## ppea2021071 ## Source details **Canonical URL:** [ppea2021071](https://www.imf.org/-/media/files/publications/pp/2021/english/ppea2021071.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2021/english/ppea2021071.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2021/english/ppea2021071.pdf.json) --- ### Executive summary — context, motivation, and scope - Restructurings of sovereign debt issued under domestic law (“domestic debt”) may become more frequent as the share of domestic debt in EMDEs rose and the number of countries at risk of debt distress increased following the COVID-19 pandemic. - The share of domestic debt in total debt of EMDEs rose from 31 to 46 percent from 2000 to 2020. - Paper addresses three questions: - (i) considerations for choosing to restructure domestic debt, external debt, or both; - (ii) practical, legal, and procedural issues in a domestic debt restructuring (DDR); - (iii) how to mitigate adverse spillovers of DDRs on the domestic economy and financial system. - Publication date shown: July 21, 2021. - Data coverage notes: - Public debt panels cover 86 EMs and 67 LICs (153 EMDEs total) for public debt; domestic public debt panels cover 117 EMDEs (69 EMs and 48 LICs) for certain analyses. - Analysis on domestic debt restructurings in Section II focuses on 89 countries (all EMDEs except Greece and Cyprus). ### Key trade-offs: benefits and challenges of DDRs - Benefits: - Sovereigns can restructure domestic debt through changes in domestic law. - DDRs can potentially limit external reputational costs and support efforts to retain access to external financial markets. - Challenges and risks: - Domestic banks and pension funds disproportionately hold domestic debt, creating a channel for sovereign stress to spread to the financial system and the broader economy. - Fiscal consolidation to restore debt sustainability increases the burden of adjustment on domestic residents. ### Trends and empirical patterns (1980–2020) - Since the mid-1990s, the share of domestic debt has risen as EMDEs deepened domestic capital markets and moved away from financial repression and high inflation as debt-eroding tools. - Domestic debt at end-2020 represented over 50 percent of public debt for emerging markets whose external bonds were trading at distressed spread levels. - Among LICs classified at high risk of or in debt distress under the LIC-DSF, domestic debt amounted to 36 percent of public debt at end-2020. - Historical episode counts (1980–2020, sample of 89 countries): - 63 domestic-law debt restructuring events (DDRs). - 135 external debt restructuring events (EDRs). - 80 high-inflation/financial repression episodes (IFRs). - 71 standalone EDRs. - 36 standalone DDRs. - 27 combined EDR/DDRs. - 37 EDR/IFRs. - 43 IFR-only episodes. - During 1990–2020, standalone DDRs (30 episodes) were roughly as many as standalone EDRs (27 episodes). ### Design considerations for DDRs - Objective: restore public debt sustainability while minimizing economic costs and financial system disruptions; debt sustainability incorporates solvency and liquidity perspectives. - Key design principles: - Cast the perimeter wide across claims to support participation by lowering relief sought from each creditor group. - Evaluate net debt relief for domestic debt as: gross fiscal relief less fiscal costs (e.g., recapitalization, subsidies). - Use pre-restructuring stress tests to inform design and need for policy support. - Policy responses may include liquidity support, regulatory measures, recapitalization, and establishment of a financial sector stability fund. ### Illustrative decision framework (Figure 9 steps summarized) - Step 1: Estimate debt relief target (DRT) necessary to restore sustainability anchored in a medium-term macroeconomic adjustment plan. - Step 2: Identify perimeter of claims and creditor categories. - Step 3: For each creditor category determine potential contribution to DRT; for domestic debt measure net contribution = gross fiscal relief less fiscal costs. - Step 4: Assess economic, political-economy, and reputational costs (including attenuation when incidence falls on non-residents). - Step 5: Central bank considerations—ensure payments system, monetary policy, regulatory functions; assess recapitalization needs. - Step 6: Determine which claims to restructure to minimize overall costs while achieving DRT; possible outcomes: interior solution (DDR+EDR) or corner solution (only DDR or only EDR). ### Perimeter and instrument-specific guidance - Perimeter dimensions: Type of Borrowers; Type of Claims; Type of Creditors; residency; currency; marketability; placement type; institutions; securities type. - T-bills: - Including T-bills carries risks to interbank liquidity and central bank operations; include when T-bills share is high (examples: Barbados, 2018 and Russia, 2000); exclude when not creating large refinancing pressures (examples: Grenada, St. Kitts and Nevis, Cyprus, Jamaica). - Loans and advances: - Can be renegotiated bilaterally or securitized into new instruments (example: Greece, 2012 conversion of bank loans into bonds). - Payment arrears: - Require validation and legal-basis verification; independent audits advisable though time-consuming. - Currency denomination: - Denomination should not determine inclusion/exclusion; including both local and foreign currency domestic-law debt can allow greater savings (examples: Jamaica, 2010 and 2013). - Financial derivatives: - Often governed by foreign law and collateralized; inclusion in DDRs is challenging and depends on net positions and contractual close-out arrangements. ### Breadth beyond central government - Include SOE debt if SOE struggles and receives government support; complications arise from separate legal personalities and creditor bases. - Subnational governments: national government-led restructuring possible or via special insolvency regimes; uncoordinated approaches costly. - Government guaranteed debt can be proactively restructured when guarantee risk exists. ### Legal toolkit and collective action - Local law advantage: sovereign control over domestic legal/regulatory framework allows modification of domestic debt terms via legislation or executive acts in some systems, but constrained by constitution and international obligations. - Retrofitted statutory majority mechanisms (retro CACs) have been used (e.g., Greece, 2012; Barbados, 2018) to bind untendered domestic bonds, but carry legal and investor-confidence risks and should be used only when absolutely necessary and with limits. - CACs in domestic bonds are an alternative that can increase legal certainty; since 2013 euro area members require CACs in domestic and foreign law bonds with maturity > 1 year. ### Process, stakeholder engagement, and instrument design - Process best-practices: - Hire external advisors to identify holders and design a menu of instruments. - Conduct creditor consultations and consider a creditor committee for negotiated DDRs. - Balance confidentiality and transparency in communication; create stakeholder committees to build political consensus (examples: Jamaica 2010, Grenada 2013, Barbados 2018). - New instrument design: - Aim to restore sustainability and prevent new distress; diversify portfolio across currency, maturity, and liquidity. - Use allocation rules to achieve policy objectives (example: Jamaica, 2010). - Consider state-contingent features (e.g., hurricane deferral clauses in Grenada, 2013; Barbados hurricane clause in international bonds). - Incentives and penalties to induce participation: - Carrots: upgrades in governing law, trust structures, eligibility for liquidity facilities, warrants, credit enhancements, buyback clauses, support to mitigate FX risk, tax policy allowing loss carry-forwards. - Sticks: 100 percent risk-weighting and non-acceptance as collateral, tax surcharges on interest income, retrofitted CACs, regulatory disincentives (examples: Uruguay 2003, Jamaica 2010). ### Central bank holdings, arrears, and public-sector creditors - Central bank holdings: may affect income, capital, and open market instruments; remedies include rollovers, maturity/interest alterations without face value reduction, swaps into excluded securities, or recapitalization when losses cause negative capital (example: Barbados). - Domestic arrears clearing options: cash payment (Lesotho), conversion into contractual debt or repayment schedule (Gabon, Liberia), securitization into marketable securities (Madagascar). - Public sector creditor treatment depends on balance-sheet strength and systemic importance; public sector creditors often limited in capacity to bear losses (example: nominal haircut to central bank and National Insurance Scheme in Barbados, 2018). ### Financial stability, sovereign–bank nexus, and accounting - Prevalence of crises before restructurings: - Roughly 70 percent of all debt restructuring events were preceded or accompanied by real, external, or banking crises. - Triggers by restructuring type: - DDRs: often preceded by recessions and/or external shocks; very rarely by banking crises. - EDR/DDRs: over half preceded or accompanied by banking crises; about a third associated with triple crisis events. - Pre-restructuring median public debt (percent of GDP): - DDRs: 70 percent - EDRs: 79 percent - EDR/DDRs: 88 percent - Share of domestic public debt (median, percent of public debt): - DDRs: 37 percent - EDRs: 27 percent - External public debt held by private creditors (median share of public debt): - Prior to DDRs: 9 percent - Prior to EDRs: 28 percent - Prior to EDR/DDRs: 65 percent - Pre-restructuring domestic bank credit to private sector (percent of GDP): - DDRs median: 15 percent - EDR/DDRs median: 38 percent - Banking sector impacts and accounting: - Debt restructurings can cause capital losses; recognition depends on accounting classification under IFRS 9 (FVTPL, FVTOCI, amortized cost) and provisioning rules. - Regulatory forbearance that masks losses is discouraged; supervisors should encourage timely recognition and sound valuation. - If capital shortfalls exist, options include credible recapitalization plans, targeted public recapitalization as last resort, and use of bank resolution frameworks. - Example magnitudes: - Greek (2012) nominal haircut led to banking sector losses amounting to €38.7 billion (overall NPV loss of 78 percent). - Maximum cumulative output loss in an average EDR/DDR that coincided with a banking crisis was about 10 percent (and about 11 percent for similar EDR events). Median cumulative loss for low- and middle-income countries experiencing a banking crisis: nearly 14 percent cumulative over four years. ### Managing non-bank