The process of dealing with insolvent economies is under threat due to the emergence of a new force in sovereign debt. China’s lending to developing countries, alongside their refusal to comply with western-established rules, has been identified as the greatest challenge to government debt workouts. More than 60 countries are in debt distress or in danger of becoming so, with concerns raised over a potential wave of debt restructuring requests and the handling of them at a time when current restructuring cases are already facing costly delays, with Zambia being the most recent example.
China's stance on debt relief is more about geopolitical competition than economic rationalities, according to Yu Jie, a senior research fellow on China at think-tank Chatham House. China wants to shape the agenda of debt relief, not to have it dictated by the west. However, some experts suggest that Beijing's lending spree and refusal to comply with western-established rules are the single greatest impediment to government debt workouts and threaten to leave some countries in debt limbo for years.
Jay Newman, the former Elliott fund manager, says the emergence of China as a significant player has left the entire system in uncharted waters. There is now one big state creditor with the power to dictate terms and the patience not to make a deal if it doesn't suit them, which has completely changed the game.
The debt restructuring process is broken, according to Reza Baqir, a former senior IMF official and governor of Pakistan’s central bank, largely because it was primarily designed for a bygone era when creditors were overwhelmingly western countries and western banks. The Paris Club was formed in the 1980s to coordinate between government creditors, while bankers formed the London Club to restructure their debts. Western governments drove the process and occasionally leaned on banks to accept painful settlements. It was largely improvised and often slow, but it mostly worked.
But the decline of bank lending and the growth of the bond market shook things up in the spate of sovereign defaults that started in the early 1990s. Creditor co-ordination became trickier with myriad bondholders trading claims around the world, rather than just a handful of banks. In the wake of the Argentine debacle, the IMF responded by setting up a framework for debt restructuring. However, the framework has proven inadequate to deal with the current situation, which is further complicated by China's involvement.
In a grim sign of the times, Alvarez & Marsal - one of the world's biggest corporate bankruptcy advisers - has set up a sovereign practice for the first time. The latest IMF data from the end of February indicates that nine poorer countries, such as Mozambique, Zambia, and Grenada, are already in what it terms "debt distress," while another 27 countries are at "high risk" of falling into it. A further 26 more are on the watchlist. Baqir suggests that there are also many struggling state-controlled companies in these countries that will require assistance.
The potential for business is clear. There is an opportunity for a more holistic approach. The debt restructuring process was primarily designed for a bygone era, and the entire system is in uncharted waters due to China's involvement. Some experts believe that the process is broken, and the current situation requires a new approach to deal with the emerging risks. The consequences of not addressing these issues could be severe for the countries that have defaulted on their debts, and the IMF thinks that more than 60 countries are in debt distress or in danger of becoming so.
