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It would be easier to laugh at the brazenness of Mozambique’s tuna bond scandal if the consequences hadn’t been so awful — costing one of the world’s poorest countries the equivalent of an entire year’s economic product and plunging an estimated 2mn people into poverty.
The saga highlighted one of the biggest problems when it comes to sovereign debt in the developing world: how much of it can lurk in the shadows, unrecognised until it blows you up.
This is why “debt transparency” has become a hot topic in the sovereign debt restructuring world, with various proposals floating around in recent years for how to enforce standards of disclosure.
One of the most comprehensive treatments of the subject that Alphaville has seen is this working paper published by the IMF’s legal eagles yesterday. Here the Fund lays out the issue nicely, with its emphasis below:
Hidden, undisclosed, and opaque debt is not a theoretical matter and can be costly for debtors, creditors, citizens and the system as a whole. The costs are well-known undisclosed debt can undermine debt sustainability and investor confidence and increase borrowing costs. Lack of full and accurate information about a country’s outstanding debt and contingent liabilities prevent both borrowers and creditors from properly assessing risks and making informed borrowing and lending decisions. Debt opacity also complicates debt restructuring efforts, as debt service capacity and risks of debt distress are all the more difficult to assess. At the extreme, massive amounts of unaccounted public debt can shock an economy when exposed. This, in turn, harms ordinary people who suffer the effects of a weakened currency, spiralling inflation, and the austerity inherent in any debt restructuring. Accountability, too, collapses without accurate information about the use of public resources, increasing the risks for corruption.
The paper focuses on the domestic legal obstacles to debt transparency, surveying 60 jurisdictions to show — deep breath — “weak reporting obligations, limited coverage of public debt, inadequate monitoring, unclear borrowing and delegation processes, unfettered confidentiality arrangements and weak accountability mechanisms”:
Debt opacity burdens the public and can exacerbate debt vulnerabilities in many countries. Both low-income and developing countries and emerging market economies have critical gaps in debt transparency, and the implementation of international standards and guidelines has lagged.
. . . Because laws entrench practices and bind the discretion of policymakers and debt managers alike, subjecting them to public scrutiny, legal reform is a necessary part of any solution to the problem of hidden debt, though it may entail a difficult and time intensive process in many jurisdictions.
Alphaville would add that debt transparency shouldn’t just be a focus in emerging markets. While the tuna bonds case was extreme, there are many countries on the hook for vast sums that don’t show up plainly on the sovereign balance sheet.
Webs of guaranteed debts often on state-linked entities or supplier credit agreements can often cause headaches in developed countries as well. For example, Greece discovered how painful this could be back in 2010–12, when it emerged that a smattering of agencies like the railway system had borrowed another €10bn that was guaranteed by the state but not counted in its public debt burden.
Rather than learn the lessons from this, many European countries with high direct government debt burdens have instead increased their issuance of guaranteed bonds that don’t show up in debt-to-GDP ratios, as this 2014 paper by occasional Alphaville bloggers Lee Buchheit and Mitu Gulati pointed out.
It’s not just dodgy players who aren’t being fully transparent either. Last summer the Debt Justice lobbying group said that only two international banks had disclosed six loans for a total of $2.9bn under the IIF’s “voluntary principles for debt transparency”, but that it had found another $37bn of undisclosed loans from 19 banks.
The IMF published a good round-up on various debt transparency initiatives floating about last summer, but as yesterday’s paper highlights, “full implementation of international standards and guidelines in domestic legal frameworks is significantly inadequate”:
Cognizant of the scale and scope of the problem, international standard setting bodies have promoted debt transparency, but critical implementation gaps remain. Clear and detailed guidance on public debt disclosure can be found in international standards and guidelines for sound public debt management, fiscal transparency, and statistical reporting.
As a complement, several public and private sector initiatives aim to promote creditor disclosure of transaction-level financial information through voluntary adherence (eg, G20 Operational Guidelines on Sustainable Financing and IFF Voluntary Principles for Debt Transparency). Despite all these efforts, critical implementation gaps remain, particularly in LICDs and EMs. Limited coverage of debt reporting, under-reporting of local governments, EBFs, SSIs, SOEs, and misreporting on complex debt instruments comprise the most urgent challenges.
. . . A survey of sixty jurisdictions identified several shortcomings in domestic laws. The coverage of public debt is often limited to government securities and loans, which excludes more complex instruments (eg, supplier credit agreements, accounts payable) that must be classified as liabilities in the balance sheet.
Further, alignment of domestic accounting and statistical practices with international standards is generally deficient and not required by law. Reporting and dissemination requirements are scarce or inadequate at best. A bare minimum of laws requires the disclosure of loan-level information of the terms of debt contracts.
More broadly, weak borrowing frameworks for entities outside the central government, unclear delegations of borrowing powers from the Minister of Finance down, fragmented institutional arrangements for debt data collection and disclosure, and the absence of proper monitoring and oversight further hamper debt transparency.
One solution that Alphaville is taken by is to make the IIF’s voluntary principles de facto mandatory.
The UK and the US — under whose jurisdiction the vast majority of international bonds are issued — could pass laws stipulating that only debts transparently disclosed and formally registered with the IMF as a state liability will be considered valid and legally enforceable.
That would mean that any creditor buying non-disclosed debts would have zero creditor protection and face a full wipeout if the sovereign debt poop hits the fan. It won’t eliminate the problem, but it would help.