financial institutions and pension systems - Long-term institutional holders (insurance and pension funds) often captive and face large losses. - Policy responses: - Comprehensive pension reform may be required if reserves are acceleratedly depleted. - Medium-term reforms could include making public pension scheme contributory for new employees, increasing earliest eligibility age for new employees, reducing rate of benefit accrual for new employees. - Fiscal consolidation accompanying DDRs may increase need for pension reform. ### Liquidity backstops, stability funds, and capital flow measures - Liquidity backstops and stability funds: - Useful as lifelines for institutions losing access to market or deposit funding; may be supported by IFIs. - Historical examples: Jamaica, St. Kitts and Nevis (financial stability funds); Jamaica’s FSSF remained untapped but supportive. - Collateral eligibility rules may need review if banks face large haircuts on government bonds. - Capital flow measures: - Temporary outflow CFMs may be considered to prevent frontrunning and sudden capital flight in line with the IMF’s Institutional View (IMF 2012c). - CFMs should be temporary, legally grounded, and part of a broader stabilization package; removal conditional on restored stability and reserve rebuilding. ### Case-study lessons — selected outcomes and instruments - Case studies (12 episodes) show variation in perimeter, terms, and outcomes; common features: - Many recent DDRs were preemptive rather than post-default (stand-alone DDRs: Nicaragua, Jamaica 2010/2013, Cyprus). - Short-term T-bills commonly excluded unless they represent a large refinancing pressure (Barbados, Russia, Ukraine included T-bills). - NPV losses tended to be lower in DDRs than in EDR/DDRs; examples: - Jamaica (2010): NPV loss about 10–15 percent without face value haircuts. - Cyprus: NPV loss of 36 percent via maturity extensions only. - Barbados: private creditors’ NPV loss around 30 percent from interest reductions and maturity extensions. - Grenada: NPV loss of 50 percent including face value haircuts. - St. Kitts and Nevis: average NPV loss 65 percent (EDR and DDR components). - Greece: NPV losses in range 65–78 percent depending on exit yield and convention. - Participation rates in domestic exchanges were often very high: - Barbados: 100 percent participation. - Grenada: 100 percent participation. - St. Kitts and Nevis: 100 percent participation. - Jamaica: 99.2 percent (2010) and 99 percent (2013). - Greece (Greek law bonds): 100 percent participation (foreign law bonds 75 percent). - Uruguay: 99 percent participation for domestically issued bonds. - Russia (second restructuring): 95 percent resident, 89 percent nonresident. - Participation achieved through carrots and sticks tailored to domestic context (e.g., regulatory disincentives, tax surcharges, retrofitted CACs, liquidity facility eligibility, trust structures, allocation menus). - Market re-access: - Average time to re-access domestic market: 1.7 years. - Average time to re-access international market: 0.6 years. - Three sovereigns had not yet tapped either market following restructurings: Barbados, Grenada, St. Kitts and Nevis. - LC and FC credit ratings tended to cluster within the single-B range at the 2-year mark after restructuring; ratings often did not recover to pre-restructuring levels within 2 years. - Real long-term domestic bond yields tended to rise sharply around restructurings and typically did not revert to pre-crisis levels within 2 years, except Cyprus. ### Empirical synthesis and policy-relevant considerations - Four empirical regularities on restructuring choice: - Stand-alone DDRs: chosen when privately held external debt is small and financial system is shallow or resilient; domestic financing-channel impacts are manageable. - Stand-alone EDRs: chosen when total public debt and share of external debt to private creditors are relatively high. - Comprehensive restructurings (EDR/DDRs): chosen when debt problem and pre-restructuring economic stress are significant. - Restructurings accompanied by banking crises: associated with larger output losses for any restructuring type. - Practical implications for design: - Consider net (not gross) benefit after fiscal costs (e.g., bank recapitalization). - Wide perimeter supports participation by lowering relief from each creditor group. - Fair, transparent processes and a menu of instruments equivalent in NPV reduction can foster participation and accommodate preferences. - Limit use of local law advantage; legislative or executive changes to domestic contracts should be last resort and used with strict limits. - Data and research gaps: - Small sample sizes and lack of granular data (NPV losses, debt relief, restructured debt amounts, holders) constrain analysis. - Population of standalone DDRs largely in LICs and small economies with shallow domestic markets; extrapolation to larger economies is difficult. ### Conclusion — policy guidance (key takeaways) - Restructurings of domestic debt have become more frequent since mid-1990s and likely to be more common post-pandemic. - DDRs can help avoid protracted standoffs and ring-fence external reputation, but impose losses on domestic stakeholders and may cause large domestic financial spillovers. - Sovereigns considering DDRs should: - anticipate impact on domestic financial system; - limit use of the local law advantage; - design mitigation measures for banks, non-bank institutions, and households (liquidity/solvency support, temporary CFMs, central bank interventions); - evaluate net debt relief after fiscal costs; - set a wide perimeter where appropriate to enhance participation. - Strengthening debt data, public debt management legal/regulatory frameworks, and crisis management/bank resolution frameworks are important preparatory steps. *Source: ppea2021071 — Issues in Restructuring of Sovereign Domestic Debt (excerpts and background paper, July–August 2021).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Context and motivation - Restructurings of sovereign debt issued under domestic law (“domestic debt”) may become more frequent in the future as the share of domestic debt in EMDEs has risen and the number of countries at risk of debt distress increased following the COVID-19 pandemic. - The share of domestic debt in total debt of EMDEs rose from 31 to 46 percent from 2000 to 2020. - The paper addresses three questions: (i) considerations for choosing to restructure domestic debt, external debt, or both; (ii) practical, legal, and procedural issues in a domestic debt restructuring (DDR); (iii) how to mitigate adverse spillovers of DDRs on the domestic economy and financial system. - Publication date shown: July 21, 2021. ### Key trade-offs: benefits and challenges of DDRs - Benefits of DDRs: - Sovereigns can restructure domestic debt through changes in domestic law. - DDRs can potentially limit external reputational costs and support efforts to retain access to external financial markets. - Challenges and risks: - Domestic banks and pension funds disproportionately hold domestic debt, creating a channel for sovereign stress to spread to the financial system and the broader economy. - Fiscal consolidation to restore debt sustainability increases the burden of adjustment on domestic residents. ### Trends and empirical patterns - Since the mid-1990s, the share of domestic debt has risen as EMDEs deepened domestic capital markets and moved away from financial repression and high inflation as debt-eroding tools. - Domestic debt at end-2020 represented over 50 percent of public debt for emerging markets whose external bonds were trading at distressed spread levels. - Among low-income countries classified at high risk of or in debt distress under the LIC-DSF, domestic debt amounted to 36 percent of public debt at end-2020. - Historical classification of public debt reduction/restructuring episodes (1980–2020) falls into five categories: (i) high inflation/financial repression episodes (IFR); (ii) standalone external debt restructurings (EDR); (iii) standalone domestic debt restructurings (DDR); (iv) EDR accompanied by IFR (EDR/IFR); (v) comprehensive restructurings with both EDR and DDR (EDR/DDR). - During 1990–2020, there were roughly as many DDRs (30 episodes) as standalone EDRs (27 episodes) among the sample of episodes analyzed. ### Design considerations for DDRs - The design of a DDR is important to achieve required debt reduction while minimizing risks to financial stability and the broader economy. - Casting the perimeter wide across claims when identifying which instruments and creditors are included can support participation by lowering the relief sought from each creditor group. - Financial stability considerations should inform DDR design: - Pre-restructuring stress tests can provide critical information to inform the design and need for policy support. - Depending on severity of spillovers, policy responses may need to include liquidity support, regulatory measures, recapitalization, and establishment of a financial sector stability fund. ### Operational, legal, and procedural themes covered - The paper discusses practical, legal, and procedural issues for DDRs, including: - How domestic debt should be restructured (instruments and tools). - Deciding the perimeter of a DDR. - Legal toolkit and use of domestic law instruments. - Process of restructuring domestic debt (negotiation, legislation, executive acts). - The paper differentiates domestic sovereign debt (debt governed by domestic law and subject to exclusive domestic courts) from external debt (debt issued under foreign law), noting overlap with currency denomination and residency of holders but emphasizing the legal-jurisdictional distinction. ### Scope and limitations - The analysis focuses on situations where a sovereign faces unsustainable debt and seeks to address it through restructuring; alternatives such as eroding debt via inflation or financial repression are noted as historically used but typically inappropriate for crisis timeliness and costly in economic dislocation, and thus not the paper’s focus. - Dataset and coverage notes: - Domestic debt data is based on residency due to data limitations; the data in the paper covers 86 EMs and 67 LICs (153 EMDEs total) for public debt; domestic public debt panels cover 117 EMDEs (69 EMs and 48 LICs) for certain analyses. - The analysis on domestic debt restructurings in Section II focuses on a smaller sample of 89 countries (all EMDEs except Greece and Cyprus) that experienced at least one debt crisis episode. ### Structure of the paper (high-level) - Section II: overview of recent sovereign debt reduction