June 21, 2023


Feasibility Pact?

A brewing sovereign debt crisis threatens to engulf as many as sixty-one countries in debt distress over the coming year. Aid flowing from the global North—which carries the most responsibility for the atmospheric carbon stock—to the global South—which bears the brunt of its impacts—must be dramatically scaled up. Despite professing the need for global climate solutions, governments in the more prosperous countries have responded to this threat with lassitude and indifference, as evidenced by the slate of unambitious, unserious, and demonstrably ineffective responses issued from their recent summits. Meanwhile, democratic deficits within the institutions of multilateral governance show the difficulty of grappling with the pronounced asymmetries in our international financial architecture. Even the most ambitious reforms slated for discussion at week’s Summit on a New Global Financing Pact in Paris fail to confront the fundamental role of debt in that asymmetrical architecture.  

There is a growing consensus among global South governments, civil society organizations, and even some staff within the twin pillars of the Bretton Woods Institutions (BWIs), the World Bank and International Monetary Fund, that a thoroughgoing overhaul is required to contend with twenty-first century problems. New governance of the institutions, new trade conditions, and a new debt architecture should all be part of reforms that acknowledge that the main barrier is not access to finance, but who sets the terms and defines the processes of the current economic framework.

As United Nations Secretary General António Guterres recently noted in a policy brief on reforms to the existing financial architecture, there is a substantial gap between what must be achieved to create equitable pathways toward financial and environmental sustainability and what global North governments will allow. G7 countries seem to be taking a wait-and-see approach to catastrophe by failing to support long-term green and just transition plans in the global South. Debt restructurings advance at a glacial pace without a workout mechanism, the US and Germany block new Special Drawing Rights (SDR) issuances and the end of IMF surcharges, and Japan blocks multilateral development bank (MDB) reform, unwilling to finance a capital increase. Transformative change, G7 countries seem to say, is politically infeasible. 

The problem of the case-by-case approach

The combined pressures of debt and ecological crisis have rendered places such as Pakistan, Dominica, Kenya, and Ecuador doubly vulnerable to macroeconomic fluctuations. A recent report from ActionAid showed that 93 percent of the countries most vulnerable to climate impacts are in or near debt distress, and that more than half are likely to cut spending on social services in order to continue servicing debt. 

This is particularly true for middle-income countries that are facing extreme vulnerability to climate shocks and have relatively high debt burdens that are being further strained by the global cost-of-living crisis, to which European countries responded with almost 800 billion euros in energy subsidies in 2022. This situation echoes the Third World debt crisis of the 1980s and 1990s, during which middle-income countries languished without access to concessional debt restructuring made available to countries the BWIs classified as low-income. When the Heavily Indebted Poor Countries Initiative eventually broke the standstill in the late 1990s, middle-income countries were largely left out. 

According to a report released by Recourse in mid-June, 62 percent of the IMF borrower countries are at the bottom third of the ND-GAIN Index of countries’ vulnerability and readiness to climate change. The double vulnerability to climate and economic shocks comes from a complex brew of local and global political economic relations, but its ramifications are clear. Heavily indebted countries must rely on foreign currency-denominated bonds due to creditors’ preference to hedge exchange rate risk, exposing those countries to greater risks from interest rate volatility (both the 1980s and current debt crises were linked to the US hike in interest rates). Not all these countries have access to international debt markets, but the ones that do have higher borrowing costs than their less vulnerable peers. Official climate finance has so far been primarily loan-based, to the tune of 81 percent in 2020. This leaves vulnerable borrowers in need of climate finance at the mercy of BWI policy.

In the face of these mounting challenges, the governments at last year’s COP27 conference resolved that the 2023 World Bank and IMF Spring Meetings should be a turning point for international finance reform. They called on these institutions to generate a “full suite” of climate finance products, “from grants to guarantees and non-debt instruments,” especially to fill the gaps in responding to loss and damage from climate change. 

The COP27 text builds on the proposal by some G7 countries during the 2022 IMF/WB Annual meetings in October 2022, which kickstarted the discussion on an Evolution Roadmap for the World Bank. Shareholders would agree on a document on what reform of the World Bank should look like, including its new mission, operating model, and financial capacity. Lofty rhetoric, however, has not translated into meaningful commitment or action. The Evolution Roadmap’s consultation draft does not recognize the need to overhaul the bank’s unequal governance structure, and the biggest shareholders at the IMF have made no commitments to increase the capital base or subsidy accounts of the Poverty Reduction and Growth Trust, the IMF’s concessional lending program, or the Catastrophe Containment and Relief Trust, which provides grant-based disaster relief.

