Sovereign (over)borrowing during the COVID-19 pandemic: Do creditors have a responsibility to prevent unsustainable debt situations?

The coronavirus disease 2019 (COVID-19) pandemic has prompted across the world massive state intervention for the containment and management of the epidemic, and the mitigation of its socio-economic consequences. The measures so far adopted by many countries are not only indispensable to avert a dramatic deterioration of living conditions (especially for women and the most vulnerable) and inequality within and across countries. Their prompt adoption is also mandatory, under international law, in light of the state obligations to realise the human right to health (Art. 12 of the 1966 International Covenant on Economic, Social and Cultural Rights and Art. 11 of the European Social Charter (Revised 1996)) and, more generally, to take steps to achieve progressively the full realisation of all economic and social rights (Art. 2(1) ICESCR), including the rights to work, social security, adequate standard of living and education (Arts. 6, 9, 11 and 13 ICESCR) threatened by the very economic consequences of the pandemic.

These measures are currently demanding exceptional public spending and financing efforts, which many countries, including several advanced economies, are able at present to fulfil only through additional borrowing and, in the case of euro area Member States, by necessarily deviating from EU fiscal targets. According to the European Commission 2020 spring forecast, the negative economic effects of the pandemic (EU GDP is forecast to contract by about 7½% in 2020, far deeper than during the 2009 Global Financial crisis) together with the countercyclical measures adopted by the Member States, are expected to widen the euro area fiscal deficit to around 9% of GDP in 2020. This implies “a deterioration of public debt positions, with significant debt increases”, in some cases to alarming levels (e.g. for an overview of Italy’s position, whose debt is forecast to rise from 134.8% of GDP at the end of 2019 to 158.9% in 2020: see Scali, ‘Sovereign Financing During the COVID-19 Pandemic: The Debt Implications of Italy’s Socio-Economic Measures for 2020 and the Response of the European Union’ in Acconci and Baroncini (eds), Gli effetti dell’emergenza Covid-19 su commercio, investimenti e occupazione – Una prospettiva italiana, AMS Acta – AlmaDL, University of Bologna, 2020).

It must also be noted that, with the exception of (part of) a possible Recovery Fund (not yet agreed upon), the new mechanisms so far established at the EU level to assist the Member States with their exceptional financing needs – i.e. the ECB’s Pandemic Emergency Purchase Programme (PEPP), the ESM’s Pandemic Crisis Support and the Art. 122 TFEU-based European instrument for temporary support to mitigate unemployment risks in an emergency (SURE) – all rest on the offer of (further) loans, thus suggesting that, the pandemic notwithstanding, there seems to be no alternative to (more) debt.

Do creditors, including international organisations and their Member States, have a responsibility to prevent unsustainable debt situations?

As is well known, international law is very much underdeveloped in regulating sovereign financing, “whether we focus on treaties, customary law, or case law” (Esposito, Li and Bohoslavsky, Sovereign Financing and International Law, OUP 2013, p. 4). Especially since the Global Financial Crisis, however, there have been increasing attempts to fill this normative gap by extrapolating relevant principles and rules from existing domestic laws and practice, international (human rights) law and, more generally, from principles governing international relations. These have been outlined in a number of soft law instruments – for example, the UNCTAD Principles on responsible sovereign borrowing and lending (2012), the Guiding Principles on foreign debt and human rights (2012), the Basic Principles on sovereign debt restructuring processes (2015), and the Guiding Principles on human rights impact assessments of economic reforms (2018). These instruments are not intending to create new rights or obligations under international law, but ultimately to “persuad[e] and influenc[e] the conduct of states and other subjects on sovereign borrowing and lending” (whether they have managed, so far, to do so is uncertain) (Esposito et al., supra).

Sovereign over-borrowing/-lending (assuming that this ‘over-’ can always be unambiguously defined, see infra) is not per se prohibited under international law. Nonetheless, the systemic risks of such a practice are nowadays well-acknowledged, and the idea that “creditors and debtors must share responsibility for preventing unsustainable debt situations” (UNGA Res. 65/144, para. 3) has made its way in the practice of international institutions such as the UN, the IMF and the World Bank, representing a considerable majority of the international community (see also Addis Ababa Action Agenda, 2015, para. 97). The legal contours of the creditors’ responsibility to prevent, though, remain uncertain.