episodes and macrofinancial patterns around restructurings. - Section III: policy and operational aspects of DDR design and implementation, including perimeter, tools, and approaches to achieve participation and sustainability. - Section IV: exploration of spillovers and macro-financial effects from DDRs and how authorities can mitigate them. - Section V: conclusion. - Accompanying background paper: in-depth analysis of past domestic public debt restructuring episodes in EMDEs using historical data and case studies. *Source: EXECUTIVE SUMMARY (ppea2021071)* ### 8. Most standalone DDRs occurred either in ### ppea2021071 - 8. Most standalone DDRs occurred either in ### Patterns by country type and restructuring choice - Most standalone DDRs occurred either in LICs or in small states, while most comprehensive restructurings (EDR/DDR) occurred in EMs. - Restructuring choices were linked to structural features and typical shocks: - LICs and small states rely more on external official creditors. - EMs tend to have higher domestic debt levels and greater reliance on external private creditors. - A probit regression analysis shows that the level and composition of public debt, the state of the banking system, and pre-restructuring economic and fiscal conditions affect the likelihood of different types of debt restructurings. ### Public debt composition and financial depth (conditions prior to restructuring) - Public debt levels (pre-restructuring median, percent of GDP): - DDRs: 70 percent - EDRs: 79 percent - EDR/DDRs: 88 percent - Share of domestic public debt (pre-restructuring median, percent of public debt): - DDRs: 37 percent - EDRs: 27 percent - Share of external public debt held by private creditors (pre-restructuring, percent of public debt): - DDRs: 9 percent - EDRs: 28 percent - EDR/DDRs: 65 percent - Interpretation: Very low external private creditor exposure prior to DDRs suggests sovereigns may opt for standalone DDRs because restructuring external debt would not have resulted in significant debt relief (while imposing costs). - Domestic bank credit to private sector (percent of GDP): Countries with DDRs had much lower private sector reliance on domestic bank credit than EDRs or EDR/DDRs, implying shallower financial systems and lower capacity for banking losses to transmit shocks to the real economy. ### Macro-financial patterns around restructurings - Prevalence of crises before restructuring (EMDEs, 1980–2020): - Roughly 70 percent of all debt restructuring events were preceded or accompanied by either real, external, or banking crises. - The remainder were likely triggered by political upheavals or fiscal pressures. - Triggers by restructuring type: - DDRs were often preceded by recessions and/or external shocks, and very rarely by banking crises. - Over half of all comprehensive restructurings were preceded or accompanied by banking crises. - About a third of comprehensive restructurings were associated with triple (real, external, and banking) crisis events. - Outcomes and dynamics: - Comprehensive restructurings (EDR/DDRs) typically occurred under more stressed economic conditions and were followed by sharper output and credit contractions than standalone DDRs or EDRs. - Pre-restructuring growth rates were typically lower for EDR/DDRs than for standalone DDRs and EDRs. - Post-restructuring cumulative output declines were sharper, on average, in EDR/DDRs than in standalone EDRs and DDRs. - During standalone DDRs, capital inflows/GDP tended to rise after the restructuring. - The more muted credit contractions in DDRs are consistent with relatively shallow financial systems in DDR countries. - Banking crises and output losses: - Public debt restructurings accompanied by banking crises were associated with larger output losses. - The worst outcomes occurred when banking crises coincided with the year of the restructuring, followed by restructurings that occurred after banking crises (i.e., when financial systems were already weak). - The maximum cumulative output loss in an average EDR/DDR that coincided with the banking crisis was about 10 percent (and about 11 percent for similar EDR events). - This is somewhat lower than a median loss of nearly 14 percent (cumulative over four years) for low- and middle-income countries that experienced a banking crisis. ### Granular features of recent restructuring operations - Pre-emptive vs post-default patterns (public marketable debt restructurings, 1998–2020): - Pre-emptive operations were more prevalent for DDRs and EDRs than for EDR/DDRs. - The share of restructured debt was, on average, lower in DDRs and EDRs than in EDR/DDRs. - DDRs typically took less time to complete than other restructurings: - DDR episodes concluded more than a year faster than episodes where external debt was restructured. - DDRs’ reliance on pre-emptive restructurings contributed to shorter durations. - Net present value (NPV) losses tended to be lower in DDRs than in other restructurings. - Implications: - Stand-alone DDRs took less time to complete, involved restructuring of a lower share of total debt, and were less costly for creditors than other forms of public debt restructuring. ### Synthesis: channels and policy-relevant considerations - Four main empirical regularities about when each restructuring type is chosen: - Stand-alone DDRs: chosen when privately held external debt is small and the financial system is either shallow or fairly resilient; governments may opt for DDRs when the domestic financing channel impact is manageable or unavoidable. - Stand-alone EDRs: chosen when total public debt and the share of external debt to private creditors are relatively high; external restructuring is necessary despite adverse effects on external finance access. - Comprehensive restructurings (EDR/DDRs): chosen when both the debt problem and pre-restructuring economic stress are significant, making targeted restructuring unlikely to solve the problem. - Restructurings accompanied by banking crises: associated with larger output losses for any form of public debt restructuring because banking crises impair domestic financing channels similarly to combined restructurings. - Practical implications for design of restructuring processes: - Consider net (not gross) benefit of restructuring after accounting for fiscal costs (e.g., bank recapitalization) and broader economic costs. - A wide perimeter of claims can support participation by lowering debt relief sought from each creditor group. - A fair and transparent process that encourages participation is essential. - Offering a menu of instruments—equivalent in NPV reduction—can foster participation by accommodating creditor preferences. *International Monetary Fund — Issues in Restructuring of Sovereign Domestic Debt (excerpts from the supplied content)* ### 16. The objective of the framework is to identify the type of restructuring that will restore ### ppea2021071 - 16. The objective of the framework is to identify the type of restructuring that will restore ### Framework objective and definitions - Objective: identify the type of restructuring that will restore public debt sustainability while minimizing potential economic costs and financial system disruptions. - Debt sustainability in the Fund’s definition incorporates solvency and liquidity without a sharp demarcation between them. - Liquidity perspective (footnote 22): sovereign must be able to refinance obligations falling due and finance new fiscal deficits at interest rates that prevent market stress or aggravate solvency deterioration. - Solvency perspective: sovereign must be able to sustain a given debt level without substantial risk of reverting to explosive debt dynamics or requiring protracted primary surpluses that could undermine growth. - The perimeter of restructurable debt: defining it as widely as possible helps reduce concessions sought from holders of claims (Figure 9, Step 2). Section III.B discusses perimeter considerations in more detail. ### Illustrative decision framework (Figure 9: Steps) - Step 1: Estimate the debt relief target (DRT) necessary to restore public debt sustainability. - Note 1: DRT is anchored in a comprehensive, medium-term macroeconomic adjustment plan and, under plausible assumptions, is the amount of debt relief required to shift from the current debt profile to a path expected to be sustainable with a high probability. - Step 2: Identify perimeter of claims (instrument type) and categories of creditors holding “restructurable debt”. - Step 3: For each creditor category determine potential contribution to DRT: - International experience in external debt restructuring can guide the extent of potential relief from external creditors while limiting external reputational costs. - For domestic debt, measure net contribution to DRT as: gross fiscal relief less fiscal costs (e.g., recapitalization, subsidies). Fiscal resources used for compensation reduce fiscal relief obtainable from the restructuring. - Domestic banks, domestic NBFIs, public sector entities, other domestic non-financial institutions, and foreign private creditors are categories to assess. - Step 4: Assess economic costs associated with obtaining relief: - Economic costs include credit conditions after restructuring, prospects for domestic market development, external financing conditions. - Political-economy costs include distributional aspects and role of special interests. - Reputational costs affect external market re-entry and domestic market access. - Consider attenuation when ultimate incidence falls on non-residents (examples: Barbados 2018; Cyprus 2013). - Consequence of an insufficiently deep restructuring: larger and longer fiscal adjustment may be required. - Step 5: Central bank: ensure normal operation (payments system), continue monetary and regulatory functions, assess need for immediate or future recapitalizations. - Step 6: Determine which claims to restructure to minimize overall costs while achieving DRT and supporting broader macroeconomic reforms. - Possible outcomes: an “interior solution” (combination of DDR and EDR) or a “corner solution” (only a DDR or only an EDR). ### Estimating restructurable debt and net debt relief - Key consideration: estimate potential debt relief given structure of claims and composition of holders (Figure 9, Step 3). - For domestic debt: relevant metric is net debt relief from the exchange = gross fiscal relief less fiscal costs (e.g., recapitalizing affected banks). - Recapitalization fiscal cost may be less than total losses imposed on financial sector if some institutions liquidate or use shareholder funds (footnote 24). - Iterative nature: losses imposed and cost of maintaining financial stability may increase disproportionately with haircut (footnote 25). ### Assessing broader economic costs (Figure 9, Step 4) - Assess, per creditor type, potential costs of: - For domestic banks: macro-financial implications; adverse effects on market access; creditor coordination and holdout risks; political economy considerations. - For foreign private creditors: capital outflows; exchange rate pressures; macro-financial disruptions; adverse external reputational effects on market access; creditor holdouts and litigation risk; spillovers from unresolved debt. - Consider market development risks: in nascent markets, reform agenda for local currency debt market could suffer and result in prolonged reliance on foreign borrowings and prolonged vulnerability to future debt sustainability concerns (footnote 26). ### Political economy and creditor leverage - Feasibility and debt relief sought may be constrained by creditor leverage in political process (paragraph 19). - Public debt securities commonly held by pension funds, insurance companies, banks, other financial institutions, and retail bondholders. - Constituencies may use political influence to avoid burden-sharing and shift adjustment onto other creditors. - Casting perimeter as wide as possible supports participation by reducing relief sought from each creditor group. - Governments with strong political support are more likely to achieve objectives (Borensztein and Panizza, 2011). External creditors may condition participation on burden sharing with domestic creditors. ### Central bank considerations (Figure 9, Step 5) - Central bank must be able to continue monetary policy and regulatory functions, operate payment systems, provide liquidity backstop, and conduct foreign exchange operations despite DDR. - Losses on central bank balance sheet from DDR may require addressing, including recapitalization depending on ex-ante equity position. ### Deciding the perimeter of a Domestic Debt Restructuring (Section III.B) - Scope depends on degree of debt relief needed. Decisions required on which public sector borrower institutions, instrument and creditor types to include. - In principle, all domestic debt liabilities of the government could be part of restructuring, subject to potential financial and economic costs. Central government securities and sometimes bank loans are most commonly treated in restructurings (paragraph 22). - Figure 10 outlines dimensions to consider when setting perimeter: Type of Borrowers, Type of Claims, Type of Creditors, residency (resident vs non-resident), currency (foreign vs local), marketability, relationship with borrower (private vs public sector), placement type (wholesale vs retail), institutions (banks vs other non-bank institutions), securities type (bonds vs T-bills), entity (entities vs individuals). ### Specific instrument considerations - T-bills: - Including T-bills carries risks: adverse effects on interbank liquidity, central bank’s ability to conduct monetary policy operations, and sovereign’s capacity to manage short-term payments. - If T-bills share of domestic debt is high, inclusion may be unavoidable to reduce short-term financing needs and rollover risk (examples: Barbados, 2018 and Russia, 2000). - Where T-bills do not create large refinancing pressures, generally advisable to exclude them from DDR. - Loans and advances from domestic financial institutions: - May be included or renegotiated bilaterally; non-marketable instruments can be securitized or restructured into a new loan. - Example: most bank loans to Greek sovereign converted into bonds in 2012. - Non-securitized conversions to illiquid assets (land in St. Kitts and Nevis; SOE assets in Greece) have been used; suitable for investors with longer horizons (e.g., pension funds) (footnote 31). - Loans backed by collateral and governed by foreign law generally afforded protection outside domestic jurisdiction, but if governed by domestic law they could be approached with legislative discretion in severe crisis (footnote 30). - Payment arrears: - Inclusion of arrears to suppliers is not straightforward; they need validation and legal-basis verification. - An independent and comprehensive audit is generally advisable though time-consuming (IMF, 2019, footnote 32). - If repayment capacity is severely constrained, restructuring arrears (reprofiling or haircut) may become necessary (footnote 33). - Currency denomination: - Currency denomination should not determine inclusion/exclusion. Including both local and foreign currency debt issued under domestic law sets equal conditions and allows greater savings (examples: Jamaica, 2010 and 2013). - In highly dollarized economies with very small share of local currency debt, may exclude local debt when important for payments system operation and local currency bond market development (examples: Uruguay, 2003 and Argentina, 2019). - Financial derivatives: - Often fully collateralized and governed by foreign law, making inclusion in DDR challenging. - Sovereigns “out-of-the-money” are contractually required to post collateral; sovereigns can unwind or terminate derivatives exposures, with consideration dependent on scale and net position. - Under ISDA close-out netting, outstanding transactions could be terminated following credit event; settlement amount determined by valuation and unpaid amounts. ### Breadth of perimeter: public sector liabilities beyond central government (Box 1) - Broadening perimeter to include liabilities beyond central government may be considered if it enhances prospects of restoring public debt sustainability (e.g., by reducing contingent liabilities). - Legal frameworks governing public sector bodies (insolvency regimes for SOEs and SNGs) determine scope. Separate legal personalities may lead to different restructuring treatments. - SOE debt: appropriate to include when SOE struggles to service debt and receives government support to avoid default (example: Barbados, 2018 included government guaranteed SOE debt). SOE restructuring may be complicated by separate governance and creditor base. - Subnational governments (SNGs): restructuring can be national government-led (budgetary support and transparent legal framework) or through special insolvency regimes; uncoordinated approaches can be costly. - Government guaranteed debt: can be included when guarantee risk is at risk of being called; sovereign may proactively restructure guarantees voluntarily (e.g., Greece, 2012) or unilaterally declare future claims related to guarantees will receive comparable treatment. ### Decision trade-offs and final selection - Sovereign chooses modalities to achieve DRT while minimizing overall economic costs (Figure 9, Step 6). - Outcome depends on circumstances: interior solution (DDR + EDR) or corner solution (only DDR or only EDR). - Iterative assessment required: estimating net debt relief, weighing economic, political, central bank, and market-development costs, and defining perimeter to balance participation and burden-sharing. *Source: ppea2021071 - 16.* ### 28. The central bank’s holdings of government debt are typically afforded particular ### ppea2021071 - 28. The central bank’s holdings of government debt are typically afforded particular ### Central bank holdings and options in restructuring - Central bank holdings of government debt can adversely affect its income, capital, and pool of marketable instruments to conduct open market operations. - Solutions used in past cases include: - Rolling over existing debt. - Altering the maturity and interest rate of central bank holdings without reducing the face value (for example, Russia, 1998). - Swapping central bank holdings for a new type of security that is then excluded from the restructuring (e.g., Greece, 2012). - If the central bank holding of government marketable debt is significant, it may be difficult to avoid a haircut which can impact its capital (e.g., Barbados, 2018). - New instruments offered to central banks are usually marketable instruments, but this may differ in certain cases (for example, in 2012 the central bank in Greece was temporarily provided with physical assets of SOEs in exchange for the bonds it held). - As the holdings of the central bank was subjected to significant haircut in Barbados, upfront recognition of losses from IFRS9 regulations resulted in a negative capital for which a recapitalization package is being worked out. ### Domestic arrears and clearing options - A comprehensive audit of arrears could be time consuming, especially when the public financial management systems are underdeveloped. - Restructuring some types of arrears (e.g., public sector wages and pension benefits, employer social security contributions, and tax refunds) may raise legal issues in some countries. - Options for clearing domestic arrears include: - Cash payment (e.g., Lesotho). - Restructuring either by converting into contractual debt or by announcing a new repayment schedule (e.g., Gabon and Liberia). - Securitization into marketable government securities (e.g., Madagascar). In countries where the debt market is not developed and secondary market trading is constrained, this could result in a deep discount for such securities. - To balance discrepancy in losses between foreign- (FX) and local currency- (LC) denominated instruments, a larger haircut could be built in for FX-to-FX exchanges compared to LC-to-LC exchanges. - Derivatives contracts are frequently undertaken under International Swaps and Derivatives Association (ISDA) master agreement, which are typically governed by foreign law. ### Treatment of public sector creditors and balance sheet considerations - The scope for restructuring the debt held by other public sector entities may be limited by their balance sheet strength, their linkages with the government budget, and their systemic importance. - Distinction is usually made between debt held by non-financial state-owned entities (including autonomous bodies) and financial institutions. - Public sector entities which operate on commercial principles and do not rely on budgetary support may have a higher capacity to bear the burden of debt restructuring. - Example: In Barbados, 2018, a nominal haircut was applied to public sector creditors (the central bank and the National Insurance Scheme) to obtain targeted debt relief while private creditors were spared from a nominal haircut. ### Distributional implications and retail holdings - A DDR could lower the wealth and income of individual households, directly through retail holdings or indirectly through shares in mutual funds and pension entitlements. - A DDR may affect availability of bank credit and cost