More effective support is required for African countries at high risk of debt distress. But this needs to be addressed jointly by the West and China and viewed in the context of Africa’s medium- to long-term investment requirements, particularly those relating to adaptation to climate change.
Cooperation between China and the West on African debt distress
As mentioned earlier, China’s lending to Africa did not cause current African debt distress in most cases. Equally, it is in neither China’s interest, nor that of the West, to revert to the pre-2019 situation in which China followed a largely separate track in responding to African debt problems.
Viewing the policy choices from China’s perspective, multilateral approaches are likely to continue providing the best route – even if not an exclusive one – for maximizing the recovery from outstanding loans to African countries in debt distress, while maintaining China’s reputation as a friend of the developing world. In addition, as the Chinese authorities try to ensure that future lending to Africa by Chinese institutions is sustainable and aligned with certain key priorities shared with the West (e.g. on climate change), international cooperation to enhance the African investment environment should look attractive.
From the West’s perspective, China is critical to finding a lasting solution to African debt distress. Neither the current debt crisis, nor Africa’s future financing needs, can be tackled without China’s participation. The past two G7 summits have seen high-profile initiatives to step up the West’s contribution to development finance worldwide through the mobilization of private finance. These have mainly been framed as competitive responses to China’s Belt and Road Initiative (BRI). However, it is clear they will at best have a limited impact unless underlying debt distress in the intended recipient countries is addressed first. The private sector will simply not invest or will require Western governments to take on a very large share of the risk (directly or via multilateral institutions) in order to be persuaded to do so. This is unlikely to be good value for money.
This paper shows the considerable extent to which African nations themselves have influenced the nature and impact of Chinese lending over the past two decades – for both good and bad. For the best outcome for African nations, it is critical that they play a leading role in shaping cooperation between China and the West on African debt distress. To achieve this, African nations will need, as much as possible, to consolidate and align their requirements and speak with one voice, including through institutions such as the African Union. They will need to balance often well-founded requests for support with a degree of realism about what China and other official creditors are willing to finance in the present circumstances. Critically, they may also need to change or adapt some of their own views on the best way to respond to debt distress.
The other important actor is private sector lenders (mostly based in Western financial centres), which have played a substantial role in the build-up of debt in some key African countries. They have frequently called for earlier and deeper involvement in the process of resolving unsustainable debt situations. At the same time, the environmental, social and governance (ESG) investor movement may lead some private institutional investors to be more accommodating than hitherto in handling cases of debt distress (although this remains to be seen). It may be in the interest of official debtors and creditors to meet some private sector requests in order to secure fast but fair debt treatments. However, the differences in objectives between the two groups will be a constraint on this.
As regards the wider context, the pandemic – and President Biden’s election in the US – appeared to open a window for enhanced cooperation between China and the West on addressing global threats generally. Subsequent developments, including China’s political (if not practical) support for Russia following the latter’s invasion of Ukraine and the heightened tensions over Taiwan following Nancy Pelosi’s August 2022 visit, signal that relations are going in the opposite direction. China responded to the Pelosi visit by suspending bilateral dialogues with the US on a range of issues, including climate change. However, the evidence to date – including the progress made over the summer of 2022 in the Zambia official creditor committee – suggests that cooperation on sovereign debt issues may, to some degree, be insulated from wider tensions between China and the West (particularly the US). This is not necessarily surprising. Macroeconomic management and the maintenance of global financial stability have long been issues on which the West and China have been aligned (dating back to China’s response to the Long-Term Capital Management crisis in 1999 and the international response to the global financial crisis in 2009–10).
Of course, competition between China and the West, and indeed within the West, over trade and investment links with Africa will inevitably continue. Eliminating this, even if possible, would not be in the interest of African borrowers. Similarly, some of the problems with the current approach to multilateral debt relief are underpinned by issues that are so deep seated – for example, those that link to China’s IMF quota, or the future role of the MDBs – that they cannot be addressed through an initiative centred on sovereign debt alone. However, these factors should be seen as constraints on what may be achieved in deepening cooperation between China and the West on African sovereign debt distress rather than reasons to rule it out.