Much of the impetus behind G7 and BWI willingness to at least entertain discussions of transformative change comes from a combination of deteriorating economic conditions and more concerted advocacy from social and governmental leaders across the global South. The rise of Barbadian Prime Minister Mia Mottley as a climate advocate is emblematic of this dynamic. After her 2018 election, Mottley led debt restructuring negotiations with the IMF and subsequently became a champion of reform at COP26 in Glasgow in 2021. 

Mottley’s special advisor Avinash Persaud is now spearheading the Bridgetown Initiative, an agenda to reshape international financial policy to better serve the needs of the double vulnerable. The short list of proposed reforms could plausibly be initiated within the next eighteen months, before the next US presidential election cycle renews geopolitical uncertainty. It is designed to be palatable to G7 countries while scaling up much-needed financing as the debt and climate crises accelerate. 

The first version of Bridgetown released in September 2022 was something of an inkblot test. Some saw a complete system overhaul where others saw a call to merely accelerate processes already in motion. The proposal generated substantial discussion over the ensuing ten months, culminating in a new version circulated in May 2023.

Bridgetown 2.0 has six primary components:

  • Providing emergency liquidity after climate-related disasters
  • Restoring debt sustainability 
  • Expanding concessional lending
  • Mobilizing $1.5 trillion of private investment annually towards a green transition 
  • Changing the governance of international financial institutions to include equitable representation of global South countries
  • Reforming international trade to support clean development

As the leader of a country suffering the twin consequences of predatory debt architecture and the climate crisis, Mottley’s agenda has captured the attention of the main shareholders of both the World Bank and the IMF. As momentum gathered after the publication of Bridgetown 1.0, the Egyptian presidency of COP27 managed to include international financial reform in the summit’s final declaration with the G7’s support. In response, French President Emmanuel Macron announced the Summit on a New Global Financing Pact, which is set to take place June 22 –23 in Paris.

The heads of the BWIs and high-ranking officials from major economies are in attendance, as well as a vast contingent from the private sector. The new World Bank Group President Ajay Banga is among the key participants as discussion around the Evolution Roadmap continues, as is IMF Managing Director Kristalina Georgieva, who has been increasingly vocal about the need for higher ambition in some aspects of the IMF’s operations, particularly on climate.  

The summit has been explicitly framed as a signaling moment for the next eighteen months and will set the tone and ambitions of both the BWIs’ annual meetings and COP28 this fall, as well as Brazil’s Presidency of the G20 and the UN Summit of the Future before the end of 2024. In the run up, the French organizers have defined four working groups to deal with issues such as the need to allow for more public investment in heavily indebted countries, greater private sector investment in low-income countries, incentives for green infrastructure investment, and innovative financing solutions for climate vulnerable countries through mechanisms like debt swaps.  

As broad as the slate of topics is, the Paris Summit’s proposed deliverables are not particularly ambitious. They include a roadmap for broad MDB reform, state-contingent debt instruments that pause service requirements automatically in the case of disaster, progress on rechanneling Special Drawing Rights toward MDBs, and possibly the announcement of new just transition partnerships for energy. In other words, the expected results are mostly commitments to keep talking, coupled with a few stop-gap reforms that do little to address the polyvalent drivers of conjoined debt and climate vulnerability. 

Lessons learned

The limited scale of these potential outcomes in part results from treating debt as an issue parallel rather than fundamental to the global financial architecture. This is one of the main trade-offs of Bridgetown’s and Paris’s short-term approach—fundamental reform is impossible without changing debt architecture, but discussions on a debt workout mechanism are highly unlikely to wrap up before the next US election. 

BWIs, G7 countries, and the largest economies have failed to find a solution to the debt crisis even though negotiations started at the onset of Covid-19. This included the G20’s Debt Service Suspension Initiative of 2020, followed by the group’s Common Framework for debt restructuring proposed later the same year. Only three countries have used the Common Framework so far due to painfully slow debt restructuring processes and eligibility requirements. Debt-ridden Sri Lanka, for example, was excluded.

