Last fall, the World Economic Forum warned that rising sovereign debt levels risked destabilizing the international financial order. The same article cited a recent United Nations Trade and Development study highlighting African sovereign borrowing challenges. Fifty-four developing sovereigns spend over 10% of national income on interest costs, 18.5% in Africa.
But sovereigns face an existential dilemma. They must use their power to grow the economy and improve the lives of citizens, or else lose power. Social and economic transition need investment capital; and in the Global South, it doesn’t come cheap. This is not strictly speaking a borrower creditworthiness problem.
If we are honest, pressures for structural change—energy transition, demographic shifts, changing trade patterns, obsolescing knowledge capital—are everywhere. Financing them is everyone’s problem. And while pushback is mounting against old capital accumulation models based on rent-seeking, the know-how to turn anthropogenic capital (knowledge, education, health, technology) into money is still immature.
Sovereigns that borrow debt capital are making a bet that the economic returns to scale of their investments can both raise living standards and repay debts. There is nothing inherently irresponsible about this bet, but the status quo factors are stacked against low-income sovereigns who must rely heavily on primary capital inputs, labor and commodities, to build up their fixed capital.
Lenders are likely to see their risk of default—a missed payment or restructuring—as material. This reality makes lenders unlikely to lending to low-income borrowers other than the sovereign, except perhaps in special situations.
Borrowing Is A Risky Business
Investors use debt to park idle capital and earn yield-on-the-clock. To buy growth stories, they invest equity. But “sovereign equity” is neither a capital market product nor legal. Fractional shares of countries are not, and probably would not be, bought and sold. To raise development finance, sovereigns must work within the traditional framework of borrowing and lending. The more aspirational the debt story, the higher the required yield, the more it costs to repay.
The table below shows how much money it would cost for a hypothetical fixed-rate, 24-year, level-pay loans based on current central bank lending rates across Africa. It would scale from 20% of principal for the Seychelles at a 1.75% lending rate, to 100% for Zimbabwe at 35%.
(These are hypothetical borrowings. Actual loan structures determine the actual interest payable, but cash flows from level pay structures are better for illustration because they are less scenario-dependent.)
No Bankruptcy Court For Creditor Disputes
That is a singular feature of the sovereign credit challenge, that there is no global bankruptcy court or recognized international court of justice with standing to oversee, arbitrate or negotiate when global sovereign bonds fail. The structural void amplifies the lender’s risk perception.
Dr. Daniel Cash, a global Credit Rating Research Specialist of renown, Reader in Law at Aston University and Senior Fellow at United Nations University, dedicated an entire book to analyzing the sovereign indebtedness problem and its solutions. In Sovereign Debt Sustainability: Multilateral Debt Treatment and the Credit Rating Impasse (2002) Cash painstakingly pieces together a narrative of failed procedural and market-based mechanisms for impaired African sovereign debt.
And No Silver-Bullet Market-Based Solutions
The rise of market-based sovereign workout solutions coincided with the end of Africa’s decolonization period and Oil Shock. In the 1970s and 1980s, associations of global creditors (notably Paris Club, comprising creditor countries, and London Club, comprising international creditor banks) framed sovereign payment problems as a short-term liquidity crisis and rescheduled the debts—again and again.
In the 1990s, the UK proposed new terms to restructure and extend the loans, also with failed outcomes. Troubled sovereign borrowers now bore a label: “Heavily Indebted Poor Countries.” The World Bank and International Monetary Fund launched an HIPC Initiative, supplemented by a Multilateral Debt Relief Initiative.
Around this time, the IMF also proposed a Sovereign Debt Restructuring Mechanism emphasizing arbitration to formalize the procedures of resolution, to substitute for the lack of a bankruptcy solution under law. SDRM would address shortcomings of market-based solutions with a uniform process emphasizing order, predictability and speed, to shore up asset values and protect creditor rights.
For it to take effect, however, an amendment to the IMF Articles of Agreement was required. The Articles require members holding 85% of the voting power to approve amendments, and the United States, with 17%, used its veto power.
The MDRI was in place from 2005 when pandemic hit. In 2020, the World Bank and IMF urged the G20 to set forth terms for sovereigns from low-income countries to suspend debt repayments and reallocate funds to fight COVID. It was called the Debt Service Suspension Initiative. The DSSI successfully negotiating deferrals with public institutional creditors, but private creditors stayed away. It was superseded in 2022 by the Common Framework, an initiative by the G20, which, adhering to the principle of equivalent treatment of all creditors, sought to bring private and public creditors to the table. The Common Framework is broadly considered a failure because credit rating agencies and their ratings complicated the picture. I discussed their power over sovereign borrowers here.
The Credit Rating Impasse
In his book, Cash calls international credit rating agencies “gatekeepers to the capital markets” because their ratings are embedded in all private credit investment and pricing decisions.
As CRAs define “default” as a missed payment, restructuring. or any other deviation from the terms of the original indenture, Common Framework members engaged in restructuring faced a risk of automatic downgrade to “default” status, with severe potential knock-on social, economic and political impacts. This is also an aspect of “choice architecture” I have written about here.
Unsurprisingly, only four countries joined the Common Framework . ee were either already in default or subsequently downgraded to “Strategic Default”: Ethiopia (2023), Ghana (2022) and Zambia (2020). Chad (B-), unrated at the time, has fared better.
In his book, Cash coined a phrase describing the power of CRA’s to stop markets, The Credit Rating Impasse. He explains: When CRAs don’t get involved, everyone jumps in. When they do, nobody can play.
Over two years have passed since it was published. I spoke with him this month to get an update on the Impasse. “Unfortunately, nothing has happened,” he replied.
On the other hand, Africa has been doing an excellent job of getting and keeping global attention, Cash said. But as the attention economy moves in cycles, it is important to catch this wave and work towards resolution, he cautioned.
Although he perceives CRAs as part of the problem today, he says they could well be part of the solution going forward because of market capture. Cash, a pragmatist, believes in market-based solutions because “the market is the only game in town.”
Cash views the proposed private African Credit Rating Agency, AfCRA, supported by the African Peer Review Mechanism and United Nations Economic Commission for Africa, as “a valid response from Africans. It provides capacity, authority and a sense of intervention for Africans in an environment where they had none,” and hence an important solution for African sovereign borrowing challenges.