Listen to this article
Ukraine, the international community and its creditors will soon have to reach a conclusion about how to handle the country’s debt. The case for debt reduction is as strong as any that I have encountered over the past quarter century. How the issue is resolved will say much about the extent of international commitment to Ukraine and to resisting Russian aggression. Failure to achieve debt reduction would also confirm the view of those who believe that private financial interests disproportionately influence public policy.
Ukraine is in a state of quasi-war with Russia. Other former Soviet republics, as well as the nations of central Europe are watching anxiously. How this episode is regarded in history will depend as much on what is done for Ukraine as what is done to Russia.
This is especially true as Ukraine has its most reform-minded economic team since independence in 1991. It has shown real political courage in combating corruption and moving aggressively to curb energy subsidies that generated vast waste. Ukraine has done more in the past 12 months to reform its subsidies than most nations do in 12 years.
The moral, geopolitical, and economic case for the provision of strong support is compelling. The International Monetary Fund has done as much as can reasonably be asked with a programme totalling $17.5bn. While bilateral support from the US and Europe could be increased and the World Bank is missing a major opportunity, Ukraine’s viability ultimately depends on what happens to its debts.
The question of debt rescheduling or reduction is not a new one. When countries require assistance, it can always be argued that debt service obligations be delayed or partially cancelled. Usually — as in the case of European countries in recent years, or Asian countries during the 1997 financial crisis — this argument is rejected. The grounds are that with proper adjustment countries can meet their obligations, maintain access to markets and restore growth. Also, a world in which countries were willy nilly encouraged to default in order to meet budget obligations would be inimical to the effective flow of capital.
Over the years a number of international norms have evolved as to when it is appropriate to accept debt reduction. The most important is when a country’s debts are sufficiently large and its prospects sufficiently poor that there is no realistic prospect of repayment. Things become clearer when debt reduction would not be a source of systemic risk to the financial system or license widespread defaults.
All of this suggests a compelling case for debt reduction for Ukraine. The IMF has made clear that for its finances to be sustainable Kiev needs to reduce its current debt service payments and to avoid an excessive build-up of debt over the next five years. On even optimistic assumptions of Ukrainian economic performance and the avoidance of further conflict, this is not possible without debt reduction. Ukraine’s debt is not nearly large enough for a reduction to pose a threat to the world financial system. And why not set a precedent that if you lend money at a high spread to a country that is then invaded, you should not expect the world’s taxpayers to ensure that you are paid back in full?
So Ukraine’s debt should be reduced. Will it happen? Despite the merits, it is not clear. Ukraine’s creditors— led by the investment firm Franklin Templeton, but also with the support of a number of major US fund managers, who are sufficiently embarrassed by their selfish and unconstructive position that they avoid public identification — are playing hardball and refusing any write-offs. Understandably, if there are a substantial group of such free riders, other debt holders including the Russians will not accept writedowns.
It should be unacceptable to taxpayers around the world that their money be put at risk on loans to Ukraine in order that plans be made to pay back creditors in full. The IMF and national authorities should call out the recalcitrant creditors on their irresponsible behaviour. If necessary, Ukraine should be prepared to go into default and not meet its obligations, while at the same time the international community should make clear that it will continue to provide support to Kiev. In the context of these steps, creditors will have little choice but to accept the economic reality of the situation.
There is much in Ukraine that the rest of the world cannot control. But we can make sure that the country’s scarce resources are put to use restoring its economy rather than paying off those who made loans they now regret. And we can seize the opportunity to make clear that the world financial system will be operated to support the global economy not the other way round.
The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary