Over the past three months, the sovereign debt restructuring world has called Zoom and forged its way into a new “common framework” for debt restructuring beyond the temporary global relief offered during the Covid-19 pandemic. While, unfortunately, travel and reunion restrictions did not allow for the usual seasonal feasts among sovereign debt tribes, they exchanged the traditional self-congratulations, if only electronically.
the common frame is intended to lead to a new era of transparency and harmony in the setting of terms between multilateral institutions such as the IMF and the World Bank, official lenders such as export guarantee agencies and private lenders, including banks and bondholders. The intention is to put an end to the queue and secret transactions that still disrupt negotiations between sovereign problem borrowers and their international creditors.
That would be great, so that we can all move forward in an orderly fashion to restructure struggling sovereign credits like Zambia, Lebanon and Sri Lanka, not to mention all the airlines, hotels, etc. The IMF can avoid costly and dangerous traps like its Greek and Argentinian programs.
There are still complications. Like China.
For 30 years, sovereign debt restructurings have mostly followed rules that can almost always lead to agreements between a country and its creditors.
You had two centers of gravity: official creditors, led by the IMF, and private creditors, led first by commercial bankers, then by groups of bondholders. Sovereigns in distress gravitated around these double stars of the dollar system.
In physics, you would call this a “restricted three-body problem”, for which you solve the relative motions. Since one of the three bodies – the Sovereign in Distress – has, for computational purposes, a “negligible mass”, it is possible to find a reproducible solution using classical mechanics.
Three-body problems are more difficult. The movements of the three bodies relative to each other are generally non-repetitive, which means that it is difficult, if not impossible, to find a “common framework” for predictable solutions.
“China,” by which I mean the Chinese state, Chinese financial institutions, and Chinese companies, is the world’s third largest sovereign debt body. Official China is, of course, one of the main members of the IMF-World Bank group and, at least theoretically, is committed to international financial cooperation.
Except when it isn’t. China, unlike other emerging countries, is close to being an alternative world to the dollar system. You can sell metals or oil for renminbi credits, which allows you to buy a wide range, if not a full range, of goods shipped in Chinese ships or planes. Dollar system outlaws such as Venezuela and Iran can still make trade and financial deals with Chinese counterparts, albeit on demanding terms.
And it’s not just the US sanctioned countries that have moved to the Chinese gravitational field. The scent of restructuring of the week, Zambia, is frustrating for bankers and “common framework” authorities as there is little transparency of its policies. loans from China or its contractual commitments to Chinese companies.
Chinese entities are also restructuring the debt of distressed international debtors, sometimes using variations of “debt-for-equity” swaps. These were greeted as admirable innovations when used as part of the US-sponsored Brady Agreements in the 1980s and 1990s.
But since China acquired a Sri Lankan port in late 2017 as part of a debt / equity swap, it has faced a growing political backlash to its financial and trade strategy. Yet despite all the talk and editorials about Chinese expansion, it continued to gain financial market share as long as the global economy was expanding.
Financial crises and sovereign restructuring always lag behind the contractions of the real economy. China has an interest in cooperating with the dollar-based world, so we can expect a lifting of the secrecy of its trade agreements and a partial relaxation of the preferred creditor status that it has imposed on weaker states.
And China has to some extent internally consolidated its international financial negotiating authority within its finance ministry and development bank. This makes it easier for its counterparts to reach global agreements.
China shares a fundamental interest with legacy financiers. Both sides are threatened by populists demanding a return to capital and trade controls. Remember how it worked in the 1930s?
Three-body systems are inherently chaotic.