The FT ran an opinion piece a few days ago that suggests the old arguments for debt cancellation in Africa no longer apply.

The story goes like this: the last major debt relief initiative (HIPC, which started 20 years ago) resulted in the cancellation of more than $100bn of mainly concessionary debt from multilaterals and Paris Club members. However, debt levels have risen to unsustainable levels again.

While this makes some call for a new round of relief, others, including Bright Simons, the author of the piece, argue differently. They put the blame primarily on fiscally profligate governments and bad governance. In short, their point is: “bad governance, no debt relief”.

To answer the question whether debtor countries “deserve” cancellation of their debt, it is also necessary to ask who can cancel which debt. In this vein, Simons notes a sea change in the composition of government financing.

Contrary to the past, the countries with the most unsustainable debt burden now owe money primarily to domestic holders of debt (which, historically, seems a “natural” development). On the external debt side, the role of multilaterals has significantly decreased in relative terms while international bondholders and non-Paris Club bilateral lenders (e.g., China, India and Turkey) have become relatively more important.

Simons is based in Ghana, currently embroiled in a severe economic crisis, and it looks like the perfect case study for the above: Government debt has become unsustainable, per the IMF. Three quarters of its budget’s debt service are paid to domestic investors, given higher yields and shorter duration of its domestic bonds. That’s the equivalent to more than half of the country’s budget.

In order to receive an IMF bailout, the IFI has thus asked for a comprehensive debt restructuring involving both local and foreign creditors. Yet Simons wonders whether the latter should be involved: after all, would they not condone “bad governance”, given how much of the accumulated debt had been spent on vanity projects?

Moreover, given the smaller role of multilaterals and Paris Club debt, a cancellation similar to what happened under HIPC won’t make much of a dent in the debt arithmetic.

Let’s take a closer look.

Domestic debt service (denominated in local currency) is a drain on the budget, but not on the balance of payments (BoP). External debt cannot be “inflated away” by printing money like local debt can (Ghana’s inflation is running at more than 50%). Inflation puts a big strain on the exchange rate, increasing the relative burden of external debt. So while you reduce the relative burden of one, you tend to increase the other.

External debt might have become smaller in relative terms in most places but it remains more important than domestic debt. This is because in order to service or roll over external debt, the country needs FX. These reserves are crucial to keep the economy afloat, particularly in import-dependent countries during times of global primary commodity inflation. The role of the IMF as a lender of last resort is therefore hugely important.

The signaling provided by a successful IMF package often leads to a compression in yields and might even restore market access to struggling governments. Other multilateral and bilateral lenders are also more likely to piggy-back on an IMF program and provide more funds, helping to close the external financing gap.

Recent crises in Sri Lanka and Pakistan are first of all BoP crises, where a shortage of foreign reserves has caused uncleared cargo ships mooring offshore ports as the importer cannot source FX to pay the exporter. Sri Lanka faces a shortage of crucial medicine. Stuttering trade is also extremely bad for growth.

Back to Ghana, where the IMF has linked its latest program support to a reduction in the NPV of its debt to below 55% of GDP by the late 2020s from currently 105%. That’s ambitious. It would necessitate significant expenditure cuts and a boost to revenues if to be achieved. This might easily become a structural adjustment program in all but name, with all the social ramifications.

But this therapy won’t be enough. The government has also begun to restructure its debt: A deal with more than 80% buy-in from domestic creditors has been passed now that pension funds, among others, were ringfenced. A coupon payment of an external bond was just missed. Ghana is therefore now in default both on domestic and external debt.

This is worth emphasizing: In order to gain concessionary loans from multilaterals, the country in question might have to restructure domestic debt on top of its external debt. Domestic bondholders in other countries should take note, as they will bear a significant chunk of this much-needed debt “cancellation”.

Only think of banks, which would take a significant hit on their government bond book in the event of a restructuring, and which could cause a devastating banking crisis in some places (e.g., Pakistan).

External bondholders need to bear their proportionate share of the “cancelling” of debt. After all, why have they lent money to Ghana? Because of its good governance, or the future promise thereof? No, because of the higher yields its bonds pay.

The low-interest rate environment prior to the recent tightening has seen both an increase in profligate spending in debtor countries and investors’ hunt for higher yields. I would argue that they are two sides of the same coin. Investors must accept that higher returns come with higher risks.

One should also take note that while a smaller part of the pie, multilateral and Paris Club debt is still vitally important: It has a strong signaling effect on other creditors. And for some countries, it still represents the lion share of external debt (take Bangladesh).

It might contain significant trade finance obligations the government had to take on as it underwrote external export promotion agencies guarantees to defaulting importers (we don’t have exact numbers). And a good chunk of it was counted as ODA from Western countries (as long as it is provided on concessionary terms, you can count it as aid).

It is problematic to call these sovereign debts for various reasons. In many cases, they should be cancelled, too. And why does IFI funding, particularly from IMF and World Bank, have to be senior?

The new focus on domestic debt clouds this debate and shifts responsibility away from external creditors. They are really not without blame in the current debt crisis engulfing SSA.