of borrowing for corporations and households, with potential indirect distributional effects. - This calls for a thorough assessment and mitigation of the distributional implications of the restructuring on case-by-case basis. - Due to distributional considerations, in contrast to wholesale government securities—retail debt instruments have generally been left out of the scope of domestic debt restructuring. - In Russia (1998), individual bondholders were excluded from the restructuring. ### Legal toolkit and sovereign control (local law advantage) - A sovereign’s control over the domestic legal and regulatory framework affords it considerable influence over the DDR process. - The sovereign debtor could change the terms of its domestic debt obligations by virtue of legislation or, in some legal systems, through executive acts, without the consent of creditors (so called “local law advantage”), although such a change may be constrained by the sovereign’s constitution or its international obligations. - Disputes against the sovereign are typically adjudicated in the sovereign’s jurisdiction and thus resolution would depend on the capacity, efficiency, and impartiality of the judicial system in the debtor country. - By the nature of its (captive) investor base—a function of moral suasion, regulatory requirements, and investment guidelines—the fiscal and supervisory authorities have more leeway with domestic investors, which has made the creditor coordination (holdout) problem less pressing in DDR cases so far. - Domestic debt holders may successfully bring up their disputes in foreign courts. When no explicit choice has been made, a foreign court may well take jurisdiction after finding a reasonable connection between the transaction and the forum. However, in Argentine courts bondholders were generally unsuccessful in challenging the government’s debt restructuring measures. ### Retrofitted collective action mechanisms and limits - Some sovereign debtors have used the local law advantage by introducing retroactively through legislation statutory majority restructuring mechanisms akin to collective action clauses (CACs). - Under this mechanism, affirmative votes of a qualified majority of affected debtholders in an exchange offer could amend the payment terms of any untendered domestic bonds to match those of one of the new instruments being issued in the exchange (Buchheit and Gulati, 2010). - This mechanism has been used to overcome opposition of holdout creditors (e.g., Greece, 2012 and Barbados, 2018). - Sovereigns have also directly imposed financial terms through legislative or executive acts, such as reprofiling domestic debt by extending maturity of short-term local bonds through governmental decree (e.g., Argentina, 2019). This latter type applies to all targeted creditors without allowing affected creditors to vote on the restructuring terms. - Retroactive measures tend to undermine the fundamental premise of contracts and could erode investors’ confidence, encourage investors to insist on the use of foreign law, impose a premium on investment in domestic debt, and increase the risk of potentially costly and disruptive legal challenges. - Such measures should be applied only when absolutely necessary and with strict limits (Buchheit and Gulati, 2018). - Similarly, retroactive tax measures should generally be avoided due to their negative impact on fairness and certainty, and their susceptibility to potential legal challenges; such measures could also trigger an event of default under the domestic debt instrument, depending on its legal terms. ### Retrofitted Collective Action Mechanism — notable features (Box 2 summary) - Features observed in past domestic debt restructurings: - Imposed unilaterally and retroactively by the sovereign debtor to apply to all previously issued bonds. - Structured as a single limb aggregated voting procedure, without protections for a minority of creditors that are included in enhanced CACs (e.g., the “uniformly applicable” requirement). - In certain cases (e.g., Barbados, 2018), did not include a disenfranchisement provision which excludes bonds owned or controlled directly or indirectly by the sovereign debtor for voting and quorum purposes. - Use of the retrofitted collective action mechanism could be subject to limits under the sovereign’s constitutional or other domestic law and international treaty provisions that guarantee and protect property and investment rights. - Creditors litigated against Greece’s use of such retrofitted mechanism in its 2012 DDR in domestic, foreign, international courts, and (investment) arbitration tribunals; challenges were unsuccessful on grounds of Greece’s sovereign immunity, lack of jurisdiction by courts, or Greece’s affirmative defense that the restructuring served a legitimate public interest, was necessary to avert imminent insolvency, and was proportionate to the debtor’s aim as well as the present value of creditors’ claims. ### Collective Action Clauses (CACs) in domestic bonds - CACs in domestic bonds can offer an alternative—and potentially superior—mechanism to support effective DDRs. - Compared to retrofitted mechanisms, the use of CACs could increase legal certainty and predictability for investors and reduce the risk of legal challenges to the restructuring. - Since 2013, all new sovereign bonds issued by euro area members are required to include CACs in domestic and foreign law bonds with a maturity of more than one year to facilitate debt restructurings based on majority creditor voting. - Outside the euro area, no country has so far adopted this approach in its domestically issued bonds. - As domestic bonds in EMDEs typically have shorter maturities than external bonds, it would take relatively less time for CACs to be included in a substantial portion of the domestic debt stock than for external bonds. - The potential benefits and costs of including CACs in domestic bonds require further exploration (see Box 3). ### Considerations for introducing CACs in domestic bonds (Box 3 summary) - Market acceptability: - Decide after discussion with creditor base on implications for pricing and investor demand. - Consider composition and expected evolution of sovereign domestic debt portfolio, impact on borrowing costs, attractiveness to creditors, risks of holdout behavior, design of clauses, and currently available legal mechanisms for restructuring. - Design would need to address investors’ concern about sovereign’s influence over creditors’ voting under domestic bonds. - Potential changes to domestic legal framework and bond issuance practice: - Analyze applicable legal and regulatory framework carefully. - Inclusion of CACs in domestic bonds may require changes to public debt management law and bond issuance practice. - Need to overcome current practice of limited documentation and disclosure relating to domestic bond issuance. - Model enhanced CACs contain voting procedures and investor protection features such as information covenants, disenfranchisement provisions, and minority protections (e.g., “uniform applicability” in the single-limb voting procedure). ### Public debt management legal and regulatory frameworks - Sovereigns should adopt robust public debt management legal and regulatory frameworks to ensure due authorization, accurate recording and reporting of public debt. - Key challenge: verifying the amount of total public sector debt including arrears owed to suppliers and debt of public entities outside the central government. - Laws and regulations should stipulate a clear and comprehensive definition and coverage of public debt and government guaranteed debt, and appropriate reporting requirements (i.e., who needs to report data, to whom and how frequently). - Robust securities holding laws that ensure the dematerialized circulation of the debt instruments are also helpful in this regard. ### Process and strategy for restructuring domestic debt - After defining the debt restructuring perimeter, the government has to develop a strategy to replace existing obligations with new ones. - Unilateral modification using the “local law advantage” is an option but may carry significant adverse consequences. - Preferable strategies rely on market-based incentives and penalties, leaving room for negotiation and recalibration, and typically involve three steps: - Negotiating the terms and conditions of the debt exchange, including choice and design of new debt instruments offered. - Liaising with domestic creditors. - Presenting the exchange as part of a consistent macroeconomic plan. ### Choice and design of new instruments - New instrument design should be guided by effectiveness in restoring sustainability and preventing new debt distress. - A well-diversified sovereign debt portfolio balancing liquidity, maturity, currency, and other risks helps ensure capacity to meet future obligations and maintain market access. - A DDR could be guided by allocation rules designed to achieve specific policy objectives (example: Jamaica, 2010—allocation rules intended to ensure a reduction in the share of variable rate and dollar-denominated debt, and extending average maturity). - New instruments can absorb risk of natural disasters (example: Grenada, 2013—clause allowing deferral of debt service payments on restructured debt for up to 12 months in the event of a hurricane). - Example: Barbados (2018)—newly introduced hurricane clause in international sovereign bonds allowed for rescheduling of maturities over a two-year period following a major natural disaster. ### Incentives (“carrots”) and penalties (“sticks”) to induce participation - Incentives similar to external debt restructurings, plus DDR-specific options due to sovereign control over domestic laws and regulations. - Possible incentives: - Upgrades in governing law. - Introduction of a trust structure. - Differentiated regulations and treatments of collateral for monetary policy operations between new and old instruments. - Option to choose from a variety of new debt instruments. - Enhancing securities’ eligibility to be used to access emergency liquidity facilities. - Warrants and/or credit enhancements. - Ex ante “buyback clauses” (e.g., Argentina (2001) and Greece (2012)). - Providing unusually high cash-equivalent payout in bonds governed by foreign rather than domestic law (Greece, 2012). - Support to mitigate foreign exchange risk, e.g., indexation to inflation (Argentina, 2001). - Means to close open foreign currency positions for banks (e.g., Turkey, 2000 and Jamaica, 2010). - Tax policy allowing losses from the exchange to be carried forward without a limit. - Possible penalties: - Subjecting old securities to 100 percent risk-weighting and not accepting them as collateral in central bank liquidity facilities (helped yield a participation rate of 99 percent in Uruguay’s 2003 DDR). - Introduction of a tax surcharge on interest income earned and exercising call options embedded in old bonds (Jamaica, 2010—contributed to participation rate of more than 99 percent). - Retrofit of collective action mechanisms into marketable securities (e.g., Greece, 2012 and Barbados, 2018). - When using “sticks,” sovereigns need to be mindful of limitations under their constitution and/or other domestic laws as well as obligations under international treaties. *International Monetary Fund — Issues in Restructuring of Sovereign Domestic Debt (excerpts).