THE DEBT

PANDEMIC
New steps are needed to improve sovereign debt workouts
Jeremy Bulow, Carmen Reinhart, Kenneth Rogoff, and Christoph Trebesch

ART: ISTOCK / RUDALL30

12 FINANCE & DEVELOPMENT | September 2020

 T
he COVID-19 pandemic has greatly international travel will face roadblocks, and
lengthened the list of developing and uncertainty among consumers and businesses
emerging market economies in debt dis- is likely to remain high. World poverty has
tress. For some, a crisis is imminent. risen sharply, and many people will not be
For many more, only exceptionally low returning to work when the crisis passes. The
global interest rates may be delaying a reckoning. political ramifications of the crisis in advanced
Default rates are rising, and the need for debt economies are also still unfolding. The back-
restructuring is growing. Yet new challenges may lash against globalization, already rising before
hamper debt workouts unless governments and COVID-19, may intensify.
multilateral lenders provide better tools to navigate Although many emerging market governments
a wave of restructuring. have succeeded in borrowing more in local curren-
The IMF, the World Bank, and other multi- cies, businesses have continued to accumulate for-
laterals acted quickly to provide much-needed eign currency debt. Under severe duress, it’s likely
funding amid the pandemic as government reve- that emerging market governments would yield
nues collapsed alongside economic activity, while to pressure to bail out their corporate national
private capital flows came to a sudden stop (see champions, just as the United States and Europe
Chart 1). In addition to new loans from multilat- have done.
erals, Group of Twenty (G20) creditors granted a On top of the dramatic retreat in private fund-
debt moratorium to the world’s poorest countries. ing, remittances from emerging market citizens
They have encouraged private lenders to follow working in other countries are expected to drop
suit—albeit with little success. by more than 20 percent this year. At the same
So far, the pandemic shock has been limited to time, borrowing needs have skyrocketed, as
the poorest countries and has not morphed into a emerging market and developing economies
full-blown middle-income emerging market debt contend with the same budgetary stresses as
crisis. Thanks in part to favorable global liquidity advanced economies. Health systems must be
conditions conferred by massive central bank strengthened and support must be provided for
support in advanced economies, private capital citizens whose lives are affected most acutely.
outflows have moderated and many middle-in- Borrowing needs will only rise further as the
come countries have been able to continue to economic damage mounts.
borrow in global capital markets. According to Rising budget pressures have been accompa-
the IMF, emerging market governments issued nied by a new wave of sovereign debt downgrades,
$124 billion in hard currency debt during the surpassing peaks during prior crises (see Chart
first six months of 2020, with two-thirds of the 2). They have persisted even as major advanced
borrowing coming in the second quarter. economy central banks have eased credit condi-
Yet there are still reasons for concern about tions. Central bank purchases of corporate bonds
sustained emerging market access to capital to provide support for local firms in emerging
markets. The riskiest period may still lie ahead. market and developing economies have also
The first wave of the pandemic is not over. handicapped their debt ratings.
Experience from the 1918 influenza pandemic History shows that it is not unusual that coun-
suggests the possibility of an even more severe tries can keep borrowing even when default risk is
second wave, especially if it takes until mid- high. A review of 89 default episodes from 1827
2021 (or later) for an effective vaccine to become to 2003 shows the typical experience to be a sharp
widely available. Even in the best-case scenario, rise in borrowing, both external and domestic, in

