In 2020, sovereign debt defaults hit a record high after Zambia became
the sixth country to fail to repay its outstanding loans, to the tune of $43 million dollars in November.
This came after Argentina, Belize, Ecuador, Lebanon, and Suriname also defaulted on their debts that same year.
In fact, global debt has been on the rise since 2016.
The coronavirus pandemic has accelerated borrowing, with governments worldwide spending billions of dollars
to mitigate the economic impact of the crisis, often borrowing huge sums in the process to save jobs and livelihoods.
The shortfall is usually funded by issuing government debt in the form of bonds.
So, what happens when governments fail to pay back the investors who bought these bonds?
In 2003, Iraq owed roughly $130 billion to its foreign lenders, making it the most indebted country in the world then.
It didn’t help that the United States invaded the country in the same year.
Iraq would later turn to the Paris Club for help, and in a twist of fate
the U.S. pushed to write off around 90% of the war-torn nation’s debts.
However, its other creditors, including Germany and France, were only prepared
to forgive less than 50% of the outstanding amount.
Ultimately, the Paris club wrote off 80%of Iraq’s debt, providing fresh ground for the country to rebuild.
But debts weren’t always settled in such civilized ways.
Towards the end of 1902, Great Britain, Germany and Italy imposed a naval blockade
against Venezuela for failing to honor its debt repayments to them.
While the small Venezuelan fleet was quickly disabled, a compromise
was reached after the U.S. intervened with its much larger fleet of warships.
Worried about the “gunboat diplomacy” by the European nations in its backyard,
the U.S. later crafted a policy aimed at justifying interventions it claimed would
stabilize the economic affairs of small states in the Caribbean and Central America.
Thankfully, such strongarm tactics are a thing of the past in the 21st century.
However, global debt levels are on the rise.
In 2020, the global ‘debt tsunami’ is to reach a staggering $277 trillion, or 365% of global GDP.
Among emerging markets, debt levels rose to nearly 250%of GDP, as governments
in these developing countries diverted revenues to make repayments.
Emerging economies often have the potential for rapid economic growth,
but they are also more vulnerable to economic shocks.
To calm investors’ fears, these governments tend to pay their loans
using the more stable U.S. dollar rather than their volatile currencies.
The risks mean investors often demand a higher price for lending money,
which can increase the likelihood of these payments becoming unmanageable.
Many turn to the International Monetary Fund for relief, such as temporary loans to restore economic stability.
For emerging economies facing trouble in fulfilling their debt repayments, this is where the Paris Club steps in.
The Paris Club provides help by either canceling debt outright or rescheduling payments over a longer period.
Unlike the London Club, which is an informal group of private lenders,
The Paris club is made up of 22 permanent creditor countries.
The members include most major economies, except for China.
The group got its name in 1956, when Argentina, on the verge of default, met with the countries
it owed money to in Paris to discuss solutions to its debt difficulties.
In the years since, the club has signed more than 400 agreements worth
more than half a trillion dollars with 99 countries with long-term debt.
The process, known as debt restructuring, involves negotiations between member states
and heavily indebted countries to lower interest rates or extend the due dates.
The Paris Club usually meets 10 times a year, bringing together
debtor and creditor countries to negotiate new debt plans.
These negotiations are conducted before observers, typically from international organizations
such as the United Nations, the International Monetary Fund and World Bank.
The meetings, traditionally chaired by a senior official of the French Treasury,
are responsible for ensuring the discussions align with the Paris Club’s
set of six principles built around compromise, negotiation and consensus.
These principles include being sensitive to the impact their actions have on others in the club and confidentiality.
To be eligible for help, debtor countries need to have a track record of implementing, or
at least showing commitment to implementing economic reforms aimed at decreasing their total debt.
A debtor country, when seeking relief from other non-Paris Club members,
should also do so on comparable terms arranged with the group.
Members of the Paris Club then tailor their decisions to the needs of each country
they deal with, rather than adopting a one-size-fits-all approach.
It was in this spirit that the Paris Club members agreed to reduce debts
for the poorest countries by a third for the first time in 1988.
Six years later, the group agreed to reduce some debts by 67%.
As the debt situation in some countries continued to spiral out of control,
the Paris Club worked on a program with the IMF and the World Bank to provide further debt relief in 1996.
In April 2020, the Paris Club agreed to write-off $1.4 billion owed by war-torn Somalia, making
the impoverished nation the 37th country to qualify for debt relief under the HIPC initiative.
The Paris Club faces a challenge to its credibility and power because of China’s absence.
The Asian giant has become a major creditor in the decades since the Paris Club was established,
but prefers to deal with its debtors on its terms.
China’s conditions for lending to developing countries are often opaque,
contrasting with the club’s principles of transparency.
Beijing has, therefore, shied away from the club, reluctant to reveal the details of its debt agreements with other countries.
Yet, the continued relevance of the Paris Club, could hinge on China’s co-operation.
In 2018, 72 low-income countries had debts amounting to $514 billion.
Of this, $104 billion was owed to the Chinese government $106 billion
to the World Bank and $60 billion to private bondholders.
With China’s loans accounting for roughly 20% of the total external debt by these developing economies,
it will play a crucial role in any future negotiations on debt restructuring.
The question of whether China will work alongside the existing members of the Paris Club has never
more critical than during the coronavirus pandemic, which has left many indebted countries facing default.
The size of the looming debt crisis has driven the club to work on a broader scale than its usual case-by-case approach.
The club, along with the World Bank and the IMF, is working to reduce
the financial burden on 73 low- and middle-income countries.
This initiative, known as the Debt Service Suspension Initiative has seen around
$12 billion worth of repayments due between May and December 2020 rescheduled to mid-2021.
For low-income countries seeking debt relief, China’s absence from the Paris Club complicates
debt repayments while undermining the coordinated action needed to recover from the Covid-19 recession.
Whether the Paris Club can find its voice amidst the global debt tsunami
and the rise of China’s economic might will impact the lives of millions in the years to come.
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