CORRUPTION AND THE GLOBAL DEBT CRISIS

From a discussion hosted by the Terrorism, Transnational Crime and Corruption Center (TraCCC) at George Mason University on May 15, 2024. Moderated by Dr. Gergana D. Yordanova, PhD, a Fullbright research fellow at TraCCC from Bulgaria. Speakers - David Malpass, former President, the World Bank, and Frank Vogl, co-founder of Transparency International and the Partnership for Transparency Fund.

 Frank Vogl’s remarks.

 Introduction

 The World Bank’s December 2023 International Debt Report found that about 60 percent of low-income countries are at high risk of debt distress or already in it. David Malpass pointed out in our discussion today that while total concessional grants to the poorest nations from the International Development Association (IDA) amount to $23 billion, the total outflows from the IDA-recipient countries to services their foreign debts total about $29 billion.

 The combination of debt-serving costs, acute debt distress in many developing and emerging market countries, and illicit outflows of cash from these countries, is creating an acute development crisis. I share Mr. Malpass’s view that it is critical that these countries secure investment-led economic growth and that the prospect is bleak so long as the current debt distress situation prevails. Making the situation all the more dire is the perspective that Mr. Malpass has noted: “The international debt system is primarily organized to protect creditors rather than encourage development.”

 Today, I want to focus in particular on the current system of international sovereign debt, concerns about the behaviors of both borrowers and lenders, reforms that are urgent, and, in this regard, the key roles that civil society organization in debtor countries can and should be playing. 

 Historical lessons

 Ever since the emergence of banks in medieval Italy there has been a persistent and important relationship between banks and governments. Governments go into debt. Banks find ways to finance them, then refinance them.

 The governors of Sienna, then the financial capital, worried greatly in the 1330s about morality and banking and, accordingly commissioned the artist Ambrogio Lorenzetti to paint a giant mural titled The Allegory of Good and Bad Government.

 Mindful of these ancient concerns I was delighted that David Malpass noted in a paper published by the Hudson Institute in March that governments of developing countries should, among other things, and I quote:

·     improve the business enabling environment and rule of law; 

·      increase debt transparency and sustainability.

 Just as the nobles of Sienna worried about bad governments, so we need to do so today. It is striking that vast sums of cash are provided to governments that lock-up scores of journalists and civil society activists, have terrible human rights records, believe in press censorship, and repeatedly attain really bad scores on indexes of corruption.

 We should not be surprised if some of these governments steal large amounts of public funds and that such thefts contribute, in time, to the countries defaulting on their debts. Corruption may not be the prime cause of the defaults - but it is a contributor that the International Monetary Fund (IMF), the World Bank, and private creditors and their rating agencies, too often overlook.

Those men who ran the financial activities of Sienna were not only concerned about the ethics of the borrowing governments - they worried about the morality of the lenders.  Ironically,  John Pierpoint Morgan, the most successful and one of the most ruthless bankers of the late 19th century, amassed many ancient manuscripts in his library that dealt with this topic - recently, the Morgan Library Museum in New York held an exhibition called “Medieval Money, Merchants and Morality.”  

The prevailing culture in too many banks through the ages has been dominated by greed and an exclusive focus on profit. Today, this remains all too prevalent. Too many of the financiers and banks engaged in underwriting and investing in sovereign bonds are not driven by an ethical culture, but overwhelmingly by the prospects of high commissions, and the reach for yield, especially at times when bonds issued on behalf of developing and emerging market countries offer far better returns than US Treasuries.  These institutions repeatedly fail to do the due diligence that would determine whether the borrowing country has the capacity over time to fully service and repay its debts.

 Loans to Kleptocracies

Providing access to the capital markets to governments that have records of exceptional kleptocracy incentivizes corruption and offers the prospect of eventual debt distress.

I first became involved in debt restructuring after Mexico, then other Latin American countries and the Philippines that defaulted in the 1980s. I served at the World Bank at that time. More recently, on consulting to the Institute of International Finance, I was involved in Greece’s record debt restructuring. In every case, the record of corruption in the defaulting countries has been, and continues to be, striking, and yet these governments borrow vast sums from the international capital markets.  I call it klepto-debt.

 Critical Debt Issues Now

Let me illustrate some of the key issues key issues dominating the international debt landscape: 

·      Public sector creditors - China is the largest today, directly through government-owned entities and through corporations that receive substantial government backing. China is the largest creditor to sub-Saharan African countries. Many of China’s deals involve fast disbursing cash in return for contracts that can secure control of a country’s natural resources for years to come. Other contracts involve infrastructure developments run by Chinese companies. Many of the loans are of a more standard type. But we really do not know. Most of the terms and conditions of the loans are kept secret. If there were kickbacks to officials to accept terms on these deals, well, we will never know. Opacity is the name of the game in a great deal of Chinese foreign lending.

 ·      Private sector lenders, notably banks issuing sovereign bonds, have at times engaged in outright fraud - as Credit Suisse did in a $2 billion bond deal for Mozambique; as did Goldman Sachs did in a $6 billion bond deal for Malaysia. All too often, the rating agencies have ignored corruption when assessing risks associated with sovereign bond issues. Banks underwriting the bonds have similarly ignored corruption and focussed solely on the yield that can be secured. They ignored years of fraudulent public budget accounting in Greece before that country, owing $270 billion on its bonds, defaulted. The banks have repeatedly ignored corruption and economic mismanagement in Argentina, which has defaulted nine times. The reach for yield has pushed serious risk management aside time and again.

