New study from SPIA researcher highlights how domestic politics affects borrowing choices
Most governments worldwide borrow, for a variety of purposes. Countries in the Global South historically had fewer options for international credit, as they often were perceived by private sector investors as too risky. In the last two decades, however, the menu of options open to these countries has expanded. An important feature of contemporary global finance is the diversity of creditors who are willing to provide sovereign finance.
These creditors include multilateral financial institutions, such as the World Bank; bilateral official creditors (governments lending to other governments); bond market investors; and commercial banks. While much attention has been paid recently to China and its policy banks as sources of credit – during the last decade, China’s lending to sovereigns increased dramatically – governments’ portfolio of options often includes a variety of creditors and credit instruments.
What explains why governments with similar economic characteristics often make very different choices over creditors? In a paper published recently in International Studies Quarterly, Layna Mosley, a professor of politics and international affairs, and B. Peter Rosendorff of New York University highlight the importance of domestic politics within borrowing countries. The work uses data on a wide range of low- and middle-income countries and is complemented by a similar analysis of subnational government borrowing in Mexico.
Mosley and Rosendorff point out that much research on the political economy of sovereign finance has focused on the supply (creditor) side. Past analyses have considered how various lenders evaluate and price sovereign risk. Less attention has been paid to the demand (borrower) side, perhaps reflecting a long-standing assumption that Global South governments have little influence over the nature of their interactions with global capital markets.
They argue, however, that demand side features – the domestic political environment – play an important role, especially in an era when governments have more financing options.
“In this paper we focus on governments’ underlying propensity toward economic policy transparency,” Mosley says. “Across countries and over time, there is substantial diversity in how much information governments share about the state of their economy and financial system. This diversity is the result not only of governments’ capacity to collect data, but also of governments’ political willingness to supply it.”
These underlying preferences over transparency also affect the choice of credit instruments. Mosley and Rosendorff’s data analyses reveal that, even after accounting for a range of economic and financial factors, governments that are less inclined to transparency are more likely to borrow from commercial banks, versus via bond markets; and more likely to borrow from bilateral, versus multilateral, official creditors. Commercial banks and bilateral official lenders are typically less likely to reveal the exact terms of their lending, allowing those governments who hesitate to share information to keep the details of their borrowing activity from the public as well as from opposition parties. This reluctance to open up comes at cost, though – literally.
“Credit from more opaque lenders is often more expensive than credit from more transparent ones,” Mosley says.
The choices governments make are important over the life cycle of sovereign borrowing. Different forms of credit have different lending terms attached, both in terms of the costs of credit and in terms of non-economic (diplomatic, political, and social) conditions. Governments’ borrowing choices also are important when it comes to resolving debt crises.
“The International Monetary Fund estimates that approximately 60 low- and middle-income countries currently are in, or are at significant risk of, debt distress,” Mosley says. “The interest payments on debt may exceed spending on education, public health, climate-change mitigation, and other important development priorities, making the quick resolution of debt crises important.”
Diversity in creditors, however, can complicate the process of addressing debt crises, as different creditors are motivated by different considerations – financial as well as diplomatic.
“In the absence of a set of international procedures for addressing sovereign bankruptcy, the heterogeneity of creditor interests can lead to long delays in debt restructuring,” Mosley says. “The recent experiences of Ghana, Sri Lanka, and Zambia, among others, illustrate this point.”
Mosley’s ongoing research, under the auspices of the new Princeton Sovereign Finance Lab, seeks to understand further how borrower governments interact with their creditors. Among the topics she and her colleagues are investigating are the effect of debt to China on countries’ ability to restructure debt with other official bilateral creditors; the effect of the electoral cycle on governments’ willingness to repay or restructure their debt; the domestic and international political determinants of the pricing of bilateral official loans to governments; the reactions of bond market investors to news regarding government borrowing from China; and the effect of international bond market movements on voters’ assessments of political candidates. They are also exploring how best to measure governments’ transparency regarding their sovereign borrowing practices, as well as how to better incentivize private sector creditors to disclose their lending activities.