September 2020 | FINANCE & DEVELOPMENT 13

 the run-up to default (Reinhart and Rogoff 2009). retrench, official lenders often step in (Horn, Reinhart,
Ideally this time will be different, but the record is and Trebesch 2020, cited in Chart 1).
not encouraging. A recent analysis comparing losses (haircuts)
Amid massive and synchronous financing needs taken by official and private creditors raises further
across a broad swath of countries, there is brewing in doubt about the supposed seniority of official sector
the background a growing need for debt restructurings loans (Schlegl, Trebesch, and Wright 2019).
in numbers not seen since the debt crisis of the 1980s. These outcomes should not be surprising. After
Official creditors should be prepared to act as needed. all, governments have a history of protecting
Here they will be impeded by two trends that have domestic creditors who lent abroad (think north-
been developing independently of the COVID-19 ern European banks in the case of Greece), and at
crisis. Call them “preexisting conditions.” the same time also care about stability and welfare
First, private creditors are increasingly claiming in the borrowing country. Such altruism, in turn,
outsize shares of repayment in debt restructurings. weakens the official sector’s bargaining position—
Although theoretically the official sector is a senior especially vis-à-vis private creditors. Thus, official
creditor to the private sector, much of the historical creditors may be left holding the bag for the bulk
experience suggests otherwise. of the losses, even when they start with little of
During the 1980s emerging market debt crisis, the outstanding debt, as in Greece.
private creditors were quite successful at pulling out A further challenge comes from new holdout
funds as official creditors went in ever deeper (Bulow, and litigation tactics by private investors to resist
Rogoff, and Bevilaqua 1992). Similar developments large debt write-downs and restructurings. As the
were at play during the European debt crisis, when number of restructurings has declined, an increasing
investors did take some losses in Greece; a large share of them have involved lawsuits (see Chart 3,
portion of their funds had been pulled out, with from Schumacher, Trebesch, and Enderlein 2018).
Bulow, 08/04
repayments facilitated by large-scale loans by euro While this may not completely explain the private
area governments (Zettelmeyer, Trebesch, and Gulati sector’s success in maximizing its share in debt
2013). This pattern has recurred over two centuries restructuring, it is disconcerting.
of private and official lending: when private investors The second preexisting condition is the length
of time debt crises are dragging on. As former
Citibank chairman William Rhodes famously said
Chart 1 during the debt crisis of the 1980s: “It is easy to
Multilateral lifeline get into a debt moratorium. It’s tough to get out.”
Quick funding by multilaterals helped offset a collapse of government Default episodes have taken, on average, seven years
revenues and the withdrawal of private capital. to resolve and typically involve multiple restructurings
(see Chart 4). Unfortunately, debt restructurings can
(billions of dollars)
become a bargaining game in which the country
150
Official international capital flows debtor is often (rightly) willing to exchange higher
(cumulative multilateral commitments) future debt for lower payments now, fully intending
100
IMF to restructure debt again as necessary. Delay also helps
50
Regional banks both sides bargain for larger infusions from official
0
World
*+,-
Bank creditors (Bulow and Rogoff 1989). And creditors may
Jan. 2020 Feb. 2020 Mar. 2020 Apr. 2020 May 2020
often be willing to repeatedly renew (or “evergreen”)
–50 debt in order to temporarily make their balance sheets
–100 look better. The COVID-19 crisis could, in the worst
Private international capital flows
(net debt and equity purchases of
case, lead to another “lost decade” in development,
–150 with long delays in debt resolution.
nonresidents, 32 emerging markets,
–200 Institute of International Finance data) What can governments and multilateral lenders
do to make sure new funding ends up benefiting
–250 the citizens of debtor countries affected by the pan-
Source: Horn, Sebastian, Carmen M. Reinhart, and Christian Trebesch. 2020. "Coping with demic rather than lining the pockets of creditors?
Disasters: Two Centuries of International Official Lending," NBER Working Paper 27343,
National Bureau of Economic Research, Cambridge, MA.
And how can they make debt restructuring more
expedient? Here are three practical ideas:

14 FINANCE & DEVELOPMENT | September 2020

 RESILIENCE
Bulow, 8/4/20

Chart 2
Sovereign debt downgrades
A surge in rating downgrades in 2020 has surpassed peaks in previous crises.
(three-month sums of share of sovereign downgrades, 1980–2020)
30

25

20

15

10

0
Jan 1980
Apr 1981
Jul 1982
Oct 1983
Jan 1985
Apr 1986
Jul 1987
Oct 1988
Jan 1990
Apr 1991
Jul 1992
Oct 1993
Jan 1995
Apr 1996
Jul 1997
Oct 1998
Jan 2000
Apr 2001
Jul 2002
Oct 2003
Jan 2005
Apr 2006
Jul 2007
Oct 2008
Jan 2010
Apr 2011
Jul 2012
Oct 2013
Jan 2015
Apr 2016
Jul 2017
Oct 2018
Jan 2020
Sources: Fitch; Moody’s; Standard and Poor’s; and Trading Economics.

• More transparency on debt data and debt contracts pension burdens is also increasingly important, as
recent debt workouts in Detroit and Puerto Rico
It is of utmost importance that the World Bank, the vividly illustrate.
IMF, and the G20 continue to insist on strength-
ening the transparency of debt statistics. • Realistic economic forecasts that incorporate
A new and significant complication in assessing downside risks
the external indebtedness of many developing econ-
omies involves China, which has become the largest Realistic growth forecasts are critical to avoid
bilateral creditor in recent years. Unfortunately, underestimating a country’s near-term financ-
China’s lending is often shrouded in nondisclosure ing needs and overestimating its capacity to ser-
clauses, and a full picture is still elusive. More gran- vice its debt commitments. IMF historian James
ular data on private sector creditor exposure may Boughton notes that during much of the 1980s
facilitate, in case of debt distress, more expedient debt crisis, overoptimistic growth expectations
creditor-debtor negotiations and allow both creditors persisted, especially in Latin America. Realistic
and governments to identify which bonds are at risk forecasts, particularly recognizing the fragility of
of holdout or litigation tactics. An encompassing highly indebted countries, can speed resolution
transparency initiative would include, for instance, of any crisis. Earlier detection of insolvency and
full disclosure on sovereign bond ownership as well identification of cases in which large write-downs
as credit default swaps that shift lender composi- are necessary cannot guarantee a faster resolution
tion overnight. Knowing the players involved and but are a step in that direction.
the amounts owed would allow the international
community and the citizenry of affected countries • New legislation to support orderly sovereign
to better monitor how scarce resources in a time debt restructurings
of crisis are being deployed. The accounts for the
country itself must become more comprehensive, Legal steps in jurisdictions that govern interna-
with improved data on domestic debt and debt tional bonds (importantly but not exclusively
owed by state-owned enterprises. Accounting for New York and London) or where payments

