Debt restructuring for commodity exporters

Jeffrey Frankel April 28, 2023 09:24

The world is in the midst of a debt crisis. A recent report estimates that 61 emerging-market and developing economies – nearly one-third of the International Monetary Fund’s member countries – are facing debt distress. The G20’s Common Framework for Debt Treatments, which aims to help low-income countries restructure their sovereign debts, was supposed to prevent this crisis from spiraling out of control. But progress so far has been slow and uneven.

Many of the world’s debt-distressed countries are in Africa. Chad, for example, restructured its debt in 2021, the first to do so under the Common Framework. Zambia defaulted on its foreign debt in 2020 but has not convinced its creditors to agree on how to restructure its debt, partly because of China’s refusal to join the Paris Club. Ghana, which defaulted on its external debts in December 2022, appears to be on its way to a successful restructuring. Meanwhile, negotiations between Ethiopia and its creditors, delayed due to the country’s civil war, may resume soon. And Angola, which agreed to a three-year debt-relief package in September 2020, is still in trouble.

One of the main challenges facing debt-distressed developing countries is that they remain vulnerable to external shocks such as oil-price volatility. Suppose, for example, that the IMF supports a debt restructuring deal in which the creditors agree to a big write-down, and the indebted country agrees to strengthen its budget balance. Even if these measures are enough to stabilize the country’s debt-to-GDP ratio today, the chances of an unforeseeable shock undermining its debt position in the future are worryingly high.

For most African economies, commodity prices represent the biggest source of uncertainty. Angola, Chad, and Nigeria, for example, rely on oil exports. Zambia’s economy depends on the price of copper, Ethiopia is vulnerable to swings in the price of coffee, and Ghana’s exports are dominated by oil, gold, and cocoa. This means that commodity-market fluctuations can wreak havoc on their finances, rendering even recently restructured debt unsustainable. A 50% drop in the price of an export commodity could mean a 50% increase in an indebted country’s debt-to-exports ratio.

Fortunately, there is a potential solution to this problem. By issuing debt that is denominated in terms of the price of a certain commodity, rather than in dollars or other currencies, exporters could shield themselves from market volatility. Zambia, for example, could issue copper bonds, and Angola could issue oil bonds. If the prices of these commodities fall and lead to a drop in export revenues, the cost of the debt will automatically fall in proportion, preventing their debt-to-exports ratios from skyrocketing.

To be sure, commodity bonds are hardly a new idea. But commodity-exporting debtor countries have been wary of adopting them, partly because policymakers fear that there would not be enough demand from investors.

But there is an untapped market. Airlines and power companies are vulnerable to commodity-price volatility and have reason to go long on oil. Similarly, electronics manufacturers need to hedge against fluctuations in copper prices, chocolate makers need to hedge against increases in the price of cocoa, and steel producers need to hedge against increases in the price of iron ore.

Of course, companies that want to hedge against commodity-price risks do not necessarily wish to expose themselves to the credit risk of, say, Chad. This is where multilateral lenders could come in. The World Bank or some other financial institution (perhaps a state-owned Chinese bank) could denominate loans to countries like Chad, Angola, and Nigeria in oil instead of lending in dollars or euros, thereby helping to create a market for commodity bonds.

Given that the World Bank jealously protects its balance sheet and triple-A rating, it does not want to be exposed to the risk of oil-market fluctuations. But, by offering investors a highly-rated World Bank bond linked to, say, a standard oil-price index, it could perfectly offset its collective exposure to oil markets.

Similarly, countries that export cocoa, gold, coffee, iron ore, and other commodities could receive loans from institutions like the World Bank denominated in terms of the prices of the commodities they export. The World Bank, acting as an intermediary, could then unload that risk in the private market.

Airlines and chocolate companies, which are not in the business of investing, need not necessarily hold the World Bank commodity bonds directly. Hedge funds or other financial intermediaries could buy the 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 exposure on better terms than they can now. That way, all parties – the borrowers, the intermediaries, the futures market, and the ultimate buyers – could avoid exposure to unwanted risk.

While this idea may sound quixotic to some, commodity bonds should be an easier sell than GDP-linked bonds, which have already been put into practice. In addition to a natural, latent market, commodity bonds have another advantage: Transparency. The commodity price index is observable in London or Chicago, is not subsequently revised, and is less vulnerable to government manipulation than GDP and inflation statistics.

Admittedly, commodity bonds will not help debtor countries that do not export commodities. Nor will they solve the problem if China intransigently refuses to coordinate with Paris Club sovereign creditors. But they could remove the most significant source of future risk facing many indebted countries in Africa, Latin America, and the Middle East. Commodity exporters, creditors, and multilateral institutions should embrace them.

Copyright: Project Syndicate
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Jeffrey Frankel

Professor of Capital Formation and Growth at Harvard University