* ### 39. Constructively liaising with domestic debt holders helps the restructuring process. It is ### Constructively liaising with domestic debt holders helps the restructuring process. ### Creditor liaison and negotiation - Sovereign should generally hire external advisors to: - Ascertain who are the holders of domestic debt and what is their ability to absorb losses. - Gauge the scope to produce a menu of new debt securities tailored to constraints of different creditor categories while considering intercreditor equity and participation concerns. - For negotiated DDRs, creditor consultations are more important to secure sufficient creditor consent before executing the debt restructuring. - In absence of domestic equivalents to the international debt architecture, debt advisors often must create ad hoc means of communicating and negotiating with domestic creditors. - A creditor committee in negotiated DDRs can: - Facilitate information sharing and negotiations. - Provide a venue to negotiate important intra-creditor tradeoffs. ### Communication strategy and stakeholder engagement - An effective communication strategy with different stakeholders is key to a successful domestic debt exchange. - Balance confidentiality and transparency to contribute to process efficiency. - Government and advisers should engage with key stakeholders in a confidential manner to inform intentions and solicit views where warranted from a financial stability perspective. - Maintaining unnecessary secrecy about details of the impending exchange can be counterproductive and cause market instability. - Examples of building political consensus and monitoring: - Jamaica (2010), Grenada (2013), and Barbados (2018) created stakeholder committees with civil society and banking sector representatives to monitor progress of the debt restructuring and economic adjustment program. ### Preconditions for a successful DDR: macroeconomic and reform credibility - A successful DDR requires: - Consistent macroeconomic policies and a credible plan of economic reforms. - Trust in the government’s willingness and capacity to implement reasonable macro-fiscal adjustment while mitigating spillovers. - A credible reform plan will often include: - Sustainable macroeconomic and financial sector policies: - Overall financial loss borne by creditors depends as much on the macroeconomic outlook and performance following the exchange as on the nominal reduction in principal and interest from the exchange. - Realistic fiscal consolidation plan and consistent monetary and financial policies to underpin debt sustainability and reduce sovereign risk are key determinants. - A plan to regain market access in a timely manner: - Robust debt management strategy is critical for securing timely and affordable market access, including establishing a resilient debt profile across currency composition, maturity structure, and refinancing risk. - Early and consistent engagement with local creditors on upcoming redemptions, financing needs, and envelope of securities to be offered can facilitate renewed domestic market access. - Elements include investor relations and debt transparency, a clear issuance calendar, targeting new domestic investors, and establishing an adequate cash buffer. - IFI monitoring, capacity development, and financial support: - IFI support can provide a robust commitment device to the reform plan and macro-framework to underpin the DDR as well as capacity development. - Since the IMF cannot lend to member countries with public debt trajectories that are determined unsustainable, an IMF-supported program would only contemplate a DDR if the debt operation is deemed necessary to restore public debt sustainability. ### Mitigating spillovers: scope of policy responses - Policy responses to safeguard financial stability following a DDR may include: - Liquidity and solvency support to financial institutions affected by the restructuring. - Temporary capital flow management measures and central bank interventions to support orderly market functioning. - Tailored policies for non-bank institutional investors and households. - Consideration of implications for the central bank’s balance sheet. ### Financial stability impact: sovereign-bank nexus and direct effects - The sovereign-bank nexus typically increases in the years prior to a domestic restructuring. - Financial systems in countries with public debt at risk are likely vulnerable because they are exposed to the same shocks as the sovereign. - Fiscal stress can lead sovereigns to rely more on financing from domestic financial institutions. - Direct impact on financial institutions: - DDR will directly affect balance sheets and earning potential of financial institutions holding sovereign debt. - Loss in value of government debt exposures leads to capital losses unless absorbed by provisioning and mark-to-market (MTM) accounting. - Losses may arise from face value haircut, coupon or interest rate reduction, and maturity extension with below-market coupon rates. - Banking sector capacity to absorb losses may be higher where it is well capitalized; if banks can absorb losses without government recapitalization, fiscal consolidation and burden-sharing by other creditors required to restore debt sustainability would be smaller. - Historical examples and magnitudes: - Greek (2012) restructuring involving a nominal haircut of 53 percent for the banking sector resulted in a loss of 170 percent of the core Tier 1 capital for the consolidated banking sector. - Other countries with substantial domestic banking exposure to government debt experienced significant negative banking effects: Argentina (2001); Ecuador (1999); Russia (1998). ### Indirect effects and channels of contagion - Indirect effects that are damaging and harder to assess include: - Deposit runs on affected banks with potential spillovers to other banks due to loss of confidence in government backstops. - Disruptions in interbank market liquidity, especially if DDR includes T-bills. - Impaired payment system functioning. - Capital flight and attendant effects on the net international reserves position. - Margin calls or withdrawal of foreign credit lines triggered by a sovereign rating downgrade, requiring topping up of collateral or repayment. - Exchange rate depreciation pressures driven by runs to safety or increased demand for foreign currency to meet margin calls. - Loss of access to central bank normal liquidity facilities due to limited eligibility of restructured assets as collateral. - Rapid decline in asset values driven by fire sales and deleveraging by banks. - Spillovers due to ownership and financial interlinkages among banks, insurance companies, investment funds, etc. - Combination of side effects could give rise to sizable bank recapitalization needs. - Example: overall NPV loss of 78 percent in Greece produced banking sector losses amounting to €38.7 billion. ### Designing DDRs to limit bank losses and accounting implications - DDR design can limit bank losses but losses should not be hidden. - Reprofiling with moderate NPV loss (no principal haircut) can limit direct balance sheet impact (e.g., Jamaica, 2010; Barbados, 2018; Grenada, 2013; St. Kitts and Nevis, 2012). - The precise impact depends on accounting and regulatory treatment of the debt restructuring. - Regulatory relief measures to reduce the impact of a reprofiling on banks’ capital should be avoided because they may: - Undermine credibility of banks’ reported figures. - Delay appropriate mitigating actions. - Examples of accounting/regulatory approaches: - Maturity extension may not require recognition of impairment if no reduction in NPV and no assessment of significant increase in credit risk. - Coupon reductions on reprofiling were in some cases exempted from recognition of impairment, allowing banks to avoid additional provisions (e.g., Jamaica, 2010; Cyprus, 2013; Uruguay, 2003) — but this overestimates banks’ financial and prudential ratios and may increase risks to financial stability. - Reprofiling of domestic debt categorized as HTM by the banking sector in Barbados (2018) was recognized as impairment due to expected loss provisioning under the IFRS9 standard. - In Greece (2012), recognition of a nominal haircut on domestic bonds led to severe banking sector losses even though bulk holdings were classified as held-to-maturity; with an overall NPV loss of 78 percent, banking sector losses amounted to €38.7 billion. - Box 4 (Accounting Treatment) summary: - Under IFRS 9, financial assets classified as Fair Value (FVTPL or FVTOCI) or amortized cost have different timing of loss recognition: - FVTPL: mark-to-market (MTM) valuation affects regulatory capital through profit and loss. - FVTOCI: realized gains/losses reflected in bank capital; unrealized gains/losses accounted as Other Comprehensive Income (OCI). - Amortized cost: not affected by market price changes but expected credit loss is accounted in loan loss reserves. - IFRS 9 requires timely recognition of impairment losses; fair value accounting can lead to earlier recognition of losses, enhancing loss-absorbing capacity before a DDR event materializes. ### Supervision, valuation, and restoring capital buffers - Supervisors should encourage banks to reliably measure and promptly recognize losses on sovereign exposures according to sound accounting and prudential standards. - For held-for-trading or fair value portfolios, MTM requirements should continue being enforced, including for new securities issued in the exchange if market valuation remains below par. - Impairment should be measured and recognized for expected losses on sovereign exposures, including those held at amortized cost. - Past episodes allowed gradual phasing in of MTM valuation to smooth price volatility impacts on bank capital around the exchange. - Regulatory treatment of sovereign exposures (higher risk weights and provisioning) imposed during distress may be gradually phased out as sovereign creditworthiness improves following the debt exchange. - If banks’ capital buffers are insufficient: - First step: accurate estimation of capital shortfalls through asset quality diagnostics, typically including an asset quality review (AQR) and possibly forward-looking stress testing and scenario analysis. - Strategy to eliminate shortfalls must balance financial stability and fiscal risks: - Supervisors should require viable banks likely to need recapitalization to develop credible plans to restore compliance with capital requirements and buffers over a reasonable period with close supervisory oversight. - Public sector recapitalization or state support may be considered as a last resort to maintain financial stability but may offset part of the debt relief targeted through the DDR; additional debt relief may need to be obtained from sovereign’s other liabilities. - Leveraging a well-designed framework for bank resolution, resolution funding, and deposit insurance can help mitigate risks, though contagion risks tend to be higher in debt restructuring cases where credible public sector guarantees and funding backstops may not be available. *International Monetary Fund — Issues in Restructuring of Sovereign Domestic Debt (excerpts).