Paris Club and Sovereign Debt Restructuring

More than a century ago, debt restructurings involving the interventions of foreign governments were arranged for countries like Greece and the Ottoman Empire. These sorts of arrangements were rare though. In the second half of the 20th century, the number of independent countries grew as did their access to foreign credit. The result was more frequent sovereign debt restructurings than ever before. While not originally intended as such, a meeting of creditor countries in Paris became the permanent venue for arranging such restructurings, the Paris Club.

Three Days in Paris

The Paris Club came into existence in 1956. That year, Argentina needed to be given more time to make payments on its foreign borrowings or it would default on its debts. To assist in preventing this, the government of France arranged a meeting between representatives from Argentina and its foreign-government creditors.

Governments are party to other countries’ debt restructurings because states often owed money to official creditors, that is to say foreign governments and their respective agencies. A common official creditor would be an export credit bank, a financial institution established by governments to finance foreign purchases of local products in order to enhance exports. In any case, the meeting in 1956 lasted three days and it was not expected to be the founding moment of a new international financial organization, yet this is what it became.

Pre-1980

A few more debt restructurings came up after Argentina’s so the Paris Club convened again, such as in the case of Indonesia in 1966. Other Asian countries with debt restructurings prior to 1980 in which the Paris Club was involved include Pakistan, Turkey and Cambodia. In sum, between 1956 and 1978, the Paris Club conducted twenty-six negotiations with twenty-four countries. Considering there were just about 150 independent countries at the end of this period, this was a fairly brisk pace of activity.

Outside Asia, most restructurings were for Latin American governments like those of Brazil, Chile and Peru. Financial stress in this era was often the result of balance of payments crises. These were often temporary problems and, as a result, did not result in write-offs of debt but only rescheduling of payments to alleviate short-term problems. After the mid-1970s some African countries, including some that had hardly been independent for long, approached the Paris Club for relief. This wave started with Zaire in 1976 which was succeeded by restructurings for Sierra Leone, Togo, Sudan and Liberia. It was around this point that the Paris Club began to evolve into what exists today.

A permanent secretariat was established in Paris in the late 1970s, turning the Paris Club into a formal international organization with a permanent staff, albeit one tied to the French Treasury, whose officials led meetings. Today, there are typically about ten such meetings a year. Basic principles came to be developed in this early period; they were solidarity, consensus, conditionality, case-by-case restructuring, and comparability of treatment across creditors. These principles survive to today and are intended to ensure creditors are treated equally both within and outside the Paris Club and that debtors are put on a course towards renewed fiscal health.

Typical arrangements at the time included a rescheduling of debts coming due into new ten-year repayment periods with a three-year grace period. From here, the specifics could be negotiated on a case-by-case basis. During this period, the International Monetary Fund would be involved in adjusting the fiscal and economic policies of defaulting countries. Typically, an agreement with the IMF must have been reached before the Paris Club reschedules debts at all. This structure became known as the ‘classic terms’ of the Paris Club, turned to routinely at this time for several debtors. A parallel venue for restructuring talks among privately-held debt was established by private creditors, the London Club.

Debt Crises Around the World

The frequency of sovereign debt crises was about to pick up markedly. In the 1970s, the surpluses of oil-exporting countries were invested in sovereign debt. Banks had also made more loans to developing countries. The ‘recycling’ of oil money ended with sliding oil prices in the 1980s and this withdrawal strained the public finances of many countries.

After 1980, debt crises became more common, starting with a Mexican default in 1982. Thereafter, many other African, Latin America, Asian, and Middle Eastern countries entered into debt restructurings. This wave of restructurings even included communist Central and Eastern European countries like Poland, Yugoslavia, and Bulgaria.

In the 1980s, the Paris Club reached 134 debt agreements across forty-nine countries. In inflation-adjusted terms, the amount of debt subject to restructuring in that decade was four and a half times greater than in all pre-1980 restructurings taken cumulatively. The situations that arose in the 1980s were not just larger but also more complex than earlier debt crises. As just one example, more of the debt of troubled countries was owed to private, and not government, creditors; thus, Paris Club creditors made up a smaller share of debt and could not, by themselves, ensure countries were put on a sounder fiscal path.

