Does pandemic debt relief work?

Rather than pursue more debt relief to help the developing world weather the COVID-19 crisis, rich countries should provide pandemic-related necessities directly. Debt relief is so imprecise a mechanism that it is as likely to benefit private-sector creditors as it is to help the poor.

WASHINGTON, DC – The COVID-19 pandemic has spread globally and will not be over until it has been brought under control everywhere. Hence, international efforts are underway to support the world’s poorest countries. COVAX, a multilateral initiative organized by the World Health Organization and Gavi, the Vaccine Alliance, is arranging purchases of vaccines to be distributed equitably to developing countries.

This worthwhile program has already raised about $2 billion, but it will need more funding to complete its mission. As of December 2020, most of the world’s rich countries had ordered enough doses to vaccinate their own populations three times over, whereas 90% of people in the world’s poorest countries are unlikely to receive a vaccine until 2022. While any additional support for poor countries would certainly help, there simply aren’t enough resources to meet all needs. All available resources thus will need to be directed as efficiently and effectively as possible to combat the pandemic.

Though many commentators have called for debt relief to free up resources in poor countries, suspending payment obligations is almost certainly not the most effective option available. Last May, the G20 launched a Debt Service Suspension Initiative (DSSI) in coordination with the International Monetary Fund and the World Bank. By December 2020, about 40 eligible countries had been granted postponements on about $5 billion of debt service that would have come due before June 2021.

The problem with this approach is that poor countries’ needs are not highly correlated with their debt levels. Neither debt nor debt-service costs—in absolute terms or as a percentage of GDP – is a good indicator of a country’s relative needs. Because debt suspension rewards countries regardless of whether they have a strong or poor macroeconomic record, there is no guarantee that it will result in more resources being allocated where they are needed most to fight COVID-19.

True, under the DSSI, postponements are supposed to be granted only to applicants who have enacted reforms under an IMF program or otherwise adopted economic policies judged to be appropriate for sustained growth. In practice, however, the urgency of the situation has overridden these conditions.

Consider Zambia, which received debt relief eight times between 1983 and 2002, and had its debt forgiven under the Highly Indebted Poor Countries initiative in 2005. Between 2011 and 2018, Zambia’s debt rose from 21 percent of GDP to 120 percent, and it then had $165.4 million (0.7% of GDP) of its debt-servicing obligations suspended under the DSSI. Nonetheless, in November 2020, Zambia defaulted.

The Zambian experience points to another problem with using debt relief to help poor countries. In cases where debt is high, suspensions granted by one set of creditors simply allow for other, less forbearing creditors to extract more debt-service payments before the borrower defaults.

These “other creditors” can include both sovereign and private-sector lenders who have not agreed to participate in the debt-relief initiative. Zambia continued to service its debts right up until its default in November 2020. Now, when the country’s creditors do agree on debt restructuring, the amount available to compensate them will be smaller than it would have been had the debt servicing been suspended sooner.

In the case of the DSSI, the 33 most indebted countries that are eligible for relief owe around one-quarter of their public debt to China – the world’s largest official creditor. While China has signed on to the initiative and provided some debt relief, it has done so on different terms than other DSSI participants. Worse, most private-sector creditors haven’t signed on at all.

Yet another reason to question the debt-relief strategy is that there is no assurance that the funds will be used for COVID-related expenditures. Consider South Africa, which is not eligible for DSSI support. Like Zambia, it has increased its debt sharply, from 22 percent in 2008-09 to 82 percent in the current fiscal year. Now in a fiscal crisis, its deficit this year is expected to reach 15 percent of GDP. While the South African government blames COVID-19 for its current fiscal problems, the real issue is that for the past decade, its expenditures have grown without commensurate increases in revenue.

Given that South Africa would have experienced debt-servicing difficulties even without COVID-19, offering it debt relief probably would not free up many resources for fighting the pandemic. It is safe to assume that some countries that have already received relief are in the same boat.

Owing to these weaknesses, it would be far better for rich countries to allocate available resources directly to pandemic-related expenditures, either by purchasing vaccines, personal protective equipment, and other necessities and sending them where they are needed (the COVAX model), or by directly financing domestic purchases. This way, countries with high, unsustainable debt levels could still receive support, but it would go toward the most urgent expenditures, while payment obligations to other creditors and unwarranted fiscal expenditures might need to be postponed. The IMF could then support countries with unsustainable debt burdens in the usual way.

Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the Johns Hopkins University School of Advanced International Studies and Senior Fellow at the Center for International Development at Stanford University.