* ### 53. Gaps in crisis management and bank resolution frameworks should be identified prior ### 53. Gaps in crisis management and bank resolution frameworks should be identified prior ### C. Managing the Impact on Non-bank Financial Institutions - Findings and risks: - Long-term institutional holders of government debt (i.e., insurance and pension funds) typically have large exposure to sovereign securities and are likely to suffer significant losses in the event of a DDR. - These holders are often captive because of investment and regulatory guidelines and lack of other investment opportunities. - Depending on the size of the impact and the pre-restructuring financial condition of pension funds, pension reform might be required to address income and valuation losses from a debt restructuring. - Policy recommendations and reform options: - A comprehensive pension reform may be required to restore long run sustainability if reserves are acceleratedly depleted due to the haircut on sovereign securities. - For a funded pension system, a haircut can cause reserves to be depleted earlier than without the restructuring; under a scenario where liability cash flows start exceeding asset cash flows, reserves would have to be utilized to pay off current expenditures. - Medium-term systemic or parametric reforms could include: - making the public pension scheme contributory for new employees, - increasing the earliest age of eligibility for new employees, - reducing the rate of benefit accrual for each year of service for new employees. - A commitment to fiscal consolidation as part of a debt restructuring strategy, which seeks to reduce contributions from the government, could further increase the need for and extent of pension reforms. *For more details on the crisis management and resolution frameworks see Dobler, Moretti, and Piris (2020) and Bank for International Settlements (2014). For the role of government in corporate debt restructuring see Grigorian and Raei (2013).* ### D. Managing the Impact on the Central Bank and the Need for Systemic Liquidity - Objectives: - A sovereign DDR should be calibrated to minimize the effect on the central bank’s ability to conduct its main functions. - Channels of impact on central bank operations: - A DDR may reduce the central bank’s ability to: - (i) manage liquidity in the financial system through open market operations; - (ii) define and implement collateral policy given the decline in the stock of available government securities; - (iii) hold government securities as counterpart to central bank liabilities, such as currency in circulation and commercial bank deposits with the central bank. - A temporary relaxation of collateralization rules may have implications on the quality of the central banks’ assets. - Contingent fiscal and resolution considerations: - In some cases, a recapitalization of the central bank by the government (to compensate for the losses from haircuts on its holdings of government securities) may be unavoidable (e.g., Barbados, 2018). - If recapitalization is not feasible without endangering the sustainability of general government debt, imposing a higher debt relief burden on other creditors may be the only solution. - Liquidity backstops and stability funds: - Liquidity facilities designed to provide emergency support to eligible institutions affected by DDR have been key elements of the financial safety net in some recent episodes. - A liquidity backstop serves as a lifeline for financial institutions which may lose access to market or deposit funding; it is especially useful for banking systems with a high degree of interconnectedness and for institutions without access to a central bank window. - Collateral eligibility requirements may need to be reviewed, especially if banks face large haircuts on government bonds typically used as collateral for central bank operations. - In countries with underdeveloped financial markets, the size and scope of liquidity backstop facilities would be limited. - The establishment of a financial sector stability fund, possibly supported by IFIs, can help provide liquidity support to the banking system and enhance investor confidence. - When set up with contributions from IFIs (including the IMF), such a fund can serve as a confidence-building instrument for affected financial institutions. - The primary role of stability funds in past episodes was to provide liquidity support in the event of pressure on deposits, external funding calls, or assets under management attributable to debt restructuring. - Liquidity support could be provided up to a threshold (as a share of the affected institution’s capital), beyond which regulatory interventions would be triggered. - Inclusion of non-bank institutions which normally do not have access to central bank liquidity can also benefit from such funds. - A key rationale for a dedicated stability fund is to ring-fence external funding. - Historical instances: - Financial Stability Funds were set up during domestic debt restructuring events in Jamaica and St. Kitts and Nevis. - In Jamaica, the Financial Stability Fund was not limited to liquidity support and could provide solvency support subject to appropriate conditions. ### Capital flow measures and sequencing - Findings and recommendations: - To safeguard financial stability from the risks of sudden and rapid capital flight following a debt restructuring, temporary capital flow management measures (CFMs) on outflows may need to be considered in line with the IMF’s Institutional View (IMF 2012c). - For EMDEs, sudden and large capital flight could lead to pressures in the forex market, losses of international reserves and disorderly conditions in domestic financial markets. - Well-designed outflow CFMs could be effective in mitigating a crisis before implementation of macro-financial stabilization measures. - For countries facing imminent crisis, outflow CFMs may need to be introduced swiftly to prevent frontrunning. - Imposition of CFMs should be temporary and part of a broader policy package that also includes macroeconomic, financial sector, and structural adjustment to address the fundamental causes of the crisis. - CFMs should take into account country-specific factors and be based on a clear legal framework, with central banks generally playing a key role (Gudbjartsdottir, et. al. 2020). - Following restructuring, as macroeconomic and financial stability are restored, market confidence is regained, and foreign exchange reserves rebuilt, removal of the CFMs could be considered as a durable exit strategy. ### SECTION V. CONCLUSION — Key takeaways and policy guidance - Trends and context: - Restructurings of domestic debt have become more frequent since the mid-1990s and will likely become even more common in the future. - Through the development of domestic capital markets, EMDEs are increasingly relying on marketable, domestically issued debt to finance fiscal deficits and rollover requirements. - With a high number of countries at risk of debt distress as a result of the pandemic, domestic debt restructurings will likely be required more often to restore sustainability. - Decision framework for DDRs: - When public debt is unsustainable, policymakers need to decide whether domestic debt restructurings should be part of the resolution strategy, how to carry out the restructuring, and how to mitigate its economic costs. - The paper’s premise: EDRs and DDRs impact the economy through different channels; the sovereign’s control over domestic law affords greater influence over the DDR process than over EDRs. - This control can be used to avoid a protracted standoff with creditors and to ring-fence external reputational consequences, but DDRs impose losses on domestic stakeholders and may have large direct and indirect costs for the domestic financial system with spillovers to the domestic economy. - Practical guidance: - Sovereigns considering a DDR should: - anticipate its impact on the domestic financial system, - limit the use of the local law advantage, - put in place policy measures that mitigate costs for banks, non-bank institutional investors, and households. - Key considerations in deciding whether to undertake a DDR include its net—rather than gross—benefit after accounting for fiscal costs (in particular, related to bank recapitalization needs) and broader economic costs. - A wide definition of the perimeter of claims to be included in the restructuring supports participation by lowering the debt relief sought from each creditor group. - A fair and transparent process that encourages participation and accommodates creditor preferences to the extent possible can reduce operation costs. - Sovereigns should only use legislative or executive acts to change the terms of domestic debt contracts when absolutely necessary and with strict limits to avoid potential legal risks and negative consequences on the domestic debt market. - Safeguarding financial stability may include liquidity and solvency support to financial institutions affected by the restructuring, temporary capital flow management measures, and other central bank interventions to support orderly market functioning. - The implications of a restructuring for the central bank’s balance sheet and non-bank financial institutions need to be considered and mitigated through tailored policies. - Data and research gaps: - Further experience with domestic debt