How to structure cooperation
In the light of this analysis, the G7 should internally agree a plan to make an offer to China, leading African nations, the IFIs and pan-African institutions to work collectively on addressing Africa’s closely related needs for both faster action on debt distress and external support for medium- to long-term investment.
This plan should have three core components:
- A broad-based dialogue led by, but not limited to, the G7, China and leading African nations, focused on identifying, agreeing and implementing actions necessary to secure Africa’s medium- to long-term external financing needs.
- A high-level political understanding between the West and China on the mutual benefit of strengthened cooperation to address African debt distress and the continent’s investment needs.
- A detailed action agenda, led by the G7 and G20 Finance Tracks, to address obstacles to faster implementation of the Common Framework (in relation to low-income countries), and to address the potential needs of emerging African economies at risk of debt distress.
Broad-based dialogue on meeting Africa’s medium- to long-term external financing needs
The dialogue should start with an independently led assessment of Africa’s future external financing needs over a 20-year period, drawing on the IFIs’ existing analysis, and that of pan-African institutions, as well as inputs from think-tank and academic experts in Africa, China and the West.
The assessment should seek to establish a shared understanding of Africa’s overall external financing needs, both at the national level, and for the region as a whole. This should include a central scenario, but also map out the uncertainties arising from a range of factors, such as financial market developments, physical and policy events linked to climate change, and the evolving contributions from diverse bilateral and multilateral investment initiatives (including the IMF’s Resilience and Sustainability Trust, the EU’s Global Gateway, the G7’s Partnership for Global Investment and Infrastructure and the continuation of China’s BRI). Having developed this baseline assessment, the next step should be to use the dialogue to explore the impact of, and support for, different policy choices.
Much of the work necessary to underpin such an assessment and policy analysis has been done. However, the proposed dialogue should add value in three ways: (a) by doing the analysis as a joint exercise between China, the West and leading African nations; (b) by drawing together disparate but closely linked elements – e.g. including work on debt distress, climate investment needs, the pandemic legacy and long-term implications of the war in Ukraine; and, (c) by applying it to the specific circumstances of the African region.
Delivering a ‘macro’ view should be a priority, but this should also be accompanied by enough detail to capture the key differences between countries. A realistic approach to the likely (inadequate) scale of private sector flows under ‘business as usual’ will also be critical.
Dialogue should be structured to achieve as much consensus as possible between China, the West and leading African nations.
The dialogue should then be structured to achieve as much consensus as possible between China, the West and leading African nations on the following four live policy issues.
First, proposals to scale up debt-for-climate swaps so as to address simultaneously excessive debt and the need for a sharp increase in climate-related investment, as well as providing incentives for other kinds of climate action. Climate swaps are an attractive concept in theory, but face a number of practical difficulties. These include the need for reliable data, the fact that the complexity of climate swaps makes them unsuitable for implementation in the middle of a debt crisis, and the ‘catch-22’ situation whereby countries that would most benefit from a ‘macro-level’ debt-for-climate swap are also typically not facing levels of financial stress that would persuade creditors to make significant concessions and offer such a transaction.
Second, proposals to ‘leverage’ public finance to generate much larger amounts of private finance. This has received considerable attention given the large gap between the likely availability of external public finance and Africa’s investment needs. However, there are a number of ways to achieve this; ranging from the public sector fully funding strategic investments that create the right business environment for private investment in related areas, to allowing the MDBs to borrow more against their publicly provided capital, to complex ‘blended finance’ instruments in which the public sector takes on higher risk tranches – and the private sector lower risk ones – in a given investment project.
Hybrid financial instruments that mix public and private finance may be of particular interest to Chinese commercial and development finance institutions, given that the existing boundaries between public and private risk are less clear-cut in the Chinese financial system. There is also a potentially important and beneficial interaction between the desire of many Western financial institutions to align their investments with environmental, social and governance considerations and their approach to leveraged finance instruments. On the other hand, mixing public and private risk-sharing raises a number of difficult questions that need to be addressed regarding how to judge (and then ensure) value for money for the public sector over the long term.