·      Now, the banks and the investors have taken comfort in the fact that at the center of the system is the IMF. While it approved a robust anti-corruption framework in 2018, it has rarely deployed it when it comes to enforcing conditions in its credit arrangements to bail-out defaulting countries. Its actions are often beyond comprehension. It created a vast credit line for Argentina - the country owes the IMF $44 billion and will never repay it. The IMF was discussing a $3 billion bail-out for Egypt as it was on the verge of default, then at the end of March it suddenly announced a $8.2 billion loan. Why it should so swiftly boost the loan by so much has not been adequately explained by the Fund, especially as it coincided with an $8 billion grant to Egypt from the European Union also in late March, and a fast-disbursing $35 billion investment fund for Egypt from the government of Abu Dhabi, also in March.  Too often, one gets the impression that powerful political forces, rather than economics, determines the Fund’s decisions. The result is that, for example, the citizens of Egypt and Argentina will face years of hardship as their governments seek to reduce their currently huge foreign debt burdens.

·      The current system is one where the IMF, and arguably other multilateral financial institutions, fail to adequately monitor how their member borrowing countries manage financial inflows. The IMF failed to discover massive thefts of funds and mismanagement at the central bank of Lebanon, which has been a critical factor in the debt default and economic depression in that country; it failed to see the huge multi-billion dollar thefts from the 1MDB development fund by the President of Malaysia, his cronies and their Goldman Sachs associates; it repeatedly fails to focus on corruption in Pakistan, which is constantly flirting with default; just as it so often turns a blind eye to the malfeasance that has wrecked Nigeria’s economy time and again.

·      The World Bank, while investigating corruption in public procurement associated with its own funds, has repeatedly been silent about the scale of kleptocracy in so many countries to which it provides loans and grants. Today, the World Bank is widely viewed as having reduced the priority that it once claimed for seeking to curb corruption. 

 Not only should there be a far greater focus on anti-corruption by sovereign borrowers and by creditors alike, but we need to be innovative. For example, Transparency International Sri Lanka and other NGOs in that country developed a list of anti-corruption reforms that it wanted the IMF to include in its bail-out conditions for the country. At first the IMF ignored the requests, but changed its tune when TI managed to draw the attention of these issues to members of the US Congress and senior officials at the US Treasury. The agenda that is resulting is impressive. The IMF responds to political pressure and civil society organizations need to use the Asri Lanka model to ramp-up their efforts to influence IMF programs.

One interesting idea, emerging from the Sri Lanka initiatives, is the floating of new sovereign bonds tied explicitly to governance reforms. Governance bonds could be attractive to investors because solid actions against corruption could lower borrowing rates and trigger inflows of investment vital for economic growth.

 Promoting Civil Society

A broader initiative could see in-country civil society organizations (CSO) playing a far larger partnership role with the World Bank, especially with its IDA affiliate, in monitoring the disbursement of aid to ensure transparency, accountability and sustainability.

Professionally managed CSOs are now in place in many countries, but their services cannot come free. IDA should allocate a tiny percentage of its funds - perhaps two percent - to establishing a funding facility for CSOs to play an essential role in seeking to secure the efficiency and integrity of aid inflows. A detailed report on how this system can work has been published recently by the Partnership for Transparency Fund.

Money Laundering

In conclusion, permit me to make a broader point about sovereign debt, and international capital flows.  The Nasdaq Verafin 2024 Global Financial Crime Report, recently stated: “In 2023, an estimated $3.1 trillion in illicit funds flowed through the global financial system. Money laundering accounted for trillions of dollars funding a range of destructive crimes, including an estimated $346.7 billion in human trafficking and $782.9 billion in drug trafficking activity, as well as $11.5 billion in terrorist financing.”

The U.N. Conference on Trade and Development has estimated that illicit flows of cash from sub-Saharan Africa exceed $85 billion – close to double the total amount of foreign aid flowing into the region. The World Bank and the IMF are irresponsible in failing to work much harder to counter the dirty money flows and recognize the scale of the problem and the damage produced by these flows to the prospects of middle-and low-income countries.

Raymond W. Baker, the founder of Global Financial Integrity, has written about the grave threat to democracy and security that is posed by the failure to counter dirty money in his most recent book, INVISIBLE TRILLIONS.  Professor Louise Shelley, our host today and the Director of the George Mason TraCCC program, has explained the complexities of corruption and dirty money in her outstanding book - which is required reading by my students - DIRTY ENTANGLEMENTS.  There are other important books on the subject of our discussion today - it is time that their conclusions be taken seriously by the leaders of the IMF, multilateral development institutions and the underwriters of sovereign bonds. 

Too much of the foreign debt provided to developing countries is stolen - if we fail to acknowledge this and fail to do something about this, then the scale of debt distress over time will become greater.  And we dare not fail to address the current debt restructuring systems that favor the creditors and, as a result, can so often leave the borrowers facing years of low growth and sharply reduced anti-poverty programs.

 

Thank you.

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