As the pandemic wreaks havoc on the global economy, low- and middle-income countries are especially hard hit. Many developing economies are already struggling to meet debt obligations yet they need to channel the few resources they have toward fighting COVID-19.
In a positive first step in mid-April, the Group of 20 leading economies granted 76 of the world’s poorest countries a standstill on official debt repayments until the end of 2020. But private creditors, a key lending group, are under no obligation to postpone debt servicing. To insist that these countries negotiate consent from each creditor introduces unnecessary and costly delays that would largely defeat the purpose of providing debt relief.
In “Born Out of Necessity: A Debt Standstill for COVID-19,” Chazen Senior Scholar Patrick Bolton and leading sovereign debt scholars and practitioners propose a simple mechanism for involving commercial creditors in debt relief on comparable terms to those offered by the official sector. Bolton and his colleagues suggest that a debtor country could establish a central credit facility (CCF) with a multilateral institution, such as the World Bank, in which it would transfer interest payments due, so that they can be redirected towards fighting the COVID-19 crisis. Once the CCF is in place, all the sovereign debtor would need to do is notify all creditors that payments due have been deposited into the CCF. By commingling interest payments due together with some multilateral funding commercial creditors would stand a better chance at getting repaid at a later date when the crisis has passed.
The proposal also calls for the official sector to recognize the necessity of debt relief (referring to the international law doctrine of “necessity,” which justifies the suspension of performance of contracts in times of exigency). This would provide debtor countries with some backing against recalcitrant commercial creditors, who would choose to sue rather than provide relief.
Some fear that the stigma from the suspension of debt payments could close international capital markets for some time. However, recognition that a standstill is a necessity brought about by a worldwide pandemic, rather than the result of fiscal profligacy, should mitigate the effect.
The creation of a CCF structure with an existing multilateral institution could be accomplished very quickly and would provide timely and comprehensive debt relief to poor countries fighting the COVID-19 crisis.
· Developing nations, especially middle-income economies, need debt service standstills from both official and private lenders on comparable terms to fight the health crisis.
· The CCF provides a simple and effective way of involving the private sector, and it offers guarantees that the debt relief will be properly redirected and will not be diverted.
· Once the crisis is over developing countries would be in a better position to repay existing creditors. Assurances that such relief will only be granted again in rare and special situations of necessity will maintain the confidence of debt capital markets going forward.
About the researcher
Patrick Bolton is the David Zalaznick Professor of Business. He joined Columbia Business School in July 2005. He received his PhD from the London School...Read more.