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Current sovereign debt challenges and priorities in the period ahead

By Ceyla Pazarbasioglu

The pandemic has exacerbated existing debt vulnerabilities in many countries, particularly low-income countries. Addressing these vulnerabilities is a complex undertaking. In this Q+A, Ceyla, Pazarbasioglu, Director of the IMF’s Strategy, Policy and Review Department explains how the IMF is taking a deliberate, case-by-case approach to help its member countries address these debt challenges and outlines the priorities in the period ahead.

How do you see the situation of debt in low-income countries (LICs)?

Debt levels were already at record high levels before the crisis and the COVID-19 crisis is pushing them to new heights. The pandemic is adding to spending needs as LICs seek to mitigate the health and economic effects of the crisis, while revenues are falling due to lower growth and trade, increasing these countries’ debt burdens. Some vulnerable countries are also facing higher financing costs or have very limited access to external financing. As a result, the pandemic has adversely affected LICs’ solvency and liquidity indicators; over 50 percent of them are now assessed to be at high risk of or in debt distress according to the joint IMF-World Bank Debt Sustainability Framework.

We are concerned that some countries with high pre-crisis debt vulnerabilities may face unsustainable burdens. It is critical that these countries pre-emptively restructure their debts, before they are pushed into default. Some LICs have already announced their intention to restructure their debt. To avoid the situation worsening even further, it is of utmost priority to address it sooner rather than later.

What is the IMF doing on debt?

Issues around debt are complex and country-specific, and the IMF is taking a careful and deliberate approach to help member countries address them. The IMF is working hard to support its members with policy advice, financing, and capacity development to ensure debt sustainability and to avoid a disorderly debt restructuring. We help identify and overcome debt risks in our member countries through debt sustainability analysis and policy advice; provide lending to LICs at below market rates—helping to catalyze support from donors—thereby preventing liquidity shortfalls; and we are providing technical assistance on debt management and fostering debt transparency. Where debt is unsustainable, IMF-supported programs complement the necessary debt restructuring by countries with sound economic policies and fresh financing.

The IMF is also providing debt relief through grants to the 29 poorest countries under the Catastrophe Containment and Relief Trust. Debt relief under the CCRT has so far been approved to cover debt service to the IMF falling due between April 2020 and April 2021. The total debt relief for these first two tranches amounts to almost US$500 million.

For countries where public debt is not sustainable, the global creditor community needs to enable faster and more effective debt reduction. The current frameworks and practices, while they have served us well in the past, need to adapt to a creditor landscape that has grown much more complex with new official creditors and new forms of lending. We have therefore called for urgent reforms of the International Debt Architecture. Key priorities include further strengthening contractual provisions in debt contracts, enhancing debt transparency, and coordinating restructuring of official bilateral debts with official and private creditors participating on comparable terms.

The Common Framework for Debt Treatments beyond the DSSI that was just adopted by the G20 is an important step forward and we will work closely with the G20 and debtor countries on its implementation. We are also examining the potential role that State-Contingent Debt Instruments can play in reducing the costliness and risk of sovereign debt restructurings.

In addition, we are strengthening our own debt policies. The recent reform of the Policy on Debt Limits in IMF-supported programs provides countries with more flexibility to manage their debt, while placing safeguards to preserve or restore debt sustainability. One key element is enhanced data disclosure requirement to the IMF.  The forthcoming Review of the Debt Sustainability Framework for Market-Access Countries encompasses a much-improved framework for predicting debt distress at short, medium- and long-term horizons.

The forthcoming Review of the IMF’s Lending Into Arrears Policies will encompass a review of the perimeter of official and private claims with an objective to maximize incentives for constructive creditor-debtor engagement in pre-default restructurings and enhance the IMF’s role in furthering creditor engagement—the famous debtor’s ‘good faith efforts’—in post-default cases.

What is the IMF doing to improve debt transparency?

Debt transparency is critical to prevent a build-up in debt vulnerabilities. Without the full picture of a government’s outstanding debt and contingent liabilities, as well as its terms, debtors and creditors cannot take informed decisions to ensure debt remains sustainable, and accountability is weakened by a lack of public information on public debt. That said, debt transparency is not an easy fix and depends on a multitude of factors, such as a country’s institutional capacity, legal frameworks, governance, and civil service organization more broadly.

Taking these considerations into account, the IMF, together with the World Bank, work on multiple fronts to enhance transparency over a multi-year horizon. Efforts have focused on scaling up capacity development efforts to enhance public debt reporting in borrowing countries. We also set standards for debt statistics and disseminate public debt reported by borrowers through their databases to the general public. In addition, we are setting higher requirements on debt reporting for our surveillance activities and to be used in our debt sustainability analysis. The recent reform of our Policy on Debt Limits in IMF-supported Programs aims to further raise the bar on debt disclosure to the IMF.

What is the status of the G20’s Debt Service Suspension Initiative (DSSI)?

During 2020, 44 eligible countries who requested debt service suspension are expected to benefit from an estimated US$5 billion of debt service being deferred. For now, G20 bilateral official creditors have agreed to extend the initial debt service suspension by six months through end-June of 2021. The IMF, together with WB, have presented strong arguments for extending the DSSI for even longer, and the G20 have agreed to examine the need for a further extension by the time of the IMF-World Bank Spring Meetings in April 2021.

What do you think of the Common Framework just agreed by the G20?