Meanwhile, the government of India in its capacity as head of the G20 launched the Global Sovereign Debt Roundtable alongside the IMF and the World Bank, aimed at bringing public and private lenders together to agree on common principles based on failed past restructurings. While discussions during the Spring meetings were claimed to be promising due to China’s willingness to drop down its stance on the preferred creditor status of international financial institutions in exchange for more concessional finance, the roundtable is not aiming for a debt workout mechanism proposal any time soon, despite this being a central demand of debt justice movements and some Southern governments. Mirroring problems of the Paris summit, the roundtable suffers from an opaque negotiating process that limits the participation of borrowing countries. 

The BWIs’ incrementalist approach risks further aggravating acute crises, and this is clearly demonstrated by the IMF’s Resilience and Sustainability Trust (RST), meant to address balance of payments issues arising from climate action. The RST is itself a consequence of a previous crisis response mechanism in the form of the extraordinary issuance in 2021 of $650 billion of SDRs to help member countries cope with the disruptions of the pandemic. But two-thirds of them ended up in global North countries’ reserves due to the IMF quota system. 

As the European Central Bank continues to prohibit Eurogroup countries from rechanneling their SDRs through MDBs, the rechanneling is limited to the IMF, which still lacks the expertise necessary to advise on climate policy, even as the rechanneling process is picking up speed. Seven arrangements have been approved by the board so far, with more than forty countries waiting in the queue and more than $34 billion have already been facilitated by fifteen countries. Some of these deals have included requirements for winding down fossil energy subsidies, one the policy conditionalities preferred by the IMF as it supposedly addresses both climate and macroeconomic stability, despite the disproportionate burden borne by the poor when these subsidies are removed. This has already triggered heated debates in Pakistan, Bangladesh, and Argentina, some of the largest economies under the IMF programs. Imposing harsh measures on RST recipient countries is consistent with the IMF’s continued failure to look beyond austerity for much-needed fiscal relief. These measures contrast the IMF’s own latest World Economic Outlook, which asserted that “fiscal consolidations do not reduce debt-to-GDP ratios.” 

“Innovative solutions” or systemic reform?

The message from the global South is clear: Countries need more fiscal space to accelerate climate action and cannot achieve their policy objectives through austerity. While global North countries have offered just enough concessions to keep their Southern peers at the table, including at the Paris summit, the gap between blocs nevertheless appears to be growing. As an example, while a G7 IMF Executive Director expressed support “in spirit” to the Bridgetown Initiative during the Spring meetings, she failed to support multiple concrete measures proposed in Bridgetown 2.0, including IMF governance reform and a new SDR issuance or the end of IMF surcharges.

The discussion around the international financial architecture is currently framed in terms of political feasibility for G7 governments. Even as the IMF calls for timely and efficient debt relief and the acceleration of effective concessional financing for low income countries, a comprehensive debt workout mechanism seems far away. This will lead to a repeat of the outcomes from the Heavily Indebted Poor Countries initiative, which, despite providing debt relief, saw participating countries return to debt unsustainability by the beginning of the twenty-first century in the absence of a debt workout mechanism and adequate non-debt development and climate financing.   

The conflicting objectives of urgent economic transformation and multilateral incrementalism will be on display in the many climate meetings to come, whether they’re a part of official agendas or carried out on the sidelines. As was the case with HIPC in the 1990s and more recently with the World Bank’s Evolution Roadmap, it is only global North countries that can kickstart reform. The prospect for a sudden burst of collective enthusiasm for these reforms seems dim given Europe’s intransigence on even modest SDR reform, despite the US’s nominal shift to a post-neoliberal approach to foreign relations that includes “evolving the multilateral development banks.” This shift appears to not have been communicated to US voting delegations at the BWIs, which continue to more narrowly pursue its geopolitical interests over structural reform that can enhance countries’ resilience to the various crises. 

The unequal response between Northern and Southern countries to the pandemic, the spike in energy and food prices after the Russian invasion of Ukraine, and the multifaceted climate crisis all underscore the need to create more resilient economies. Failing to frontload public investment in adaptation and mitigation will inexorably accelerate global progress in the opposite direction. Adjusting the role of the BWIs will be central to achieving equitable transitions in the fiscal and climate crises. The standstill on key issues and inability to contend comprehensively with those issues casts serious doubt on the prospects for transformational reform in the near to medium term.  

The Polycrisis is a publication focusing on macro-economics, energy security & geopolitics.

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