The Brave New World of Sovereign Debt Restructuring: The ‘China Conundrum’ and Other Challenges

In the last few years, emerging economies and developing countries have been buffeted by very strong headwinds, as they have attempted to grapple with the fallout from two truly epic global developments, namely the COVID-19 pandemic and the war in Ukraine.  These twin external shocks have played havoc with their economies and have strained sovereign balance sheets in ways that might not have been imaginable even just a few years ago.

Emerging economies and developing countries are now faced with a broad array of economic and financial challenges.  They have seen their currencies depreciate sharply against hard currencies such as the US dollar, they have experienced unusually high levels of inflation (particularly with rising energy and food prices in the wake of the start of the Ukraine war), and they have seen widening budget and balance-of-payment deficits.   Moreover, their foreign exchange reserves have dwindled considerably, and in some cases, these economies have only had available foreign exchange reserves sufficient to finance a month or two of imports (including, in particular, necessary items for any economy and society such as medicines, foodstuffs, and fuel). 

Against this backdrop, many of these economies are now faced with significant difficulties in servicing their outstanding sovereign debt burdens—ie, they are experiencing what is commonly referred to as ‘sovereign debt distress.’   Indeed, institutions such as the International Monetary Fund (IMF) have indicated that at least 60% of low-income countries are either already in debt distress (15%) or at high risk of debt distress (45%).  Moreover, many emerging economies—at least fifteen, according to a Bloomberg index of such economies—have seen their sovereign debt trading at distressed debt levels (that is, 1000 basis points, or ten percentage points, over comparable US Treasuries).

This rising level of sovereign debt distress among emerging economies and developing countries has given rise to a new wave of sovereign debt defaults and sovereign debt restructuring situations.   Several countries have defaulted in the last few years, and there are other countries that appear to be on the precipice of potentially defaulting.  There have been high-profile defaults in countries such as Zambia (the first African country to default in the wake of the COVID pandemic), Sri Lanka (the first Asian country to default in over twenty years), and Ghana.  Other countries, such as Pakistan and Egypt, have not yet defaulted on their external sovereign debt obligations but have been forced to approach the IMF in order to arrange IMF financing to help them address their current economic and financial travails.  

There have been two features of the current sovereign debt restructuring landscape that are particularly noteworthy.  First, the sovereign debt restructurings that have been taking place have been fairly protracted processes.  For example, it took Zambia, which had defaulted on its external sovereign debt obligations in November 2020, over two-and-a-half years to come to an agreement with its official bilateral creditors, a group which included both Paris Club creditors and non-Paris Club creditors such as China.  Similarly, Sri Lanka, which defaulted on its external debt in May 2022, only recently reached a deal with its bilateral creditors.

Second, China has emerged as a major, if not pivotal, player in many of the ongoing sovereign debt restructuring situations.  In past rounds of sovereign debt restructurings (whether it was the developing country debt crisis of the 1980s, the Asian financial crisis of 1997-98, other debt crises in the 1990s such as those involving Mexico and Russia, or otherwise), China was generally not a significant player at all in such restructurings.  However, by contrast, in the current round of sovereign debt restructurings, China looms large since China often has one of the largest, if not the largest, exposure to the sovereign debtors in question. This reflects the fact that, in recent years, China has become the largest official bilateral creditor to developing countries as a whole, and over the last decade it has undertaken massive lending to these countries through its globe-spanning infrastructure development program, the Belt and Road Initiative (BRI).       

It should be noted that these two developments—the desultory pace of current sovereign debt restructurings, on the one hand, and the emergence of China as a critical player in many of these restructurings, on the other hand—are not unrelated.  The involvement of China in these restructurings has made the restructuring dynamics among and between creditors and sovereigns far more complex and more challenging, thereby contributing to delays in reaching agreements on terms for restructuring the debt of the relevant sovereign.

Earlier this year, various stakeholders in the international financial system, including former World Bank president David Malpass, IMF Managing Director Kristalina Georgieva, and US Treasury Secretary Janet Yellen, attributed much of the blame for the dysfunction in the ongoing sovereign debt restructurings to China.  Fundamentally, though, the problems in achieving progress in the current round of sovereign debt restructurings stem from the fact that China and the Western international financial community approach sovereign debt restructurings from markedly different perspectives and world views.

For example, the Western international financial community, especially the international financial institutions (IFIs) and Western governments, believe that many of the developing countries and emerging economies facing sovereign debt distress require debt forgiveness (or principal reductions) as part of the sovereign debt restructuring process in order to restore debt sustainability for these countries.  China, on the other hand, generally opposes such debt forgiveness and instead favors debt rescheduling (or stretching out required debt service payments), reflecting China’s traditional approach to sovereign debt restructuring.  Furthermore, the Western international financial community generally favors multilateral negotiations with the relevant sovereign debtor, whereas China has generally favored bilateral negotiations between itself and the sovereign debtor (which the Western international financial community has criticized as allowing China to engage in an opaque debt restructuring process).   

While China has faced a barrage of criticism for how it has approached the current sovereign debt restructurings, China for its part has pushed back with its own criticisms of how the Western international financial community approaches sovereign debt restructuring.  For instance, earlier this year China objected to the so-called ‘preferred creditor status’ that has long been accorded IFIs such as the World Bank and International Monetary Fund, a status which essentially exempts these IFIs from the impact of debt restructuring in contrast to how other creditors such as private sector creditors are treated.  China argued that all creditors, whether IFIs or otherwise, should participate in the burden-sharing associated with debt restructurings.  (In recent months, China appears to have stepped back from its unequivocal position on this matter provided that IFIs such as the World Bank provide concessional financing to sovereigns that are undergoing debt restructuring.) 

In a new article ‘The Brave New World of Sovereign Debt Restructuring: The “China Conundrum” and Other Challenges,’ I discuss the rising level of sovereign debt distress experienced by emerging economies and developing countries, provide an overview of some of the major ongoing sovereign debt restructurings (eg, Zambia, Ghana, Sri Lanka, etc.) and other important situations involving sovereign debt distress (eg, Pakistan, Egypt, etc.), and explore the dynamics of China’s newly prominent role in the current round of sovereign debt restructurings giving rise to what I term the ‘China conundrum.’ Furthermore, I discuss the important role that local debt (as opposed to external debt) is playing in several of the ongoing sovereign debt restructuring situations) as well as the significant role that private sector creditors, particularly bondholders, continue to play in these situations.

An updated version of the article, which can be found here, appeared in AIRA Journal (the publication of the Association of Insolvency & Restructuring Advisors) and is reprinted with permission, and the original version of the article appeared in International Insolvency & Restructuring Report 2023/24 published by Capital Markets Intelligence. 

A version of this post previously appeared in Columbia Law School’s CLS Blue Sky Blog on August 8, 2023 and in the Harvard Law School Bankruptcy Roundtable on October 31, 2023. 

Steven T. Kargman is a leading expert on international restructurings, and the Founder and President of KARGMAN ASSOCIATES, New York City.