The principle of prevention, requiring states and other relevant international actors to take all available measures not to cause harm to the environment, persons and property, also beyond national jurisdictions, was initially developed in the context of environmental law and progressively accepted in several multilateral treaties (including some human rights treaties and the 1948 genocide and 1984 torture conventions), and is deemed today to correspond to customary international law certainly in relation to environmental protection. In the context of sovereign financing, however, given the above-mentioned scarcity of international rules and practice, prevention is still to be regarded as a ‘guiding principle’ aspiring to influence the conduct of relevant actors and the development of international law. At present, all that the creditors’ ‘responsibility to prevent unsustainable debt situations’ can be said to entail as a matter of legal obligation, is a due diligence duty to undertake, prior to lending, a comprehensive, objective and reliable assessment of public debt sustainability (defined as “a situation in which a borrower is expected to be able to continue servicing its debts without an unrealistically large future correction to the balance of income and expenditure”, see IMF, Assessing Sustainability, 2002, para. 7). The responsibility of lenders (be they private or public, bilateral or multilateral) “to make a realistic assessment of the sovereign borrower’s capacity to service a loan based on the best available information and following objective and agreed technical rules on due diligence and national accounts” is acknowledged by the UNCTAD Principles (Principle 4, ‘Responsible Credit Decisions’), and confirmed by the practice of the IMF, the World Bank, and the European Stability Mechanism (see Article 13(1)(b) ESM Treaty), where debt sustainability is a key requirement for the provision of financial support and, in the case of the IMF, also bears important consequences for any decision on the necessity of a debt restructuring prior to the provision of assistance.

To assess debt sustainability, these and more generally all financial and fiscal monitoring institutions adopt diverse methodologies, the definition of which can entail “a fair amount of discretion[, …] a balance between art and science, with slight adjustments potentially altering binary [i.e. sustainable/unsustainable] outcomes” (Rediker and Crebo-Rediker, ‘COVID-19 uncertainty and the IMF’, 14 April 2020). Furthermore, in recent years, EU institutions and some Member States in particular have supported, on more than one occasion, the ‘flexibilization’ of existing fiscal rules, including on the pre-requisite of debt sustainability, so as to align the law to the political necessities of the moment. For instance, in order to participate in the financial assistance provided to Greece, in 2010 the IMF was pressured to amend its requirement of “a high probability of public debt being sustainable in the medium term” for providing exceptional access SBA financing, to include circumstances where “there are significant uncertainties that make it difficult to state categorically that there is a high probability that the debt is sustainable over [the medium-term] [… but] there is a high risk of international systemic spillovers” (pp. 426-427).

In preparation for the activation of a Pandemic Crisis Support by the ESM, the European Commission has recently assessed the public debt sustainability and COVID-related financing needs of euro area Member States, concluding that “notwithstanding risks, the debt position remains sustainable in all euro area Member States over the medium-term”. The Commission has, however, overtly acknowledged that “[p]articularly large uncertainties surround the current set of projections” (p. 9). More generally, all financial and fiscal monitoring institutions are cautioning about the potential unreliability of current forecasts, as they depend “on factors that interact in ways that are hard to predict, including the pathway of the pandemic, the intensity and efficacy of containment efforts, the extent of supply disruptions, the repercussions of the dramatic tightening in global financial market conditions, shifts in spending patterns, behavioural changes […], confidence effects, and volatile commodity prices” (IMF, World Economic Outlook, April 2020, Chapter 1). There is a concrete risk, in other words, that, also because of the ostensible political impossibility of agreeing on any form of non-debt-based assistance, creditors are “attempting to define as ‘sustainable’ what could more fairly be classified as ‘uncertain’”, and current debt sustainability analyses are “tilting more heavily into art over science, so as to attain the desired outcome of providing necessary support” (see Rediker and Crebo-Rediker, supra).

What if these analyses should turn out to have been too ‘optimistic’?

As in the case of Greece – where the tangible failures of the Economic Adjustment Programmes led the IMF to admit that it had “had misgivings about debt sustainability”, and that the “tension between the need to support Greece and the concern that debt was not sustainable with high probability” had commanded the “lower[ing of] the bar … in systemic cases” – international financial (and EU) institutions may find themselves, once the health and economic emergency and the current state of ‘legal exception’ will be over, in the position of having to revise their judgement. Besides the practical implications of an ex post realisation that debt was actually unsustainable (i.e. the potential losses for the financing institutions, such as the ESM, and for the private sector if involved, and the costs of an eventual default for the country in question and for the euro area as a whole in case of contagion), precisely because of the speculative nature and the amount of discretion involved in debt sustainability analyses, the possibility to prove ex post that creditors have not observed expected standards of due diligence in carrying out their assessments (i.e. an actual violation of their duty of conduct) seems scant. This certainly raises a problem of accountability of international organisations before their Member States and international investors, and the risk that reservations on the reliability of past debt sustainability analyses might be used by some (creditor) Member States to contest the organisation’s assistance-related decisions before jurisdictional (including constitutional, as in the recent case of Germany) fora, and by other (possibly over-indebted) Member States to argue, as Greece has done in the past, for the non-repayment of their financial obligations and the necessity of debt relief.