Third, measures to protect climate-related financial flows from corruption risk. The need to provide a very large amount of external climate finance for infrastructure in a very short space of time, quite often in countries where governance is relatively weak, risks a significant part of the cross-border flow being lost. The dialogue should look at how this threat can best be managed to protect and enhance cross-border financial flows.
Fourth, other steps to increase African financial resilience over the long term through greater use of local currency lending by MDBs and the private sector, and through the use of state contingent debt, including GDP-linked bonds.
High-level political understanding between China and the West
To underpin the dialogue, prominent members of the G7 and China should agree with each other and with leading African nations, effectively to ‘carve out’ action on African debt distress and support for Africa’s broader investment needs from strategic competition between China and the West.
The rationale for doing so is the strong mutual benefit to all parties of cooperation in this area. Such an agreement would be a first in the current phase of international relations between the West and China, and would not be straightforward to achieve. However, such an agreement is urgently needed in order to address the worsening situation faced by African nations in debt distress. Success in this area could potentially be followed by a similar approach in other areas, such as organizing and funding pandemic preparedness and response, and most critically, essential international cooperation on tackling climate change.
Provided agreement could be reached on making such an offer within the G7, officials of the G7 presidency would begin by putting out informal feelers to their Chinese counterparts. If the response was positive, or at least open, this could be followed by a carefully framed high-level public speech from the G7 presidency setting out the rationale for developing cooperation in this specific area, but also the wider context in which it would need to take place and the necessary limits. This would need to be accompanied by supportive statements from other G7 members and, if the response from China continued to be positive, could be followed by informal discussions and then negotiations between the G7 presidency and China. If agreement is reached, this could then be crystalized through a formal joint statement (e.g. in the margins of a G20 finance ministers’ meeting or leaders’ summit).
Action to enhance the Common Framework
The IMF and World Bank have called for four practical steps to improve the functioning of the Common Framework: a clearer timetable for the process in relation to an individual country; a comprehensive debt service payment standstill for the duration of negotiations; greater clarity on how comparability of treatment will be enforced; and expansion of the Common Framework’s scope to include other highly indebted countries facing debt distress. In addition, there have been many other thoughtful technical proposals from external experts to improve the effectiveness and functioning of the Common Framework since it was established.
The first two recommendations from the IMF and the World Bank are a good starting point for reform. Beyond these, five concrete steps should be prioritized in order to improve the functioning of the Common Framework and to make it more attractive to debtors.
First, an increase in incentives for public debt transparency. The ideal outcome is full publication of comprehensive debt figures, in line with the UK’s G7 initiative. However, this is politically very hard. The minimum requirement is for credible figures to be shared among official creditors and between them and the private sector. This is how the Paris Club has operated in the past and appears to be the approach now being followed to progress the current Common Framework cases. However, non-public debt figures are harder to validate and do nothing to address the kind of political and reputational blowback China suffered in Zambia. This paper recommends a renewed effort by Western nations and IFIs to persuade African debtor nations and China of the specific benefits they would each gain through public debt transparency. The IFIs should also explore strengthening the incentives for ex post public debt transparency in their lending conditionality, while rating agencies should consider how transparency can be rewarded in their evaluation methodology. As a longer-term measure, private sector lenders should look at including ex ante transparency requirements in loan covenants.
Second, the engagement of a wider group of stakeholders in the process for undertaking debt sustainability analyses (DSAs). The IMF and World Bank must remain independent and in charge of the DSA process, but they should seek to engage all stakeholders, particularly the Chinese authorities and lenders, more fully in the process that compiles individual DSAs.
This paper recommends a renewed effort by Western nations and IFIs to persuade African debtor nations and China of the specific benefits they would each gain through public debt transparency.
Third, the de-mystification of the impact of debt restructuring on credit ratings. The IFIs should work with rating agencies to take African borrower countries through the impact of debt rescheduling and renegotiation on credit ratings, and in particular demonstrate how a country that undergoes a technical default may restore its rating and market access relatively quickly.