September 2020 | FINANCE & DEVELOPMENT 15

Bulow, 08/04

government bonds bought at a deep discount. In

Chart 3 2010, the United Kingdom enacted such a law
Legal risks for countries taking part in the Heavily Indebted
An increasing share of sovereign debt restructurings involve litigation. Poor Countries (HIPC) debt relief initiative,
(number of restructurings) (share of restructurings affected) while Belgium in 2015 passed the so-called
16 100 Anti–Vulture Funds Law, which prevents liti-
Restructurings (left scale) gious creditors from disrupting payments made
14 Restructurings with litigation (left scale)
Share affected by litigation (5y m.a. right scale) 80 via Euroclear. It would also energize legislation to
12
facilitate a majority restructurings, which would
10 60 allow a sovereign and a qualified majority of
8 creditors to reach an agreement binding on all
40 creditors subject to the restructurings.
6
The global pandemic is a once-in-a-century
4 shock that merits a generous response from offi-
20
2 cial and private creditors toward emerging market
0 0
and developing economies, including preserving
the global trading system and helping countries
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Bulow, new 08/11
weather debt problems.
Source: Schumacher, Julian, Christoph Trebesch, and Henrik Enderlein. 2018.
"Sovereign Defaults in Court." CEPR Discussion Paper 12777, Centre for Economic Support must be forthcoming, regardless of
Policy Research, London. what progress can be made in better managing
Note: 5y m.a. = five-year monthly average.
debt workouts. However, to make sure as much aid
as possible gets through to debtor country citizens,
it is essential to ensure inter-creditor equity and
fair burden sharing, especially between official
Chart 4
and private creditors. The more official aid and
Long sovereign workouts soft loans can go toward helping needy citizens
Defaults, on average, last more than seven years. around the globe—and the less such assistance
(number of default spells, 1970–2015) ends up as debt repayments to uncompromising
50 creditors—the better.
45 Descriptive statistics (in years)
40 Average 7.2 JEREMY BULOW is the Richard A. Stepp Professor of Economics
35 Median 5 at Stanford Business School; CARMEN M. REINHART is
Max 30
30
No. of observations 107
vice president and chief economist of the World Bank Group;
25 KENNETH ROGOFF is Thomas D. Cabot Professor of Public
20 Policy and professor of economics at Harvard University; and
15 CHRISTOPH TREBESCH is a professor of International Finance
10 at the Kiel Institute for the World Economy.
5
0 References:
0 5 10 15 20 25 30
Bulow, Jeremy, and Kenneth Rogoff. 1989. “A Constant Recontracting Model of Sovereign
Default spell duration (in years) Debt.” Journal of Political Economy 97 (February): 155–78.

Source: Meyer, Josefin, Carmen M. Reinhart, Christoph Trebesch, and Clemens von ———, and Afonso Bevilaqua. 1992. “Official Creditor Seniority and Burden Sharing in
Luckner, 2020. "Serial Sovereign Debt Restructurings and Delay: Evidence from the 1930 the Former Soviet Bloc.” Brookings Papers on Economic Activity 1, 195–222. Washington,
and 1980s Default Waves." Unpublished, Harvard University, Cambridge, MA. DC: Brookings Institution.
Reinhart, Carmen M., and Kenneth Rogoff. 2009. This Time Is Different: Eight Centuries of
Financial Folly. Princeton, NJ: Princeton University Press.
are processed can contribute to more orderly Schlegl, Matthias, Christoph Trebesch, and Mark L. J. Wright. 2019. “The Seniority
restructuring by promoting a more level playing Structure of Sovereign Debt.” NBER Working Paper 25793, National Bureau of Economic
Research, Cambridge, MA.
field between sovereign debtors and creditors.
For instance, national legislation can cap the Zettelmeyer, Jeromin, Christoph Trebesch, and Mitu Gulati. 2013. “The Greek Debt
Restructuring: An Autopsy,” Economic Policy 28 (75), 513–63.
amounts that may be reclaimed from defaulted

16 FINANCE & DEVELOPMENT | September 2020