The Creditor Advantage

Developing economies have long argued for the need for a multilateral legal framework within the United Nations where they have more representation and can make a coordinated push for restructuring crippling debt burdens.

At forums like the Paris Summit or even the G20, such coordination is impossible, since invitations to these are opaque and ad hoc, and debtor countries are made to plead their case for restructuring one at a time with no collective leverage. But only by acting together can debtor countries shift the conversation from one in which individual countries beg for loan extensions to one focused on the imbalance in the availability of financing for vital investments.

That imbalance is severe. For example, at the beginning of the pandemic developed economies took advantage of historically low interest rates to expand their borrowing and support their pandemic-hit economies. Such borrowing and spending in advanced economies far outpaced that in developing economies. Developing countries were shut out of such low-interest funding during the pandemic, and they’re shut out in noncrisis periods as well.

Multilateral agencies were supposed to help development efforts with concessional loans. But they haven’t done their job, and long-term declines in those loans have led more countries to depend on private investors, issuing international sovereign bonds. Meanwhile, private investors have been able to demand much higher premiums to move funds to developing economies due to their lower credit ratings. Credit-rating agencies based primarily in the United States and Europe tend to rate developing economies much lower and are quick to downgrade them disproportionately, as happened during the COVID crisis. This only pushes up borrowing costs for them further.

Likewise, advanced economies automatically benefit from the reserve-currency advantage. Reserve currencies are those that are used for international transactions. The dollar is the primary reserve currency, followed by the euro and a few other advanced-economy currencies. Investors naturally favor investments in reserve-currency economies, which leaves low-income economies behind.

The IMF’s Reign

The customs and technologies that structurally empower creditor countries are all part of a skewed global financial system that was established after World War II, at the historic Bretton Woods conference in 1944.

That conference, which was also dominated by US and European interests, debated a few different proposals for facilitating a new era of global monetary exchanges. British economist John Maynard Keynes worried that reserve-currency advantage could concentrate investments in a few countries. He therefore proposed the creation of a neutral currency unit for global trade and an International Clearing Union (ICU) to oversee all global transactions. In Keynes’s proposal, the ICU would impose a penalty on countries that built up an excessive surplus in the international currency unit. This would provide an incentive to invest the surplus in other nonsurplus countries, limiting the premium gouging that developing economies now experience from private investors.

The Bretton Woods conference, however, overruled Keynes and paved the way for the dollar as the reserve currency. It also established multilateral agencies like the IMF to provide assistance to countries facing financial instability. But unlike the proposed ICU, the IMF has no mandate to oversee all global transactions. It has had very little ability to influence private creditors into lowering premiums and actually restructuring debt. A much-touted debt deal for Zambia, the first country to default on loan repayments in the post-COVID era, was coordinated by the IMF recently. The deal not only took two years to negotiate, but it is also not even binding on private creditors. It merely postpones repayment of official loans from other countries, leading to doubts about its efficacy.

Neither has the IMF shown any interest in fostering a fairer credit-rating environment that would make it possible for countries to access financing for vital development needs. The IMF’s own debt sustainability framework merely evaluates repayment capacity while focusing on fiscal consolidation or the ability of governments to limit their spending. It is often critiqued for enforcing austerity programs to improve repayment capacity without making a distinction between necessary versus wasteful spending. The governance structure of the IMF, where the United States and EU nations have the largest voting shares, also provides limited room for developing countries to make a coordinated case for funding for sustainable development goals.

In 2015, the UN provided basic principles for a more inclusive global forum for debt negotiations that would clearly link debt restructuring to human rights indicators and accommodate essential spending to sustain basic social protection benchmarks. Debt discussions that are not linked to social protection is a long-standing failing. The pandemic made clear the global need for sustained investments in health and human services infrastructure. The UN sustainable development goals project has also emphasized critical global investments to eliminate extreme poverty and address climate change.

A more representative multilateral legal framework that can link debt restructuring to social protection benchmarks is therefore the need of the hour. Such a legal framework would also enshrine principles on responsible borrowing and lending encouraging both creditors and debtor nations to be more disciplined in sovereign financing. Continued focus on nonrepresentative efforts like the Paris Summit will only lead to more disappointing non-outcomes. It is time for Global South countries to collectively take a stand against the very structure of such forums.