The Covid-19 shock hit the emerging markets

The debt crisis in Zambia casts a long, global shadow

State bankruptcies are a collision of finance, economics, law and geopolitics. Zambia is a perfect example.

The African copper producer stumbled into the coronavirus crisis in disrepair after borrowing $ 12 billion from international creditors. It is now the youngest country to default on its debts after talks with its creditors have reached an impasse.

Ecuador, Lebanon, Belize, Suriname and – of course – Argentina defaulted, restructured or are in the process of restructuring their debts as early as 2020. For comparison: In the global financial crisis there were only three complete failures of states, as analysts from Goldman Sachs found in a recent report.

Every debt crisis is like a snowflake, unique and complex. But of those we’ve seen so far in 2020, the Zambian debacle has the potential to become a template for how many of the others – and there will be more – will shake out.

In addition to entering the bond market, Zambia has raised more than $ 3 billion from Chinese lenders like China ExIm Bank and China Development Bank, according to Standard & Poor’s. But the opacity of this debt and disagreement about how to treat it has made dealing with the crisis devilishly complicated.

Bondholders don’t want to cut their investments, while Beijing-based lenders get away with it. Chinese creditors don’t want the debt relief they offer to bail out hedge funds in Mayfair or Connecticut. In the meantime, the IMF cannot agree to a Zambian economic rescue program without being certain that its debts are sustainable. The impasse resulted in a missed bond payment at the end of October, a grace period to clear the arrears from last week, and the country is now in financial limbo.

However, this is not a unique situation. China has lent generously to many developing countries in recent years, but has refused to join the Paris Club, the arena in which countries restructure bilateral debt. In addition, many Chinese loans have been issued by state financial institutions, making it difficult to judge whether they should qualify as bilateral or commercial loans.

Zambia is also a test case of how well bondholders will behave in the inevitable future workouts on sovereign debt. In previous crises, the creditors were largely Western banks that could be gathered in a room and twisted into an agreement with the arm. Nowadays they are mostly an atomized group of fund managers spread around the world, which makes negotiating much more difficult.

The debt crisis has subsided since the 1980s when creditors moved from banks to bondholders

For the most part, with a few notable exceptions, bondholders tended to take their hits and move on. The recent restructuring has been relatively smooth, albeit after a bit of a saber rattle. However, there is evidence that bondholders are becoming a little less phlegmatic lately. The refusal of Zambia’s creditors to agree to a debt freeze could be a sign of the future.

The IMF last month proposed some ideas to improve the sovereign debt restructuring process. Inspired by a number of unfortunate incidents since the last major review of the subject in 2014, many seem tailor-made to deal with Zambian-like situations. Overall, the proposals represent the most radical revision since the failed attempt by the IMF to set up a pseudo bankruptcy court for countries two decades ago. This died but led to the emergence of “collective clauses” in bonds, legal provisions that facilitate restructuring.

Line graph of the price of Zambia's 2024 international bond in cents on the dollar.  This shows that Zambian bond prices will fall as creditors prepare for restructuring

In addition to expanding the G20’s bilateral debt relief program, the IMF wants to strengthen the CAC. make them standard in government bonds and the debt of state-controlled corporations; and introduce clauses that automatically trigger payment defaults when natural disasters hit a vulnerable economy.

Perhaps most importantly, a more consistent approach to dealing with government lenders is sought that is “acceptable to both Paris Club members and others” (Husten, China). ensure that they are treated equally with commercial creditors; and bring more sunlight into the process by getting creditors of all kinds to report legitimate debt – and hopefully avoiding the undisclosed loan issuance that plagued Zambia’s neighbors Mozambique.

If an ad hoc treaty-based approach proves insufficient to deal with the inevitable tide of sovereign debt crises, the IMF has also addressed the nuclear option: legislation in the major financial centers of New York and London, and perhaps even a UN Security Council Decision to protect debtors from harmed creditors.

With the impending change of the White House incumbent, radical proposals like these are suddenly more viable.

Bar chart of the implicit probability of default over the next five years according to credit default swap prices (%).  Investors are annoyed about national bankruptcies in the coming years

[email protected]

Twitter: @Robinwigg