Bretton Woods Committee | Thu, Dec 17, 2020
by Mahesh Kotecha
The OECD has estimated that external capital inflows to emerging market countries shrank in 2020 by about $700 billion relative to 2019. The inflows came from remittances, official sources and private capital, but they are now reversing.
Over the last decade, two dozen African countries gained remarkable private capital market access with credit ratings, issuing over $100 billion in Eurobonds. The money was used well by some countries, like Cote d’Ivoire, for productive public infrastructure, increasing economic growth. Other countries started out prudently but veered off track. Moody’s estimates Zambia's public debt rose from around 20% of GDP in 2011 to 98% at the end of 2019. Then COVID-19 tripped Zambia into default. In October 2020, Zambia missed interest payments on its Eurobonds and its ratings were cut to default by S&P and Fitch (and to Ca by Moody’s), shutting down its access to international capital markets for years to come.
Zambia was not alone to default this year. Also defaulting were Ecuador, Lebanon, Suriname and Argentina. G-20 countries offered debt relief in April 2020 under their Debt Service Suspension Initiative (DSSI). The program offers suspension -- not forgiveness -- totaling some $12 billion on official debt for 2020, with a similar amount for 2021. Zambia’s DSSI offer of $165 million is a mere 1.4% of its total external debt of $12 billion. While 46 of the 73 eligible poor (IDA) countries have sought to benefit from DSSI, there has been no take-up by any country with signifcant capital markets access. Middle income countries do not quality.
DSSI is a positive step, but it is not enough. First, the program runs at most to year-end 2021. But no economist expects economic output to return to pre-pandemic levels by then. Second, private sector participation in DSSI is voluntary and no investors have stepped forward. Zambia asked the investors to do so but they refused. Third, China has also refused to play, contributing to Zambian default as the private sector was unwilling to forego interest while Chinese debt was being paid. Fourth, even under the Comprehensive Framework for DSSI announced by G-20 on November 13, 2020, China’s participation will be minimal if it excludes Chinese policy banks on the basis that they are “private sector”, despite being wholly state-owned.
In the meantime, the liquidity problems for many African (and other) countries are quickly morphing into intractable solvency problems. A global recession, broken supply chains and the health impact of the pandemic has already pushed some 50 million Africans into poverty and this will likely double in the next 12 months. The continent’s growth has turned negative after more than two decades of consistent expansion. While the IMF offers several liquidity support facilities for pandemic-strapped countries, its conditions are often too stringent, its resources are strained, and it is slow to act.
The solution is to stretch out maturities of public and private sector debts coming due to levels that the countries can afford to pay. The Brady Plan of the 1980’s for Latin American debt provides a precedent. It used US Treasury zero coupon bonds to guarantee repayment of principal on restructured longer-dated debt. “Zeros” were pledged to repay the restructured principal on new bonds exchanged for the shorter-dated loans the countries could not pay. The countries gained time and benefitted from a lower interest rates on their debt. Some offered lenders and investors sweeteners in the form of equity.
We need new “Yellen Bonds” that provide repayment certainty to investors and allow borrowing countries private market access at low interest rates. So, Yellen Bonds – like Brady Bonds - should guarantee ultimate repayment with zero coupon US (and possibly EU or European, Japanese and Chinese) government bonds. Unlike in the 1980s, such zero coupon bonds are not affordable for debt-strapped countries at today’s low interest rates. Instead, industrialized nations should contribute the zeros in global pandemic solidarity designed to preserve their market access, which DSSI does not do.
The cost of the zero coupons for the Yellen Bonds will be far less than the cost of widespread defaults which are surely on the way. Zambia has external debt of $12 billion of which about a 31% is owed to China and about 25% to the bond markets (the rest is owed mostly to multilateral financial institutions like the World Bank). Zambia’s bonds currently trade at about 45 cents to the dollar. The Chinese debt and the private sector bonds together total some $7 billion.
The cost of credit enhancement is likely to be proportional to the difference between the par and the market value of Eurobonds and Chinese debt. The market discount on the bonds is 55%. Applying it to both, the cost is about $3.7 billion. The West and the Chinese would need to agree to split the cost pro-rata based on their respective shares of Zambia’s debt. For all of Africa, credit enhancement would cost the West about $15 billion.
Of course, there are many other issues to address – how the exchange is structured, whether the exchange preserves the sovereign ratings, whether holdouts can be brought in under collective action clauses, etc. But these technical issues can be resolved if the cost of credit enhancement is covered. So, Secretary Yellen should prioritize lowering Africa’s sovereign debt burden.
Compared to the value of the industrial world’s monetary and fiscal stimulus totaling over 10 trillion dollars in 2020, the cost of such zero coupon bond contributions of some $15 billion is trifling. By contrast, inaction may drive an increasing number of the poorest countries in the world – mostly in Africa - into insolvency. This poses severe humanitarian risks as well as security risks with the potential for rising political instability and terrorism, not to mention the risk of another unknown pestilence such as Ebola as African public health systems collapse for lack of funding.
Mahesh Kotecha, CFA
President, Structured Credit International Corp.
December 17, 2020