2013, the Federal Council states that the Heavily Indebted Poor Countries (HIPC) initiative and the Multilateral Debt Relief Initiative (MDRI) by development banks had clearly been helpful in this regard in recent years. It also states that already the debt situation in some of the countries concerned is again reaching crisis proportions.

More serious than thought

International Monetary Fund (IMF) data shows that the situation is truly serious. The latest IMF estimates of December 2014 are that three developing, low income countries (LIC) have already become insolvent, whilst 14 other LICs are in a critical foreign debt situation and at considerable risk of insolvency. Of those, six countries, or almost half of them, have already been given (partial) debt relief under the HIPC initiative.

Then there are another 29 poor countries which, by IMF criteria, show at least a "moderate" risk of national bankruptcy. Sixteen of those – more than half of them – have benefitted under the HIPC and MDRI debt reduction initiatives. What this means is that partial debt cancellation under these initiatives has brought only temporary relief in many cases. In countless poor countries, the need for substantial foreign funding for infrastructure projects and for expanding the education and health systems has again considerably increased the debt burden.

Who is to blame for the debts?

Naturally, the reasons for the growing indebtedness of developing countries vary from case to case. In some countries the debt burden is growing because irresponsible and corrupt governments take out loans to finance developmentally meaningless prestige projects and arms imports, or to line their own pockets. In these cases, the lenders who support such regimes bear some of the responsibility. They generally know the type of good-for-nothings whom they are supplying with their money– at a presumably very attractive interest rate. But because insolvent states cannot declare bankruptcy, irresponsible lenders can hope – even in the case of de facto state bankruptcy, to be able to recover some part of their claims at some point.

In most cases, however, the developing country debt mountain is not growing because lenders are financing meaningless expenditures by the governments concerned. In general, loans are used reasonably for government projects that are either themselves profitable or promote economic growth in general. Yet even in such cases there is the danger that major investments can simply go wrong or that debt servicing could suddenly become impossible owing to natural disasters caused by climate change, currency losses and externally triggered financial and economic crises. The affected countries must then take out new loans to service old debts – fuelling the debt spiral to the point where no new lenders can be found.

What happens in a debt crisis?

If a state is massively over-indebted or in fact already insolvent, it cannot simply declare bankruptcy like an enterprise and initiate a regulated insolvency procedure. Instead, this triggers protracted and laborious wrangling over which creditors are prepared to renounce what part of their claims. It is therefore often the case that indebted countries and creditors do their best to drag out long overdue debt restructuring as much as possible. They hope – mostly in vain – that they will eventually be able to salvage the situation by means of repeated bridging loans. The consequence is that unsustainable situations are dragged out for years and public finances are squandered.

It would therefore be all the more important if at last a suitable international framework could be created for a fair and transparent insolvency mechanism for states. Many development organizations around the world – including Alliance Sud – have been suggesting this for years now. Meanwhile, even the Federal Council has acknowledged the possible utility of this suggestion. In its reply to a postulate in which parliament's member Felix Gutzwiller (FDP.The Libreals) and 27 co-signatories requested the Federal Council to table a proposal for a fair and independent international sovereign insolvency procedure, it stated at the end of 2011 that in the future, such a mechanism could help resolve problems of this kind. In the relevant report of September 2013, it nonetheless underlined that there was no appreciable international support for this.

Swiss obstructionism in the UN

There is now clear support in the international arena for a sovereign insolvency procedure. In September 2014, developing countries succeeded in a bid for negotiations to be held in the UN framework to devise a multilateral legal framework for sovereign debt restructuring processes. Furthermore they insisted that the final document of the forthcoming UN conference on Financing for Development in Addis Ababa should mention the necessity of such a procedure. For now, however, Switzerland is being uncooperative on the matter. It abstained in the original voting at the UN and even rejected a resolution on the specific negotiation modalities.

The official explanation for Switzerland's obstructionism is that there were procedural flaws in the voting on the negotiation modalities. The real reason however was most likely that in general it is preferred to discuss economic matters in the International Monetary Fund (IMF), where industrialized countries clearly have much more say than developing countries. The only problem is that to date, IMF debt crisis management proposals have proved woefully inadequate.