Brad Setser is a senior fellow at the Council on Foreign Relations and a former Treasury Department official. Theo Maret is a research analyst at Global Sovereign Advisory and writes a sovereign debt newsletter.
In June Zambia finally reached a restructuring deal with its overseas government creditors, more than two-and-a-half years after the country defaulted on its debt. And for a bunch of reasons, there’s a lot to learn from it.
The accord represents the first agreement under the G20’s “Common Framework” involving meaningful debt relief and where China is a major creditor. Since the messy sovereign debt architecture has historically improved ad hoc through country cases, it is only reasonable to ask what the Zambia deal means for the (sovereign debt) world.
An important caveat is that the comprehensive terms have not been made public — most were reported by various media outlets. The deal needs to be inked down in a “Memorandum of Understanding” as per the Common Framework procedure. Stay tuned, Zambian president Hakainde Hichilema is in China right now.
— Hakainde Hichilema (@HHichilema) September 10, 2023
Truth is, it’s hard to know what should be in this document due to the novelty of the process. And even then, Zambia will need to negotiate bilaterally with all creditors on the final new terms for each outstanding loan. But here are 10 lessons we can still glean from the deal.
China can offer real debt relief
The Export-Import Bank of China (China Exim) agreed to reduce the coupon on its $4bn or so in recognised official claims to 1 per cent for the remainder of Zambia’s IMF program, and if Zambia’s underlying riskiness (as assessed by the IMF) remains high, to accept a 2.5 per cent coupon for the remainder of the loan’s life.
That is a real concession. The calculated NPV reduction is around 40 per cent (using a 5 per cent discount rate). This isn’t a “push amortizations out by a couple of years and keep a LIBOR + 300 bp rate” kind of restructuring.
Getting significant debt relief from China will not be easier for the next countries in line
It took close to two years and several trips by the IMF’s top leaders to China to convince the Chinese to accept these terms. Even that wasn’t enough until French President Macron provided China with a public forum where it could get public credit for extending the time Zambia gets to pay China back — China Exim will ultimately get its money back after all, albeit with a lower-than-expected coupon.
In addition, China and other official creditors made it clear that neither the treatment of multilateral development banks nor non-resident holdings of domestic debt in Zambia would create a precedent for other countries.
China defines its “official” sector differently than everyone else
China has two big policy banks, and five big state-owned commercial banks. The policy banks are owned in part by the Ministry of Finance, in part by vehicles set up by the central bank (SAFE), and in part by China Investment Corporation, the Chinese sovereign wealth fund. The commercial banks are owned by a vehicle run by CIC. Many of the projects funded by China’s state banks are insured by another central state body, Sinosure, an export-credit agency which is also owned by CIC.
All these institutions ultimately report to the state council and have leaders selected by the party, so China’s “official” sector could be defined to include almost all Chinese external lending.
However, China has drawn strong distinctions between different parts of its state sector, and getting the Zambia deal done required accommodating this vision.
The Paris Club traditionally includes claims backed by ECAs in the official debt stock, and they are restructured alongside other government claims. Zambia hence had originally indicated that Sinosure-backed claims would be included in the Common Framework negotiation. However, after a lot of twists and turns, only China Exim’s exposure was restructured alongside other official bilateral claims. Almost $2bn of claims held by the state commercial banks and backed by Sinosure are now part of the “commercial” restructuring.
This will result in some obvious complexities — for example, a big hydroelectric project (Kafue Gorge) was financed by a consortium of China Exim and the ICBC, covered by Sinosure, and presumably will all be restructured using the term sheet agreed with Exim.
Chinese state creditor get inspiration from the private creditors
The debt relief that China offered Zambia is contingent on whether the IMF upgrades Zambia’s “debt-carrying capacity” at the end of the program period. With an upgrade, the coupon jumps to 4 per cent and the pace of amortizations steps up significantly, with the final maturity reduced by five years.
The Paris Club thus ended up accepting a deal that seeks to extract additional debt service from Zambia if the country’s recovery exceeds expectations — a behaviour more commonly seen with private creditors, who were the first to raise the idea that the IMF should adjust Zambia’s risk category within the low-income debt sustainability framework.
The Zambia compromise is almost certainly not generalisable
The path for Zambia’s debt service from 2026 to 2043 — more than 15 years — all hinges on the value of an obscure IMF-World Bank indicator in one specific year.
The reliance on that debt-carrying capacity assessment is strange. Frankly, private creditors aren’t generally keen to have their returns hinge on a binary judgment from the IMF about a country’s debt-carrying capacity in other cases.
Among other things, there is no guarantee that this indicator will continue to be used in its current form, as the IMF and World Bank are reviewing their entire low-income country debt sustainability framework.
High coupon bonds were rewarded
The official creditors deal appears to recognise all accrued interest. The net-present-value haircut was calculated based on the claim, with said accrued interest — not on the original par value. That wasn’t a given: another option was to “fix” the NPV relief relative to par so that the claim does not increase faster after the default for high coupon debt.
