The Brave New World of Sovereign Debt Restructuring: The ‘China Conundrum’ and Other Challenges

By Steven T. Kargman (Kargman Associates)

Emerging economy and developing country sovereigns have faced daunting economic challenges in the last few years as a result of the impact of the COVID-19 pandemic and the fallout from the war in Ukraine.  These twin external shocks to their economies have led to falling or less-than-stellar growth rates during this period, apart from 2021 when these economies had a fairly robust rebound from the sharply negative growth rates caused by the pandemic.  

As a result of this generally sluggish economic performance and the substantial government expenditures that were required by governments around the world to address the deleterious impact of the pandemic on the health of their populations and the state of their economies, the balance sheets of these sovereigns have been placed under considerable stress. Indeed, a significant percentage of low-income countries—as much as 60%, according to the International Monetary Fund (IMF)—have been experiencing sovereign debt distress or are at high risk of such debt distress.  Furthermore, many emerging economies—at least sixteen such economies, according to a Bloomberg index of emerging markets—have had their sovereign debt trading at distressed debt levels (i.e., a thousand basis points, or ten percentage points, above US Treasuries).

Accompanying this level of sovereign debt distress, there have been, perhaps not surprisingly, several high-level sovereign debt defaults in the last few years.  For example, in November 2020 Zambia became the first African country to default in the wake of the pandemic, in April 2022 Sri Lanka became the first Asian country to default in at least twenty years, and yet another African country, Ghana, defaulted in December 2022.  Other countries facing major financial and economic pressures, while not yet in default, have sought financial rescue packages from the IMF, including Pakistan and Egypt.

Nonetheless, in the various ongoing debt restructurings, there has generally only been very limited progress to date.  For instance, it took Zambia roughly two-and-a-half years to finally come to an agreement in late June 2023 with all of its bilateral creditors, including largely Western creditors that are part of the Paris Club and non-Paris Club creditors (particularly China), on how to deal with its outstanding bilateral debt.  Yet, Zambia still has to reach an agreement with its other creditors, especially its private sector creditors such as its large body of bondholders, on how to restructure that segment of Zambia’s debt, and it remains to be seen how quickly Zambia will be able to conclude a deal with these creditors.

In a striking new development, China has played an outsized role in a number of the current sovereign debt restructuring situations, as China has emerged as the largest official bilateral creditor to developing countries in recent years due in large part to its huge volume of lending under its expansive and globe-spanning Belt and Road Initiative (BRI). However, China’s role in these sovereign debt restructuring situations has engendered considerable controversy and elicited fairly stinging criticism from Western financial interests, including the international financial institutions such as the IMF and the World Bank as well as from Western governments, including most prominently from the US Treasury Department.  

Among other criticisms, the Western international financial community has criticized China for being opposed to debt forgiveness for the sovereigns in question and instead only favoring rescheduling (or stretching out) of the relevant sovereign debt.  China has also been criticized for favoring bilateral negotiations (and opaque dealings) with sovereign debtors instead of the multilateral negotiations that are more typical of multi-creditor sovereign debt restructurings. 

China, of course, has pushed back on these criticisms and lodged various criticisms of its own at the Western international financial community.  For instance, China has criticized the special ‘preferred creditor status’ claimed by international financial institutions such as the IMF and World Bank.  China has argued these institutions should participate in the burden-sharing inherent in any sovereign debt restructuring on essentially the same basis as other creditors (although China appears to have softened this criticism in recent months).   

The foregoing issues are discussed in a new article, entitled “The Brave New World of Sovereign Debt Restructuring: The ‘China Conundrum’ and Other Challenges,” that first appeared in International Insolvency & Restructuring Report 2023/24.  An updated version of the article, which can be found here, appeared recently in AIRA Journal (the publication of the Association of Insolvency & Restructuring Advisors (AIRA)), Vol. 36, No. 3, and is reprinted with permission of AIRA.  The article was also previously featured in a post on August 8, 2023 in Columbia Law School’s CLS Blue Sky Blog.