My post on debt restructuring from earlier this year has kept me thinking. I sit in a line of work that deals with these issues every day, from an IFI and banking sector point of view. Lots has happened since February, and I have regularly written professional updates on the situations in Pakistan, Sri Lanka and Bangladesh, which face(d) variable degrees of balance of payment crises.
Alas, my day-to-day does not allow for a deeper soul-searching and analysis of the underlying forces and trends that also matter in this debate. Given that I studied under people very critical of IFIs (and calling myself a heterodox economist if pushed for a self-characterization), I feel obliged to look a little deeper, academically speaking, into the political economy of these crises.
To recap: Since Ghana last year, the “genie is out of the bottle”, i.e., it is now mainstream to contemplate domestic debt restructuring as a crucial instrument in bringing government finances back into balance and restore debt sustainability. This comes on the heels of several decades of IFIs pushing for domestic debt market development and prior (external) debt relief that is now widely deemed to have been ineffective–among other secular trends.
A popular catchphrase that comes up in this debate time and again is the “sovereign-bank nexus”. What at first sight looks like a critical political economy concept is in fact fairly apolitical and refers to banks holding significant amounts of sovereign debt, and the sovereign being dependent on its banking sector for deficit financing.
The banking sector can arbitrage the “risk-free” character of domestic government debt (no provisioning required, compared to loans it gives out, so the bank does not have to hold capital against these exposures); and meanwhile enjoys the relatively high yields they’re being paid on it.
The health of the sovereign’s and the banking sector’s finances is interconnected and there are potential negative feedback loops. COVID-19 has only exacerbated this given the large fiscal response as well as the banking sector’s role in channeling official support to the real sector.
However, the sovereign-bank nexus crowds out lending to the private sector. Local capital markets (especially secondary markets for government debt) remain rudimentary, or at least there are very few private non-bank investors, making banks even more important. If there are significant other holders of domestic government debt, they are either state-owned (e.g., the central bank) or provident/pension funds that often hold the savings of millions of workers.
I look a lot at debt dynamics and potential modalities of restructurings –external and domestic– as well as their impact on domestic banks. Throughout these crises, I have seen banks remain profitable, sometimes even more profitable than pre-crisis. The positive spin on this is that they can build up capital cushions to withstand future shocks.
However, domestic banks are thus far let off the hook regarding their domestic government debt holdings (Ghana and Sri Lanka)–problematic given the importance their large holdings have to debt sustainability.
In short, and crudely put: Profits are privatized, costs socialized. While I am capable of seeing the arithmetic case for these restructurings within their own set of assumptions, I struggle with their political justice. Rather than being apolitical and largely technocratic, the sovereign-bank nexus and domestic debt restructuring have real life implications for millions of people.
They bring up all sorts of structural questions about power relations in the international political economy and a certain view on how development in general, and IFI policy in particular, are expected to look like in our times. There is little appreciation for economic history and the experience of other countries that had successes in doing it “differently”.
For my own intellectual journey (hopefully culminating in a research paper, perhaps collaborative), and in terms of critiques, nothing shall be off the table. From the more extreme measures such as nationalization of the banking sector and directed lending by the government (yes, even in so-called “low capacity” countries) to alternative definitions of debt sustainability and domestic capital mobilization.
What can I bring to the table in terms of original research? I have been thinking about that for a good while. All I can really come up with is some arithmetic on debt sustainability (although I do not run my models like the IMF does) or perhaps better given my position, a banking sector number crunching exercise.
I could calculate the government bond share as of sector assets (for all three South Asian countries) for a good period of time, with a running commentary on major trends and IFI involvement at the time. I can also plot credit to the private sector with domestic government bond holdings, although that’s slightly tautological. Profitability figures for the sector are also no problem.
What is the purpose of domestic government debt? Resource mobilization for (long-term) development. However, little of this has happened in the domestic markets of the three countries in question (albeit to varying degrees). I could try and shed some light on structure and terms of lending, in particular long- vs. short-term lending and what sectors are borrowing.
If I were to structure the prospective paper using several time series charts, I could try with the following structure:
- Sovereign debt statistics — from external to domestic, term structure? Concessional vs. market, etc.
- Domestic banks’ investment portfolio / share of government bonds vs. loans/assets
- Credit to the private sector, total investment, etc.
- Profitability / capitalization / NPL / loss absorption capacity of the banking sector (the IMF paper referenced above has some links to papers exploring this quantitatively)
I realize that while a lot of the data and methodology in data analysis will be “conventional”, the discussion and political economy analysis cannot–because there isn’t much out there. Domestic debt restructuring under IFI auspices (or tacit approval, at least) is relatively new. Perhaps that’s good timing. Work in progress!
