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The shadow of moral hazard over public debt

public debt

In April the G20 group of “rich” nations announced that it was prepared to defer bilateral debt service due from defined low-income countries up to the end of this year. The governments in question were expected to seek comparable treatment from private creditors, who are generally holders of Eurobonds or syndicates of banks. A fair number have since secured the relief through the Paris Club of bilateral lenders but without negotiating with the private creditors for fear of limiting future market access and of provoking negative rating actions.

The G20 was, of course, responding to the COVID-19 virus and its impact on developing economies, notably their public finances. Against this background, there have been calls for debt cancellation by all creditors including the private lenders. We would tread carefully in this area and be highly selective with full debt relief.

The complication is that, unlike at the time of the heavily indebted poor countries (HIPC) initiative of the IMF and World Bank in the 1990s and 2000s, private creditors have become an important element in sovereign external debt profiles. For much of the 2010s, EM debt investors became enchanted with exotic sovereign names they might previously have struggled to place on a map of the world. According to a study by S&P in late June, private creditors account for 65 percent of the interest due in 2020 from the 21 African sovereigns it rates. (Their share of the external debt stock is far smaller because almost all official lending, bilateral and multilateral, is contracted at below-market rates.)

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The total interest bill looks huge, and the ratio for interest payments/government revenue alarming in several cases. Quoting the same S&P study, the bill for the rated sovereigns in Africa this year is estimated at US$46bn, of which South Africa alone is responsible for 29 percent. The bill, however, is 73 percent due to domestic creditors. Even if we exclude South Africa with its very large domestic debt market, the share is still more than 50 percent.

The external interest bill for S&P’s rated sovereigns is, therefore, $12.5bn this year. The monies could be spent on health and education systems at this hour of need when tax revenue has also been hit by the downturn brought about by the virus. We are sceptical about the second round of debt relief. It is legitimate to ask why many governments have failed to capitalise on the savings and clean slate provided by the first round. In a few cases such as Ghana and Mozambique, public debt ratios last year were already worse than pre-HIPC.

Generally, fiscal, structural and governance reforms have been inadequate. S&P shows Nigeria to have the worst interest payments/general government revenue ratio of the 21 rated sovereigns, at about 55 percent last year. It is not hard to find an explanation: gross revenue collected in 2019 in Nigeria amounted to just 7.1 percent of GDP, whereas peer economies and sizable commodity exporters regularly achieve +/- 20 percent. Three other sovereigns (Ghana, Angola and Egypt) had ratios for interest paid above 40 per cent in the S&P chart: the first two are struggling while Egypt raised $5bn on the Eurobond market in May in an offer competitively priced and said to be four times oversubscribed.

As for cases where failure to improve governance has contributed to debt distress, we pick out Mozambique for the tuna bond, Angola for its public debt accounting and Zambia for a series of poor decisions including the recent dismissal of the central bank governor without a convincing explanation.

We must warn of moral hazard. Theoretically, a government could migrate from one round of debt relief to the next, confident that it will not have to bear the consequences of its policies. Therein lies a future of permanent economic underdevelopment. The virus has created a strain on public finances across the world but the answer in our view is not extensive debt relief. We should point out that the G20 initiative is deferment not cancellation of bilateral debt service due this year.

There will be a few cases where cancellation of official debt is warranted such as when the impact of a natural disaster or even the current virus has been extreme. Otherwise, we would favour more lending by official creditors in the expectation that borrowing governments raise their game in terms of reform. The IMF has provided funds equivalent to 100 per cent of quota without conditionality under its two facilities created to tackle external shocks such as COVID-19. It may well be that these funds are insufficient and that the Fund should increase its allocation of SDRs to member countries, having overcome US opposition.

For private creditors, we understand why applicants for the G20 relief did not seek comparable treatment. However, all parties know that defaults happen although this has yet to take place with a mainland African issuer of Eurobonds. Look no further than Argentina! It has defaulted again although it was not so long ago that its government-issued maiden 100-year paper. The new Eurobond issuers of the past decade in Africa and elsewhere have tapped a market when US dollar interest rates are low and investors are hungry for yield. They have raised funds quickly and without conditionality. They know that, if their plans come unstuck for whatever reason, payments delays, ratings downgrades and haircuts lie ahead. Defaulters are not generally shut out of the market; they return but at a price.

Kronsten is the Head, Macroeconomic and fixed income research at FBNQuest Capital