Break the taboo supporting unsustainable debt, pleads former central bank chief

A year ago, in an article for The Economist, I forewarned that Pakistan’s politicians and the IMF were flirting with disaster by pretending that the country’s public debt was acceptable. It was among 70 countries that faced a debt crisis. A year later, only Ethiopia has defaulted, Sri Lanka is restructuring its debt, and Pakistan is on the brink of a record 24th IMF program. But this appearance of stability is no cause for celebration.

From Egypt to Angola, debt service crowds out the development spending needed to improve lives and build climate resilience (in Pakistan, interest payments are nearly three times higher than investment spending and three and a half times higher than education spending). These countries are playing for resurrection by raising taxes and cutting spending while praying for a growth miracle. However, this gambit only increases the chances of a messy default and disintegration of their social fabric, as happened recently in Kenya.

The salvation of these countries depends on the expansion of fiscal space by restructuring their debt. For this to happen, taboos need to be broken and innovative thinking is needed in terms of dealing with new lenders and how the IMF approaches debt in its country programs.

The taboo refers to debtor governments’ fear of debt restructuring. This is due to the desire not to be perceived as an inept business owner, possible lawsuits from creditors and the consequences for future external financing.

All these fears can be overcome. In many cases, perceptions of malaise can be intelligently countered by highlighting the role of external shocks, such as an unexpected tightening of global financial conditions or COVID-19, or of predecessor governments that often took on odious debts without benefiting the state. population on secret and corrupt conditions. Cover from lawsuits in foreign courts can be provided by major official creditors, as was done for Iraq, or can be automatically triggered by an IMF assessment that the debt is unsustainable.

Regarding the market penalty for restructuring, international data, including for Ukraine in 2015, show that it is much lower and short-lived than commonly feared, especially if restructuring improves the country’s growth prospects. In this context, governments should not be afraid to restructure lower-priority commercial debt, which costs much more precisely because of this credit risk. Where domestic debt also needs restructuring, Cyprus, Jamaica and the Seychelles show that this can be achieved without causing financial instability.

On the creditor side, there is a need to rethink how to accommodate the interests of new official creditors such as China and the Gulf states, and to receive assistance from multilateral development banks (MDBs). The participation of new official creditors in debt restructuring should be more strongly encouraged, and the IMF should help debtor countries to involve them in negotiations. One idea is to give the main official creditor offering debt relief the right to force other creditors to agree to a similar dilution of their claims. The right to squeeze other creditors within the framework of debt restructuring already exists in the rules of the Paris Club of official creditors and the creditors’ committee within the framework of the Common Framework – a multilateral debt restructuring mechanism – as well as in negotiations with private creditors. It only needs to be extended to new official creditors.

At the same time, the preferential creditor status is a limitation for countries that owe large amounts to the IMF. However, MDBs can at least prolong the coming debt service. And, if their shareholders choose, they can also provide outright debt relief, as has been done under the HIPC and MDRI initiatives, perhaps in exchange for climate action by debtor countries.

Another big change that is needed concerns the central role that the IMF plays in determining whether a country’s debt is acceptable or not. The Fund needs to be clearer in its statements, using its impressive Debt Sustainability Assessment (DSA) mechanism and cross-country research. At the moment, the IMF’s debt reports are unclear, and mechanical signals from its material commitments may be rejected by the decision. This should be fixed.

In the case of Pakistan, the IMF is basing its assessment of whether the debt is acceptable on an unrealistic projection of a sharp reduction in debt over the next five years against the backdrop of a projected increase in growth despite endless fiscal austerity and high interest rates. For this to happen, a country with tax revenue of just 10% of GDP needs to double its growth rate and run a primary surplus, an achievement that Pakistan only achieved during the US-led foreign-funded “war on terror”. subsidies are indefinite. The IMF’s DSA itself admits that such an adjustment is a Hail Mary miss, with only a one-in-seven chance of success based on international experience, and that the fund’s record of forecasting Pakistan’s public debt is spectacularly poor. If only these red lights in his substantive declarations were taken more seriously in the assessment of the IMF’s debt sustainability.

It is also surprising that the IMF’s excellent research on debt problems has had little impact on the development of country programs. Last year’s updated World Economic Outlook chapter demonstrated the futility of fiscal consolidation and the overriding role of restructuring in reducing debt overhangs, especially in a weak global environment. Unfortunately, this understanding is almost completely ignored in the work of the IMF in the country today. The Fund also failed to embrace and apply innovative thinking in the exceptional compendium of sovereign debt it released in 2020, with practical guidance for practitioners and economists.

To preserve social stability and development prospects in poor countries, it is necessary to fix the broken system of debt restructuring. For this, debtors must become more powerful defenders of their future generations. And the international community should become more receptive to debt relief. To do so, it will need to rediscover its focus on global development, which has been clouded by self-centered responses to the global financial crisis and COVID, as well as damaging geopolitical rivalries.

Murtaza Syed served as the head of the central bank of Pakistan in 2022, and before that he was an IMF official. He currently works at the Beijing-based Asian Infrastructure Investment Bank. The views expressed are his own.

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