Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate. I would like to thank Sohaib Nasim for valuable assistance on this month’s commentary, as well my others this year.
An estimated 61 countries are currently in debt distress or at risk of it, which is almost one third of the membership of the IMF [32% of 190]. The G20’s Common Framework for Debt Treatment is supposed to facilitate debt restructuring for low-income countries. But it has made only slow progress.
Many of these countries are in Africa. Chad restructured its debt in 2021, the first to do so under the Common Framework. Zambia defaulted on its foreign debt in 2020, but has so far been unsuccessful in getting its creditors to agree on how to restructure its debt. Reluctance of China to participate with other creditors in the traditional Paris Club process is a particular problem in the Zambian case. Ghana, which defaulted on its external debt in December 2022, has apparently been better able to move forward with restructuring. Rescheduling of the terms of Ethiopia’s debt was delayed by civil war, but may move forward now. Angola received 3-year debt relief in September 2020, but remains in trouble.
- Volatile export prices can derail debt sustainability
One of the difficulties with debt restructuring is vulnerability to future shocks. As an IMF report on Angola noted, for example, “Although debt is sustainable, significant vulnerabilities remain. Debt dynamics are highly sensitive to further oil-price volatility.”
Consider an IMF-supported package in which the national government agrees to a sufficiently big increase in its primary budget balance and the creditors agree to a sufficiently big write-down, so that the debtor country is forecast to be back on a sustainable path. Debt is said to be sustainable if the ratio of debt to GDP is expected to decline in the future. (In the case of external debt, it is common to use export revenue as the denominator instead of GDP.) There is still a worryingly high chance that unforecastable shocks will in the future render the debt position once again unsustainable. If the write-down and fiscal adjustment were just barely big enough to restore sustainability (judged by the median of the probability distribution), then the chance that future shocks will put the country back on the wrong side of the sustainability line is up to 50%.
For most African economies, the single biggest source of uncertainty is probably the world price of one or more commodities that dominate their exports. It is the price of oil, in the cases of Angola, Chad, and Nigeria. The price of copper, for Zambia. The price of coffee, for Ethiopia. The prices of oil, gold, and cocoa for Ghana.
If the global market for the leading export deteriorates, it could render even recently restructured debt unsustainable. The price of oil [Brent], for example, fell by 74% [from $138 per barrel to $36] during the second half of 2008. It recovered, but then fell again by 57% [from $111 to $48] in the second half of 2014. Such fluctuations wreak havoc with the finances of commodity-exporting countries. A 50% fall in the price of the export commodity could mean a 50% increase in the Debt/Export ratio.
- Commodity bonds to the rescue
This is one problem that has a good potential solution: Denominate (or index), a portion of the external debt in terms of the world price of the export commodity. In the context of restructuring, the old dollar debt could be swapped for new commodity-linked debt. That way, if the commodity price and therefore export revenue fall, the cost of the debt will automatically fall in proportion, and the debt/export ratio will remain unimpaired.
If three or four commodities make up most of the country’s exports, as for Ghana or South Africa, use them all. The magnitude of the commodity-linked portions of the debt should be chosen in light of the expected magnitudes of the country’s commodity exports.
- Who would hold them?
First, potential issuers worry that there would not be enough demand for such bonds. Who would want to take the other side of the trade, finance ministers ask? The answer is that the ultimate potential customers could be the users of the commodities. Airlines and power utility companies use oil products. They have reason to “go long” in oil: the price volatility is a big problem for them, but it is an increase in the oil price that they fear, not a decrease. Similarly, electronics producers have reason to go long in copper; chocolate makers to go long in cocoa; steel mills to go long in iron ore, etc.
The companies are likely to object that, while they welcome efficient ways to hedge commodity price risk, commodity bonds that carry the credit risk of a particular country are too specialized a niche to be of interest to them. An airline wants to go long in oil, not long in exposure to Chad, whose credit risk it is not equipped to evaluate.
For this reason, I would propose that the World Bank or other financial institution (possibly a Chinese state bank) should be able to serve as intermediary, to help make the market. It would lend to Chad, Angola, and Nigeria – which is its job — in terms of oil, in place of lending to them in dollars or euros or their own currencies.
The World Bank is quick to point out that it guards jealously the quality of its balance sheet and its triple-A risk rating, and so does not want to be exposed to the risk of oil market fluctuations. For this reason, it should perfectly offset its collective exposure to oil markets by selling to investors a highly-rated World Bank bond linked to a standard oil price index. Similarly, countries that export cocoa, gold, coffee, iron ore, or other commodities would borrow from the intermediary in terms linked to the price of the commodity in question and the intermediary would then lay off that commodity risk in the private markets.
Airlines and chocolate companies may not see themselves in the investing business. But they need not necessarily hold the World Bank commodity bonds directly in order to be the ultimate holder of the commodity exposure. Hedge funds or other financial intermediaries could buy the World Bank bonds and lay off the commodity risk in the futures market. The airlines and chocolate companies could then take the other side of the futures contract, thus hedging their commodity risk on better terms than they can now. All parties – the borrower, the intermediary, the futures market, and the ultimate buyer – get exposure to what they want, and not a penny of exposure to risk that they don’t want.
The idea of commodity bonds may sound quixotic. But they should be “an easier sell” than GDP-linked bonds, which have received more attention and have been put into practice. The first reason is that they have natural ultimate customers, as noted. The second reason is that the commodity price index is observable in London or Chicago, is not subsequently revised, and is less liable to government manipulation than are GDP or inflation statistics.
Admittedly, the idea of commodity bonds won’t help countries where commodity exports are not important. Nor will it help if China intransigently refuses to coordinate with Paris Club creditor countries. But commodity bonds do have the potential to remove from debt restructuring what is perhaps the biggest source of future risk for many countries in Africa, Latin America, and the Middle East.
This post written by Jeffrey Frankel.