What Is Odious Debt?

Odious debt, also known as illegitimate debt, is when a country's government changes and the successor government does not want to pay debts incurred by the previous government. Usually, successor governments argue that the previous government misappropriated money it had borrowed and that they should not be held responsible for the previous regime’s alleged misdeeds. 

key takeaways

  • Odious debt is a term applied to a predecessor government's debt that a successor government wishes to repudiate on ostensibly moral grounds.
  • Odious debt is not an established principle of international law, but is often given as a rationale by the victors of civil or international conflict to repudiate their defeat opponents’ debts.
  • The successful application of the concept of odious debt presents a significant risk for investors in sovereign debt and may increase borrowing costs for countries under threat of regime change.

Understanding Odious Debt

Odious debt is not a concept officially recognized in international law. No national or international court or governing body has ever invalidated sovereign obligations on the grounds of odious debt. Odious debt is clearly at odds with established international law, which generally holds successor governments accountable for the debts of regimes that preceded them.

The concept of odious debt is most often raised when the government of a country changes hands violently either through conquest by another country or through internal revolution. The new government in such a situation is rarely eager to take on the debts of the vanquished predecessor. 

Other than simply wanting to get out of the debt, governments may consider debt odious when previous government leaders used borrowed funds in ways that the new government does not agree with, sometimes claiming that the borrowed funds did not benefit its citizens, and to the contrary, may have been used to oppress them. Indeed, it is routine for victors of civil war or international conflict to accuse the regimes they have deposed or conquered of corruption, abuse, or general malevolence. As the saying goes, “the winners write the history books.” 

Despite international law, the concept of odious debt has been successfully used as a post hoc rationale when the victors of such conflicts are powerful enough to enforce their will on world financial markets and international lenders. In reality, whether or not the successor regime is held to repayment by the previous government’s creditors tends to boil down to a question of who is more powerful. New regimes that gain international recognition or the support of major military powers tend to be more successful at repudiating the old debts. 

Examples of Odious Debt

The idea behind odious debt first gained notoriety after the Spanish-American War. The U.S. government argued that Cuba should not be held liable for debts incurred by the Spanish colonial regime, the colonial rulers of Cuba. While Spain disagreed, Spain, not Cuba, ultimately was left with the post-war debt, due to the balance of power between the triumphant colonial power of the U.S. and the defeated Spanish Empire bereft of the last of its overseas territories after the war.

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 previous rulers of either personally looting national funds for their own accounts or using the money to restrict liberties and inflict violence on their own citizens. In all such cases, the actual resolution or restructuring of old debt in the wake of regime changes has followed geopolitical and strategic considerations rather than the proposed doctrine of odious debt.

For example, the apartheid-era government of South Africa borrowed from international banks and investors to build dams, power plants, 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 due to the social policies of the prior regime. 

However, with the collapse of the Soviet Union in the early 1990s, which had heavily supported the ANC, the new South African government found itself lacking in powerful international allies who would be willing to support repudiation of the existing debt. In order to maintain access to international credit markets, the new government ended up paying those debts, so as not to scare off badly needed foreign investment.

Foreign Investment and Odious Debt

The prospect of regime change and the repudiation of the previous regime's contractual obligations presents a direct risk for investors who deal in sovereign debt. Investors who hold loans or bonds of 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 nearly universally to the losers of international or internecine conflict, lenders can only account for this as part of the general risk of the political stability of a borrower. This risk is embodied in a premium on the return demanded by investors, which will tend to be greater when potential successor governments become more likely to be able to make charges of odious debt stick. 

Moral Arguments and Odious Debt

Some legal scholars argue that, for moral reasons, these debts should not have to be repaid. Proponents of the idea of odious debt believe countries doing the lending must have known, or should have known, of the alleged oppressive conditions upon offering the credit. They have held that successor governments should not be liable for odious debt that earlier regimes passed down to them. 

One obvious moral hazard in labeling debt odious after the fact is that successor governments, some that may have a lot in common with the ones that preceded them, may use odious debt as an excuse to wriggle out of obligations they should pay. A potential solution to resolve this moral hazard, forwarded by economists Michael Kremer and Seema Jayachandran, is that the international community could announce that all future contracts with a particular regime are odious.

Therefore, lending to that regime following such a decree would be internationally recognized at the lender’s peril, as they would not be repaid if the regime is later toppled. This would transform the concept of odious debt from a post hoc rationalization for countries to repudiate their debts into a forward-looking weapon of international conflict as an alternative or prelude to open warfare. Rival powers and coalitions could then use the concept of odious debt to restrict each other's access to capital markets by accusing their opponents of various misdeeds, before launching a coup, invasion, or insurgency.