Reflections on Sovereign Debt Restructuring in Low-Income Countries and the ‘Shanghai Model’
Zhou Chengjun, Director of the Financial Research Institute of the People’s Bank of China, delivered a speech entitled “Building the Shanghai Model of Sovereign Debt Restructuring” at the fourth China International Finance 30 Forum held in Shanghai on May 29-30, 2021. His discussion centered on ideas for sovereign debt restructuring of low-income countries and noting, in particular, the “Brady Plan,” a package of debt restructuring plans initiated by the United States in the 1980s and 1990s in response to the sovereign debt crises of Latin American countries.
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Based on this experience, Director Zhou believes it is possible to consider building the “Shanghai Model” of international sovereign debt restructuring, suitable for the current characteristics of China’s sovereign lending. In addition to maximizing transparency, multilateralism, securitization and debt sustainability, the plan would be open, inclusive, shared and sustainable.
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Director Zhou’s proposal is important and timely. The global COVID-19 pandemic continues to rock low-income economies, precipitating a need for sovereign debt restructuring. As one of the largest creditor countries, China has actively cooperated with various debtor countries to restructure its non-performing debts, which not only protects the interests of Chinese creditors to the greatest extent but also reflects China’s responsibility to developing countries.
Of course, one of the most important purposes of debt restructuring is to help debtor countries improve their debt sustainability and restore economic growth. From a debt sustainability perspective, debtor countries have experienced ups and downs in economic growth and debt crises in the past, in part due to debt mismatches, such as currency, maturity, interest, cash flow and others. Relatively speaking, RMB bonds would provide debtor countries with a more diversified basket of currencies in their liabilities, as well as longer-term debt options. If coupled with the instruments advocated by the International Monetary Fund, such as state-contingent debt instruments, RMB bonds could be extremely attractive to debtor countries.
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Previous research has pointed out that in a theoretical risk-minimizing debt portfolio for Sub-Saharan African (SSA) countries, general dollar debt should account for only about 30 percent of its debt and should be linked to the price of SSA’s most important commodity exports, including cocoa, coffee, cotton, copper and oil. This theoretical debt portfolio reduced debt volatility in SSA countries by about 90 percent. Another example is Papua New Guinea, where the use of an optimal debt mix, including CLBs and traditional debt denominated in different currencies, played an important role in the country’s risk management strategy. In this way, the “Shanghai Model” and the “Shanghai Club” could become an important part of the international sovereign debt market.
On the other hand, the current debt crisis of developing countries caused by the impact of the pandemic also provides a rare opportunity for the development of the international RMB offshore bond market. In the process of coordinating domestic financial institutions and international organizations to issue Brady-like bonds denominated in RMB, instead of converting all bad debt into RMB bonds, the first thing the “Shanghai Club” should consider is to help debtor countries establish their optimal debt portfolio, including RMB bonds. The Shanghai Club can also optimize the structure of “RMB-like Brady bond” transactions by including features of CLBs. The Shanghai Club could also provide guidance and support for the development of market infrastructure required for various offshore and cross-border RMB bond markets.
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