This technical point — if applied to commercial creditors as well — works to the advantage of Zambia’s eurobonds, which carried an 8 per cent average coupon and now represent a claim of close to $4bn. This is a major reason why Zambia’s yet to be restructured bonds trade at over 50 cents relative to par even though the official restructuring sets out a target of a 40 per cent NPV reduction at a 5 per cent discount.
This problem is obviously not specific to Zambia. Suriname recently announced it had reached a deal with bondholders involving a 25 per cent principal haircut, on both face value and past due interest. However, the country accumulated a huge sum of accrued interest since the default so the actual haircut on original face was close to 4 per cent.
There is a path for the restructuring of private bonds
The bond holders think so — the bonds traded up on the agreement. The bond holders clearly see value in a package that, say, reduces the face value of the bonds claim by 40 per cent (so from roughly $4bn to $2.4bn) with a 5 per cent coupon and a maturity of between five and seven years — the new bonds would likely mature ahead of most payments on the Chinese loan.
That base bond would probably be combined with some form of kicker (a value-recovery instrument that gives bond holders additional upside).
Copper bonds continue to be shunned by the market
For Zambia, a copper-linked bond makes much more fundamental sense than a bond linked to an obscure IMF judgment about risk levels.
Zambia’s future payment capacity depends heavily on the volume of its future copper exports and the global copper price. Linking payments to the price of copper would thus link payments to a true source of exogenous risk. A copper-linked bond does not need to be a warrant; it could easily be designed as an index-eligible bond. Think of a bond whose coupon steps ups or steps down based on movements in the price of copper over the previous two years.
What a missed opportunity.
The Common Framework remains a bit of a dud
The main innovation of the Common Framework was that China would negotiate together with the Paris Club through a single official creditors committee.
But it doesn’t seem like China’s participation in a single committee facilitated much actual co-operation: it took a year and a half for the Official Creditor Committee to provide financing assurances after Zambia’s request for debt treatment.
Some say this was a predictable result of China’s learning process, but that argument is a little hard to square with China’s insistence that Zambia is not creating any precedents.
The structural problems of the sovereign debt restructuring process have not been solved
We’re going to cheat here and treat two big problems as one lesson.
The first is that the IMF currently isn’t a reliable source of foreign currency to help stabilise countries immediately after a default. This is because the IMF’s lending rules — financing assurances, arrears policies etc — currently allow a large official creditor like China to block IMF disbursements by refusing to provide the IMF with financing assurances.
This effectively keeps the IMF on the sidelines just when it is often most needed, and limits the IMF’s ability to serve as the world’s last-ditch supplier of foreign currency liquidity. Zambia effectively got bridge financing from the SDR allocation and by selling local market bills to foreign investors. There clearly needs to be some kind of mechanism for the Fund to be able to do what should be its core job even when a high-leverage creditor isn’t willing to play ball.
For example, when the IMF is unable to receive textbook financing assurances, it could provide an instant financing lifeline to countries by falling back on a commitment from the debtor not to restart payments to any recalcitrant creditor that has not granted the country sufficient debt relief.
The second big problem is that neither of the IMF’s two debt sustainability frameworks have proved to be useful guides to setting sensible restructuring terms and facilitating already-complicated negotiations.
The IMF’s targets for Sri Lanka don’t really require any substantial debt relief, as we discussed in an earlier piece. The IMF’s initial terms for Zambia had the opposite problem — the low-income country targets for external debt service do set out real limits, but they were designed for an era when foreign investors (non-residents) didn’t really buy Africa’s local currency debt.
That isn’t today’s world — in both Zambia and Ghana, foreign holders of local currency bonds were substantial. In Zambia’s case, the non-resident holdings interacted with debt targets designed for foreign currency payments in a way that meant a major share of Zambia’s external debt servicing capacity was going to pay the local debt held by non-residents. (Coincidently, the authorities had decided to exclude local-currency debt altogether from the restructuring perimeter, out of concerns for financial stability).
Combined with very strict debt targets due to Zambia’s low debt-carrying capacity and risk buffers applied by the IMF, as well as other excluded debts (multilateral, etc), the IMF’s framework left very little cash flows available for servicing debt to bilateral and commercial creditors. But it also didn’t reflect the economic risk of foreign holdings of local bonds, which comes from not from the maturity structure but from investors’ ability to sell the holdings for foreign exchange at any point in time.
A rather surprising solution was apparently found: the authorities have enacted a 5 per cent cap on foreign participation in new local debt auctions, and the IMF just assumes that foreign investors won’t buy new Zambian local currency bonds. But such a jerry-rigged solution isn’t a real answer to the basic question of whether the low-income country debt service targets should focus on foreign currency payments or also cover local currency payments in precisely the same way as foreign currency payments.
Bottom line, Zambia had to wait too long, but finally got a pretty good deal — at least if the IMF doesn’t upgrade Zambia’s debt-carrying capacity.
What is certain already though is that the terms of that deal are so specific to Zambia that they aren’t obviously generalisable. A deal was done; nothing significant was settled. Unfortunately.