Ulrich Volz, Professor of Economics and Director of the Centre for Sustainable Finance at SOAS, University of London, is a senior research fellow at the German Institute of Development and Sustainability and Co-Chair of the Debt Relief for Green and Inclusive Recovery project. Marina Zucker-Marques, a post-doctoral researcher at SOAS, University of London, is lead researcher of the Debt Relief for Green and Inclusive Recovery project.
LONDON – The urgency of tackling the developing world’s sovereign-debt crisis continues to grow. As global temperatures rise and the threat of irreversible damage to the planet looms, onerous debt burdens are preventing many low-income countries (LICs) in Africa and elsewhere from investing in climate action. Progress on debt relief under the G20’s Common Framework for Debt Treatment has been stymied by creditor disputes, foreclosing any possibility of a timely and meaningful resolution.
The question of whether multilateral development banks (MDBs) will take losses alongside other creditors has been particularly contentious. While the G20 has asked MDBs to develop options for burden sharing, no systematic plan has emerged. China, in contrast to the Paris Club of sovereign creditors, insisted that MDBs take a haircut, before softening its stance during this year’s Spring Meetings of the World Bank Group and the International Monetary Fund. Yet the demand for MDB involvement was reiterated at the recent BRICS summit.
Rightly so. As we show in a new report, the participation of MDBs in sovereign-debt restructurings is not only feasible but also necessary to break the current deadlock. For starters, at least half of the total external sovereign debt stock in 27 debt-distressed countries – many of which are LICs or small island developing states (SIDS) – is owed to multilateral creditors. Thus, even if all bilateral and private debt were canceled, exempting MDBs from debt restructuring would prevent some of the world’s most vulnerable countries from achieving a full recovery.
Second, perception matters. The participation of all external creditors, including MDBs, in debt restructuring would remove any impression of unfairness or free riding, in turn making bilateral and private creditors more amenable to negotiation.
Third, the debt relief generated through burden sharing would align with the MDBs’ core mandate of supporting sustainable economic development and eliminating extreme poverty. If the crisis remains unresolved, debt-distressed countries will be unable to make progress toward the United Nations Sustainable Development Goals, let alone achieve them by 2030. Only with more fiscal space can governments invest in high-priority areas.
Finally, a protracted debt crisis would result in significant costs for the MDBs’ concessionary lending arms: as LICs’ debt-distress indicators rise, so, too, must the grant element of MDB assistance. Consider the International Development Association (IDA), the World Bank’s lending arm for the poorest countries. According to our estimates, IDA grants based on debt-sustainability criteria rose from $600 million in 2012 to $4.9 billion in 2021 – that is, from 8% to 36% of its commitments. Accelerating progress on debt relief would therefore be in MDBs’ best interest.
To be sure, MDBs lend on more favorable terms than other creditors. As such, fair rules for comparability of treatment (CoT) that account for lending costs are required to achieve an equitable distribution of losses.
Using fair rules, we estimate that a debt write-off of $55 billion – a 39% haircut – for 41 IDA-eligible countries and SIDS facing debt distress would result in a loss of $8 billion for MDBs, compared to $27 billion for private creditors. This scenario would cost the IDA $2 billion, significantly less than what it is spending on grants tied to debt-distress indicators. If these debtor countries received a more generous reduction of 64% – similar to the relief provided during the Heavily Indebted Poor Countries Initiative – overall MDB losses would amount to $25 billion.
And if MDBs participated in debt relief for a larger group of 61 countries facing severe debt problems – including middle-income countries like Egypt, Nigeria, and Pakistan – a 39% haircut would cost them $37 billion using fair rules for CoT. This is hardly a trivial sum. But by accepting this loss, MDBs could unlock $305 billion in overall debt relief – including $209 billion from private creditors. In other words, each dollar contributed by donors through MDBs could translate into a whopping $7 of total debt relief.
Sharing the burden of debt relief need not threaten MDBs’ high credit ratings nor their privileged access to low-cost capital. Based on past sovereign-debt restructurings, MDBs could rely on donor contributions and internal resources to back up losses from debt relief. Moreover, MDBs could revive institutional arrangements such as the World Bank’s Debt Relief Trust Fund and tap their precautionary balances once they receive fresh capital injections.
If we are serious about addressing the mounting debt crisis in the Global South, MDBs must be willing to take a haircut. It is the only way to make progress toward debt restructuring. But, to ensure equitable burden sharing, losses must be determined using fair rules for CoT that incorporate the cost of lending and concessionary elements. Debt relief comes with a price, but it is a price worth paying to put vulnerable countries, and the world more generally, on a path to climate resilience and sustainable development.