Fourth, and as recommended by the IMF and World Bank, the implementation of an agreed system for assessing the equivalence of different types of contribution to debt burden adjustment. Suitable systems for measuring equivalence already exist, but have not been systematically implemented, reflecting opposition from some emerging economy creditors, although the reason for this is unclear. Having an agreed system would allow different lenders to choose the options that suit them best in a restructuring – for instance the choice of a ‘haircut’ vs a maturity extension at a lower interest rate, which could be designed to deliver a comparable net present value reduction – thereby increasing the chances of agreement on an overall debt treatment.
Fifth, the engagement of private sector creditors at an earlier stage in the process for determining debt treatments. Under both the Paris Club and Common Framework, debtors are expected to seek no less favourable terms from private creditors to those granted by official creditors. However, private creditors complain that they are expected to go along with whatever is agreed by official creditors without adequate consultation or participation. In cases where private creditors have significant weight, they should be engaged more deeply and earlier alongside discussions among official creditors. However, in return they would be expected to support the Common Framework process, for example, by accepting the equal treatment principle, helping to validate debt statistics and agreeing to implement the chosen system for measuring equivalence in debt relief contributions.
The IMF and World Bank have called for the extension of the Common Framework’s remit, from the 73 low-income countries covered by the DSSI to include middle-income emerging economies at high risk of debt distress. This has a strong logic given both the rising threat of debt distress in middle-income countries, against the backdrop of the energy and food price crisis, and the fact that the dividing line between countries that are classed as low-income and middle-income is fairly arbitrary. However, persuading the Chinese senior leadership to make such a change could prove time consuming, and there may also be a risk of unsettling the increasing consensus within China on the application of the Common Framework. The G7 should therefore seek to develop a similar but distinct framework for addressing debt distress in middle-income countries. The negotiations over the restructuring of Sri Lanka’s debt (where the official creditor committee is co-chaired by Japan, China and India) will, if successful, provide an important precedent, and possible model, for the handling of other middle-income countries in debt distress, including those in Africa.
To implement the three elements in the approach described above (i.e. a broad-based dialogue, high-level understanding and a Common Framework action agenda), the G7 will need to operate in three parallel and overlapping spaces: reaching consensus within the G7; reaching agreement with leading African nations and pan-African institutions; and reaching agreement with China and other emerging economies.
This will be a complex process. Critical to its success will be agreement within the G7, led by the incoming Japanese G7 presidency, on a common engagement plan with China in early 2023. This will need to be accompanied by targeted outreach to leading African nations and engagement with the new Indian presidency of the G20.
Russia’s invasion of Ukraine has put enormous strain on the G20. Many developed countries – led by the US – called for Russia to be suspended from the summit, but notable emerging economies, including China and India, were not prepared to take this step. This built on earlier tensions within the group reflected in the Chinese and Indian decision to block some of the key deliverables in Italy’s autumn 2021 G20 Summit designed to address the risk of future pandemics. Since a low point at the IMF and World Bank spring meetings in 2022 – when the US and a number of developed countries walked out of a G20 finance ministers’ meeting – it now appears likely that the G20 will continue to function as a forum in which the West and China can cooperate – if they wish – on issues of mutual benefit. The Indonesian presidency of the G20 was able to agree a leaders’ statement at the G20 Summit on 16 November, even though it was impossible to agree concluding statements for some earlier G20 ministerial meetings. But it is still unclear how far China will continue to want to use the G20 in tackling global challenges, as opposed to trying to use alternative forums, such as the UN system, which they may regard as more favourable to their objectives.
In any case, given that the current and next two presidencies of the G20 are not from the G7 or Africa, it will be necessary for the G7 to frame its proposals for G20 agreement on debt distress and investment in a broader context than just that of Africa, and to align these with the priorities of the incoming presidencies. There is also a good argument for allowing the G20 Finance Track to focus on the relatively narrow issue of enhancing the Common Framework, while the related but broader issues on meeting low-income and emerging economy investment needs are handled through the leaders’ track.
The G7 should also consider using other groups it is developing, such as the German G7 presidency’s proposal for an inclusive ‘Climate Club’ as a forum through which to re-enforce and possibly implement aspects of the overall approach.