The Common Framework for Debt Treatments beyond the DSSI—which aims to address unsustainable sovereign debt and ensure broad participation of creditors with fair burden sharing—is a highly welcome development. Importantly, it brings in official creditors previously that were not part of the established Paris Club process. The framework agreed by G20 and Paris Club creditors facilitates coordination of debt treatments tailored to the specific situation of the debtor country. The framework requires that participating debtor countries seek treatment on comparable or better terms from other creditors, including the private sector. We look forward to working closely with creditors—including China—so that this tool can be implemented effectively to help those countries most in need.

The coordination of debt treatments by official and private creditors through the framework will enable more comprehensive and timely debt resolutions. It is now essential to use the framework promptly and efficiently so countries with unsustainable debt burdens come forward sooner and avoid deeper distress, which is ultimately more costly for creditors and debtors alike. The IMF will do its part to support the framework’s implementation—especially through our Debt Sustainability Analysis, jointly with the World Bank, which will help to inform the debt treatment needed to restore debt sustainability within the context of an upper credit tranche (UCT) IMF-supported program. The IMF-supported programs will promote sound economic policies, provide fresh financing and make sure that, after restructuring, countries can service their restructured debts.

The Common Framework is a very important step on the road to improving the international debt architecture. Not only can its effective operationalization provide important relief to the poorest debt-stricken countries, but it can set the stage for a more universal and possibly permanent framework for efficient sovereign debt resolution.

Does debt reduction need to be extended to all LICs?

When debt is unsustainable, restructuring is urgently needed. That said, while many LICs are at risk of debt distress or in debt distress and may need restructuring, there are many others where debt vulnerabilities remain manageable. The IMF takes a case-by-case approach on whether a country requires debt restructuring, taking into account debt sustainability analysis and the continued availability of the financing that countries need for their long‑term growth and development.

When debt restructuring is needed, the magnitude of debt relief required will vary from country to country depending on their debt levels relative to their capacity to repay. Countries in a less difficult situation, which can continue to service their debts through sound policies and financing, don’t need to resort to debt restructuring. Creditors would not be willing to provide debt reductions to such countries in any case; at most they would agree to reschedule debt payments falling due to ease liquidity pressures arising from the crisis. In fact, extending debt reduction to these countries could be counterproductive, as it could undermine their ability to access new financing. So, debt reduction must be targeted to those LICs that really need this treatment to enable them to return to sustainable growth.

Does debt restructuring need to extend beyond LICs?

Yes. Many emerging market economies are also at significant risk of debt distress and since the onset of the pandemic a few have announced their intention to seek debt restructurings. Argentina and Ecuador, for example, have already concluded debt restructurings, while for others debt restructurings remain a work in progress, such as for Lebanon. And more countries may end up in a similar situation. The Fund stands ready to support these countries in a similar manner providing financing and supporting their efforts for debt restructuring when this is needed.

What is the role of the private sector creditors in addressing debt vulnerabilities in LICs?

As LICs develop, financing provided from the private sector gradually becomes more important and can play an important role in financing critical investments. That is how it should be. This also means that the private sector creditors can and should play multiple roles in addressing debt vulnerabilities by participating in debt restructurings, providing new financing and contributing to improved debt transparency.

The involvement of the private sector in debt restructurings ensures fairer burden sharing and is essential to unlock support for deeper debt relief by bilateral official creditors. Although the lack of private sector participation in the DSSI has been disappointing, it will now be expected under the new G20 Common Framework. As already noted, the framework requires that participating debtor countries seek treatment on at least as favorable terms from other creditors, including the private sector.

Private sector creditors also play a critical role in providing new financing. When countries are in a crisis, and the people of those countries are in desperate need as we are seeing in the current COVID-19 crisis, the IMF needs to move fast to meet financing needs. Without the IMF’s support, countries would have to cut back on essential health, social and investment spending, and their ability to meet their external debt obligations—including to the private sector—would be impeded. In cases where debt is assessed as not sustainable, the programs incorporate debt restructuring and IMF policies allow for lending into arrears. However, for countries where debt is sustainable, defaulting on debt to private creditors would be costly as this would prevent countries from accessing much-needed external funding during and after the pandemic and thus forestall the economic recovery.

What if we experience a systemic debt crisis?

Given the surging public debt levels that have been triggered by the pandemic, we are also working on options to manage a widespread sovereign debt crisis. If we were to have a situation where a large number of sovereign debt restructurings are proceeding in parallel, that could lead to creditors with claims on many countries facing large aggregate losses, which in turn could make them less cooperative in resolving the situation. Restructurings could become more protracted and difficult, creating difficulties for debtors and the system.

It is too early to tell if such a crisis lies ahead. But, if it were to arise, additional financial “carrots” or statutory “sticks” might need to be considered on a very carefully circumscribed basis as laid out in a recent IMF paper on The International Architecture for Resolving Sovereign Debt Involving Private Creditors.

“Carrots” could include IFI financing of cash or credit enhancements in difficult restructurings, when the required debt relief is very deep. Such enhancements could make debt deals more feasible.  At the same time, the paper notes that this approach is subject to significant limitations, the most obvious of which is that IFIs have limited financial resources with competing demands; such demands will be further intensified in a systemic crisis. Hence, while IFI financing of financial incentives could contribute to resolving a widespread systemic debt crisis, it is not an instrument that could be used on a very large scale.

In terms of the “sticks”, these could in principle include targeted domestic and international law statutory tools that limit or delay, in a time-bound manner, creditor recovery/enforcement actions or the timing of lawsuits, which in turn could both reduce incentives to hold out and limit the ability of holdouts to disrupt a restructuring. These statutory options carry potential legal and policy drawbacks and should be used only as a last resort and on a time-bound basis, if needed to address the unique challenges posed by a systemic crisis.



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