The changing circumstances of many distressed borrowers meant that the ‘classic terms’ used prior to the 1980s became insufficient. Some countries needed longer repayment periods and starting with Mauritania in 1987, the ‘Venice terms’ permitted countries to reschedule repayments over longer periods of time. The next year, terms negotiated with Mali included the cancellation of debts. Restructurings with debt cancellations, or ‘Toronto terms’ as they came to be known, became commonplace thereafter.

Twenty countries were granted ‘Toronto terms’ by the Paris Club between 1988 to 1991 alone! These terms were generally reserved for the poorest debtor countries though. Starting from the late-1980s, very poor countries, rather than the middle-income countries that had encountered trouble before, became more common subjects of Paris Club restructurings. In the next decade, some debt cancellations became very large. In the 1991 case of Nicaragua, 50% of the country’s debt was cancelled. Still larger debt cancellations have been called for in some cases since then, but this option was considered for only the poorest countries.

Modern Challenges

The Paris Club has grown but has never been busier and yet, it often lacks the ability to resolve all cases of distressed sovereign borrowers. Creditors from countries outside the Paris Club are more significant today, most notably China which increased its sovereign lending in the 2000s and 2010s. This means that Paris Club members make up an even smaller share of debtor countries’ debts. They cannot therefore solve fiscal problems between themselves and the country in question; other parties outside the club have an interest too.

While China remains outside the organization, there are still more Paris Club members than ever before. Some past defaulters who had turned to the Paris Club in prior decades, like Brazil and Russia, have even become regular Paris Club members. There were twenty-two regular members by 2021 though some other countries participate in specific restructurings from time to time.

To reflect the importance of China, a non-Paris Club creditor, the G-20 created a framework for debt relief, but it has been put to comparatively little use. This framework has also proven to be very slow at times compared to Paris Club restructurings. Further, China has often eschewed the very G-20 framework it had a role in formulating and often declines to participate in Paris Club restructurings also, preferring to negotiate bilaterally with debtor countries. China holds about one-fifth of low-income country debt as of 2018; if the Chinese refrain from reaching an agreement with debtor countries, Paris Club creditors and others become less willing to offer assistance because they demand concessions from other creditors alongside their own.

As much as debt restructurings became more common in the 1980s and 1990s, they became even more commonplace still in the 2000s. This was partly the result of yet another framework for debt relief, the ‘Evian approach’, which provided debt reductions to middle income countries on a more tailored basis than past frameworks which also only focused on the poorest countries. Relatively large and very customized debt restructurings were arranged for Iraq in 2004 and Nigeria in 2005. The former entailed an 80% debt write-down and the latter a 60% write-down.

Natural disasters have also triggered relief more recently, like in the case of the 2004 Boxing Day Tsunami for Indonesia and Sri Lanka and the 2010 Haiti earthquake. Haiti is a very poor country and it has been the case that the average income of countries undergoing Paris Club restructurings has been falling. By 2021, over 470 agreements addressing over $500 billion in debt have been reached through Paris Club-arranged restructurings, involving a diverse array of terms. Countries receiving debt relief tend to exhibit reductions in poverty and income inequality and accelerating GDP growth in per capita terms after the write-down. However, countries that only receive a rescheduling of payments, rather than reductions in debt, unfortunately tend not to observe these positive results.

Lesson

Countries subject to restructurings of debt with the approval of the Paris Club have often seen positive economic developments in the immediately succeeding years. However, there are some obvious signs of shortcomings. For one, the organization cannot always secure cooperation from all of a debtor country’s major creditors, this can slow down or entirely derail restructuring efforts; yet no new body has replaced it, and such a development would not look more promising by itself.

Why? Well, the Paris Club has had to address fiscal issues with the same borrowers numerous times and the frequency of fiscal crises increased between the 1980s and 2000s and this despite more generous terms being given. Perhaps more time must pass to render judgement but persistent trade, climate, political, and geopolitical complications do not augur well.

More from the Tontine Coffee-House

Read about international involvement in the public finances of Egypt, Greece, and the Ottoman Empire in the late 19th century. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.