What is odious debt?
Odious debt, also known as illegitimate debt, occurs when the government of a country changes and the successor government is unwilling to pay the debts incurred by the previous government. Usually, successor governments argue that the previous government embezzled money it borrowed and that they should not be held responsible for the alleged wrongdoings of the previous regime.
Key points to remember
- Odious debt is a term applied to the debt of a predecessor government that a successor government wishes to repudiate for ostensibly moral reasons.
- Odious debt is not an established principle of international law, but it is often given as justification by the victors of a civil or international conflict to repudiate the debts of their defeated adversaries.
- The successful application of the concept of odious debt presents significant risk to investors in sovereign debt and may increase borrowing costs for countries under threat of regime change.
Understanding odious debt
Odious debt is not an officially recognized concept in international law. No national or international court or governing body has ever struck down sovereign bonds on the grounds of odious debt. The odious debt is clearly at odds with established international law, which generally holds successor governments responsible for the debts of the regimes that preceded them.
The concept of odious debt is most often evoked when the government of a country changes hands violently either by conquest by another country, or by internal revolution. The new government in such a situation is rarely willing to assume the debts of the defeated predecessor.
In addition to the simple desire to deleverage, governments may consider debt heinous when former government leaders used borrowed funds in ways the new government disagrees with, sometimes claiming that the borrowed funds did not benefit its citizens, and instead, may have -be used to oppress them. Indeed, it is common for the victors of a civil war or an international conflict to accuse the regimes they overthrew or conquered of corruption, abuse or general malevolence. As the saying goes, “winners write the history books”.
Despite international law, the concept of odious debt has been successfully used as an ex post justification when the winners of such disputes are powerful enough to enforce their will in global financial markets and international lenders. In reality, whether or not the successor regime is obligated to repay by the previous government’s creditors tends to come down to a question of who is more powerful. New regimes that gain international recognition or support from major military powers tend to be more successful in repudiating old debts.
Examples of odious debt
The idea behind odious debt first gained prominence after the Spanish-American War. The US government argued that Cuba should not be held responsible for debts incurred by the Spanish colonial regime, Cuba’s colonial rulers. While Spain disagreed, Spain, not Cuba, ultimately ended up with post-war debt, due to the balance of power between the triumphant colonial power of the states United States and the defeated Spanish Empire deprived of the last of its overseas territories after the war.
The odious debt has been raised as an argument by regimes in Nicaragua, the Philippines, Haiti, South Africa, Congo, Niger, Croatia, Iraq and other countries who accuse former rulers of either plundering personally the national funds for their own purposes, or to use the money to restrict freedoms and inflict violence on their own citizens. In all of these cases, the actual resolution or restructuring of old debt following regime changes followed geopolitical and strategic considerations rather than the proposed doctrine of odious debt.
For example, the apartheid-era South African government borrowed from banks and international investors to build dams, power stations and other infrastructure. When the African National Congress (ANC) took power in 1994, it inherited these debts. Many members of the successor government, led by President Nelson Mandela, argued that these debts were odious because of the social policies of the previous regime.
However, with the collapse of the Soviet Union in the early 1990s, which had strongly backed the ANC, the new South African government found itself lacking strong international allies who would be willing to back the repudiation of existing debt. In order to maintain access to international credit markets, the new government eventually paid off these debts, so as not to scare away badly needed foreign investment.
Foreign investment and odious debt
The prospect of regime change and the repudiation of contractual obligations from the previous regime presents a direct risk to investors dealing in sovereign debt. Investors who hold loans or bonds from an existing government run the risk that the funds will not be repaid if the borrower is overthrown or subjugated by another power.
In particular, because the concept of odious debt is generally applied retroactively to debts that were recognized and legal and legitimate at the time, but is also applied almost universally to the losers of an international or internal conflict, lenders cannot hold account only as part of the overall political stability risk of a borrower. This risk is embodied in a prime on the return demanded by investors, which will tend to be higher as potential successor governments become more likely to be able to sustain charges of odious debt.
Moral arguments and odious debt
Some jurists argue that, for moral reasons, these debts should not be repaid. Proponents of the idea of odious debt believe that lending countries must have known, or should have known, of the allegedly oppressive terms when offering credit. They argued that successor governments should not be held responsible for the odious debts that previous regimes bequeathed them.
An obvious moral hazard in labeling debt as odious after the fact is that successor governments, some of which may have much in common with those that preceded them, may use odious debt as an excuse to shirk the obligations that they should pay. A potential solution to this moral hazard, put forward by economists Michael Kremer and Seema Jayachandran, is for the international community to announce that all future contracts with a particular regime are odious.
Therefore, lending to this scheme following such decree would be internationally recognized at the lender’s risk and peril, as it would not be repaid if the scheme were subsequently overthrown. This would transform the concept of odious debt from a post-hoc rationalization allowing countries to repudiate their debts into a forward-looking weapon of international conflict as an alternative or prelude to open war. Rival powers and coalitions could then use the concept of odious debt to mutually restrict access to capital markets by accusing their adversaries of various wrongdoings, before launching a coup, invasion or insurrection.