Jay Newman was a senior portfolio manager at Elliott Management and is the author of Undermoney, a thriller about illicit money flowing through the global economy.
Investors in government debt in emerging markets are drug addicts – addicted to the illusion of higher returns. Honestly, they are also addicted to the rush of adrenaline that comes from sitting at a high table to negotiate the terms of restructuring after default.
Decades have passed for an intervention that recognizes this dependence and helps us break the cycle of unwise loans, meaningless lending and repeated restructuring that lead to a race to the bottom: renegotiating government debt and repeatedly forgiving large chunks. until, magically, it disappears.
We are on the brink of an epidemic of bankruptcy in emerging markets, the scale and scope of which will rival the debt crisis of the 1980s. Rising interest rates from Western central banks, the aftermath of the COVID pandemic, rising food and fuel prices as a result of the economic consequences of the Russia-Ukraine war, bad governance and outright corruption are all contributing factors. Whatever the reasons, we will soon be at the height of the problem.
Consider the warning recently issued by one of the largest promoters of this schematic asset class. According to JPMorgan, Sri Lanka, the Maldives, the Bahamas, Belize, Senegal, Rwanda, Grenada and Ethiopia are “threatened with depletion of reserves” – also known as the money drawer.
Let us not miss Lebanon, Egypt, Pakistan, Russia, the inevitable renegotiation of Ukraine’s debt or, in this sense, the 27 countries with bonds that carry more than 10 percent – always a sign of trouble.
But with all due respect to Kenneth Rogoff and Carmen Reinhart: this time is different because we are about to witness the first full-fledged sovereign debt crisis in emerging markets, in which a single creditor, China, is holding the whip.
China, because of the huge sums it has given and invested through its One Belt, One Road initiative, controls the fate not only of the countries that took its money, but also of the IMF and private sector creditors.
Sri Lanka is an example of this. In 2019, the World Bank classified Sri Lanka as a country with a higher average income. Today, it has a debt of more than $ 50 billion, but it has exhausted all its reserves, and its people are queuing for kerosene, food and medicine.
There are many explanations, but last but not least is the debt trap set by China, which in agreement with the government is burdening Sri Lanka with white elephants: uneconomical, ill-conceived projects such as the port of Hambantota and the empty Matala Rajapaksa International Airport. When Sri Lanka, as expected, proved unable to meet its debt, China dropped the trap, demanding repayment, offering to replace the debt with additional concessions and huge tracts of land, and offering extra money to help the political class outperform.
China-funded port of Hambantota in Sri Lanka © Bloomberg
If China were a simple trade creditor, over-borrowing would be settled. But it’s not like that. The size, scope and terms of China’s BRI deals are a state secret. It seems that China not only intends to remain so, but also insists on seniority – probably even loans from international financial institutions such as the IMF and the World Bank.
Then what needs to be done? In the usual way, international financial institutions, the Western government, ridiculous NGOs and the international press will call on private sector creditors to offer Sri Lanka easing conditions – to forgive a large percentage of its claims and extend the maturity of the debt for decades.
Why should I do it? Unless the debtor demonstrates a willingness and ability to rediscover, and unless all creditors – including China and international financial institutions – agree to disclose all their claims and agree to negotiate a commercial solution, any restructuring will fail.
Instead of such a misguided, conventional approach, private creditors should listen to the mantra that has been good advice for addicts in every area of life: just say no.
Just say no: to negotiations before the debtor has a comprehensive, sustainable fiscal plan. Why would any creditor negotiate with a debtor who does not have a reliable plan to solve their fiscal problems?
Just say no: to the negotiations until a comprehensive, bona fide analysis of debt sustainability is completed. Until Argentina broke the model, negotiations on the level of debt that could be sustained in the long run were given.
Just say no: until every debtor who has been a victim of decades of corruption makes radical efforts to identify the culprits and recover ill-gotten gains. There is good reason to believe that in almost every sovereign debt crisis in the last forty years, countries could be put on a sound financial footing if even a small part of the stolen money was recovered.
Just say no: in negotiations before international financial institutions, such as the IMF, to specify exactly how their own receivables will be treated.
Just say no: until some political stability emerges. It is not much to ask whether the people sitting opposite will be there in six months or six years. There is no point in making a deal with a government that will not survive the signing ceremony.
Just say “no”: to the signing of a loan documentation that fails to provide stable legal rights and protections against creditors’ enforcement. The biggest failure of Argentina’s latest debt restructuring was that instead of presenting contractual terms to the government that would provide enforceable rights, creditors chose to forgive half of the debt without any quid pro quo. For Argentina, the repayment of its foreign debt has become optional, although it is possible to create a “super” bond with dramatically stronger protections in case of default. To date, bondholders have simply been too timid and scared to try.
Just say no: in any negotiation in which China and creditors in a similar situation, such as India, fail to provide complete sets of documentation for their loans and investments – and agree to participate in restructuring negotiations as commercial creditors with rights under larger or smaller than any other creditor.
Does it sound like a dream? Well, the first step in recovering from any form of addiction is testing reality: you have to admit that you have a problem, and accept that repeating the same old thing over and over will not lead to a different result.
It will not be easy. Current geopolitical operators – sovereign states, international financial institutions, NGOs – have long viewed private sector creditors as the first herd to be released on default, rather than as partners in devising lasting solutions.
Not only that, some of the world’s biggest money managers seem to have decided that their first allegiance is to some vaguely Davos-inspired notion of collegiality instead of protecting their investors.
But you really have nothing to lose – or fear. Unless and until debtors tormented by weak institutions and corruption are brought to justice, the dollar borrowed will continue to be a dollar. They will suck as much money as they can when they can – whether from markets, bribes, the IMF or China – and will hide behind the idea that things are out of their control.
Ultimately, there is only one rational, functional response to the implicit argument that there is no dishonesty in non-compliance. If you are invited to take part in a process that is fundamentally wrong and corrupt: just say no.
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