The Global South is staring at a debt crisis, but the “Common Framework” created to provide debt relief has serious shortcomings
The sovereign debt of emerging markets and developing economies (EDME) increased by 178 per cent, from $1.4 trillion to $3.9 trillion, between 2008-2021, according to a new report.
The Global South is staring at a debt crisis, but the “Common Framework” created to provide debt relief has serious shortcomings, the report from Debt Relief for a Green and Inclusive Recovery (DRGR) Project stated.
The framework was not very effective at bringing all creditors, including private and commercial creditors, on board and linking debt relief with development and climate goals, the findings stated.
DRGR Project is a collaboration between the Boston University Global Development Policy Center, Heinrich-Böll-Stiftung and the Centre for Sustainable Finance at SOAS University of London.
The “Common Framework” was established by the G20 countries in November 2020 to provide relief to debtors facing insolvency or liquidity problems.
EDMEs are seeing weakened economic growth due to a slow recovery from the COVID-19 pandemic as well as high food and energy prices fuelled by Russia’s war in Ukraine.
Escalating climate impacts have added to the financial burden of these countries. A strong US dollar and depreciating currencies for many EMDEs have exacerbated the problem, the report noted.
“These shocks have weakened economic growth and ballooned debt burdens,” the authors wrote in the report.
EDME, barring China, needs $1 trillion annually to accomplish the Paris Climate Agreement targets of keeping global temperature rise below 2 degrees Celsius, preferably 1.5°C and achieve the United Nations-mandated Sustainable Development Goals (SDG) for 2030, according to the High-Level Expert Group on Climate Finance.
The authors of the new report called for a reform of the Common Framework by proposing three pillars. The first involves public creditors granting significant cuts in debts to bring a distressed country back to debt sustainability and also helping it achieve development and climate goals.
The second pillar involves private and commercial creditors granting debt reductions comparable to public creditors. For the remaining debt, the government will issue new bonds for private creditors, backed by a guaranteed fund (an investor’s principal is shielded from any losses).
The last pillar is for countries such as India not at risk of debt distress. As the cost of the capital is high, international financial institutions can provide credit enhancement to these nations.
Credit enhancement is a risk-reduction technique that provides protection in the form of financial support to cover losses under stressed scenarios, according to Stanford University.
Further, the report’s authors called for restructuring $812 billion of debt owed by 61 countries that are in or at high risk of debt distress.
Through debt restructuring, creditors can provide concessions to a debtor. At least $30 billion in debt should be suspended over the next five years for 55 of the most debt-distressed countries, the authors calculated.
This could provide the most debt-distressed countries with some “breathing room”, the report noted.
Countries vulnerable to climate change tend to face the most significant debt distress.
Higher climate vulnerability is linked to lower sovereign borrowing space and high debt service payments (loan interest payments and principal repayments), the report noted.
This forces countries to set aside a significant portion of their foreign reserves to pay off debt. Providing immediate debt relief to EMDEs could free up their fiscal and borrowing, allowing them to pursue a low-carbon, socially inclusive and resilient future, the findings stated.
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