restructurings and improvements in the availability and quality of debt data would help gain a more granular understanding and inform policy advice. - Current analysis is constrained by small sample size and lack of granular data (such as net present value losses, debt relief, amount of restructured debt, holders of the debt). - The population sample of standalone DDRs is largely made up of LICs and small economies with very shallow or non-existent domestic debt markets, making extrapolation to larger, more diversified economies difficult. - The analysis is hampered by a lack of data classifying debt along all three dimensions (e.g., governing law, residency, and currency). *Source: ppea2021071 - 53. Gaps in crisis management and bank resolution frameworks should be identified prior* ### References ### ppea2021071 - References ### Key findings (Executive Summary) - Restructuring of domestically issued debt is likely to play a role in the resolution of future debt crises. - In the wake of COVID-19, emerging market and developing economies (EMDEs) with heightened debt vulnerabilities tend to have sizable stocks of domestic debt, increasing the potential for domestic debt to be part of future public debt restructurings. - The paper provides an in-depth analysis of domestic public debt restructuring episodes during 1980–2020 and qualitative analysis of 12 country case studies. - Restructurings of domestic debt have become more frequent relative to external debt restructurings since the mid-1990s and tend to occur in different settings. - Recent domestic debt restructurings were typically carried out through negotiations with creditors, rather than through inflation and financial repression as often in the 1980–90s. - Domestic debt is likely to be part of a public debt restructuring in two settings: - (i) as a stand-alone operation, in countries with low external debt to private creditors and/or shallow financial systems; - (ii) as part of a comprehensive debt restructuring (of both domestic and external debt) in countries with larger financial systems, often triggered or accompanied by severe crises (including banking crises). - Compared to domestic debt-only restructurings, combined domestic and external restructurings typically entailed larger losses for creditors and deeper post-restructuring economic and credit contractions. - The depth of restructuring generally depends on the extent of the debt problem, the loss absorption capacity of domestic financial institutions and the effectiveness of accompanying policies (including fiscal adjustment). - A domestic debt restructuring should be designed to anticipate, minimize and manage its impact on the domestic financial system. ### Introduction — Context and key statistics - 1. The COVID-19 crisis has led to a sharp rise in public debt burdens. In emerging market economies (EMs), public debt reached 66 percent of GDP, on average, at end-2020, while the average public debt in low-income countries (LICs) stood at 61 percent of GDP at end-2020. - 2. According to the IMF-World Bank debt sustainability framework for low-income countries (LIC-DSF), more than half of LICs were at high risk of or in public debt distress as of March 2021. Footnote: Based on the overall public debt LIC-DSF, as of March 2021, 58 per cent of countries were either at high risk of distress or in distress. - 3. The staff’s fiscal sector crisis model estimates the risk of a fiscal crisis event defined as any of the following: (1) occurrence of sovereign default or debt restructuring; (2) exceptionally large official financing; (3) high inflation or accumulation of domestic arrears (implicit default); and (4) loss of market access or spikes in sovereign yields (see IMF 2021). - Domestic debt trends and composition: - Since 2007, domestic debt (by residency of holders) has doubled from nearly 15 percent of GDP to around 30 percent of GDP, on average, for EMs and from just under 10 percent of GDP to roughly 20 percent of GDP in LICs. - Much of this debt has been issued under domestic law and has been held by residents. - LICs tend to have less domestic debt than EMs but rely more on external financing from multilateral creditors (including the IMF), which may make it difficult to secure meaningful debt relief if restructuring is limited to external debt only. ### Empirical and analytical themes covered - Comprehensive empirical analysis of public debt restructuring episodes during 1980–2020. - Qualitative analysis of 12 country case studies to draw lessons on perimeter, process, terms, financial stability considerations, outcomes, and future market access and borrowing costs. - Examination of macro-financial patterns around public debt restructurings, including distinctions between domestic-only restructurings and combined domestic-external restructurings. - Assessment of creditor composition, market re-access, bond yields, and credit ratings around restructuring events. - Policy emphasis: design restructurings to anticipate, minimize and manage impact on domestic financial systems; tailor modalities to country-specific financial sector depth and loss-absorption capacity; ensure effectiveness of accompanying policies including fiscal adjustment. ### Selected references (as listed in the source) - Awadzi, Elsie Addo, 2015. “Designing Legal Frameworks for Public Debt Management,” IMF Working Paper, WP/15/147. - Arellano, Cristina, Bai Yan, and Mihalache Gabriel, 2020. “Deadly Debt Crises: COVID-19 in Emerging Markets,” NBER Working Paper No. 27275. - Asonuma, Tamon, Chamon Marcos, Erce Aitor, and Sasahara Akira, 2019. “Costs of Sovereign Defaults: Restructuring Strategies, Bank Distress and the Capital Inflow-Credit Channel,” IMF Working Paper No. 19/69. - Asonuma, Tamon, Chamon Marcos, and Sasahara Akira, 2016. “Trade Costs of Sovereign Debt Restructurings: Does a Market-Friendly Approach Improve the Outcome?” IMF Working Paper No. 16/222. - Asonuma, Tamon, and Christoph Trebesch, 2016. "Sovereign Debt Restructurings: Pre-emptive or Post-Default," Journal of the European Economic Association, Vol 14(1), Pages 175–214. - Anthony, Myrvin, Gregorio Impavido, and Bert van Selm, 2020. “Barbados’ 2018–19 Sovereign Debt Restructuring–A Sea Change?” IMF Working Paper, WP/20/34. - Balke, Neele, 2018. “The Employment Cost of Sovereign Default,” Mimeo. - Bank for International Settlements, 2014. “Key Attributes of Effective Resolution Regimes For Financial Institutions.” Financial Stability Board. - Bank of Greece, 2013. “Report on the Recapitalisation and Restructuring of Greek Banking Sector, December 2012.” - Bocola, Luigi 2016. “The Pass-Through of Sovereign Risk,” Journal of Political Economy 124(4), pp.879–926. - Borensztein, Eduardo and Panizza Ugo, 2011. “The Costs of Sovereign Default,” IMF Staff Papers 56, pp. 683–741. - Bossu, Wouter, Cory Hillier and Wolfgang Bergthaler, 2020. “Local Currency Bond Markets Law Reform: A Methodology for Emerging Markets and Developing Economies,“ IMF Working Paper No. 2020/258. - Bucheit, Lee, Guillaume Chabert, Chanda DeLong, and Jeromin Zettelmeyer, 2019. “How to Restructure Sovereign Debt: Lessons from Four Decades.” Peterson Institute For International Economics Working Paper #WP19-8. - Buchheit, Lee, C. and Mitu Gulati, 2018. “Use of the Local Law Advantage in the Restructuring of European Sovereign Bonds,” University of Bologna Law Review 172. - Buchheit, Lee, C. and Mitu Gulati, 2014. “The Gathering Storm: Restructuring a Sovereign Debtor’s Contingent Liabilities,” Duke Law School. - Buchheit, Lee, C. and Mitu Gulati, 2010. “How to Restructure Greek Debt,” Duke Law Working Paper 47. - Cannuto, O. and L. Liu. 2013. “Until Debt Do Us Part: Subnational Debt, Insolvency and Markets.” The World Bank. - Cohen, Charles, Ali Abbas, Myrvin Anthony, Tom Best, Peter Breuer, Hui Miao, Alla Myrvoda, and Eriko Togo, The Role of State-Contingent Debt Instruments in Sovereign Debt Restructurings, IMF Staff Discussion Note SDN/20/06, November 2020. - D’Erasmo, Pablo and Mendoza Enrique, 2021. “History Remembered: Optimal Sovereign Default on Domestic and External Debt,” Journal of Monetary Economics, 117 (2021) pp. 969–89. - Dobler, Mark, Marina Moretti and Alvaro Piris, 2020. “Managing Systemic Banking Crises: New Lessons and Lessons Relearned,” IMF Monetary and Capital Markets Department Paper 20/05, Washington, DC. - Erce, Aitor and Enrico Mallucci, 2018, “Selective Sovereign Defaults,” FRB International Finance Discussion Paper 1239, Washington, DC. - Garcia, J., Monaghan, D., and Chavarri, P., 2019. “The Role of Bank Diagnostics in IMF-Supported Programs,” Technical Notes and Manual 2019/04, IMF. - Gelpern, Anna, 2008. “Domestic Bonds, Credit Derivatives, and the Next Transformation of Sovereign Debt,” Chicago-Kent Law Review 147. - Gennaioli, N., A. Martin, and S. Rossi. 2018. “Banks, Government Bonds, and Default: What do the Data Say?” Journal of Monetary Economics 98, 98–113, October. - Grigorian, David and Vlad Manole, 2017. “Sovereign Risk and Deposit Dynamics: Evidence from Europe,” Applied Economics 49, No. 29, pp. 2851–60, March. - Grigorian, David, and Faezeh Raei, 2013. “Government Involvement in Corporate Debt Restructuring: Case Studies from the Great Recession,” Modern Economy 4, No. 3, March. - Grigorian, David, Trevor Alleyne, and Alejandro Guerson, 2012. “Jamaica Debt Exchange,” IMF Working Paper No. 12/244. *Source: ppea2021071 - Issues in Restructuring of Sovereign Domestic Debt—Background Paper (References and Executive Summary, August 19, 2021).* ### 4. Increased debt sustainability ### 4. Increased debt sustainability ### Domestic debt shares and fiscal risk - For LICs assessed as high risk of debt distress or in debt distress (based on the March 2021 LIC-DSF), the average share of domestic debt in total public debt is 35 percent and 30 percent, respectively. - Domestic debt in EMs that are at high risk of a fiscal crisis is around 55 percent of total public debt, on average, compared to 37 percent in LICs. - Throughout the paper, "domestic debt" refers to sovereign debt issued under domestic law unless indicated otherwise. Under the IMF’s debt policies, alternative definitions include residency and currency criteria; there is usually a large overlap among these sets. ### Bank holdings and sovereign–bank nexus during the pandemic - Domestic banks in EMDEs absorbed a sizable share of new issuance of domestic sovereign bonds to help finance widening fiscal deficits during the pandemic. - In many cases, holdings of government debt rose faster than bank deposits. - A stronger sovereign–bank nexus increases the potential for bank losses in the event of a debt restructuring and exacerbates financial stability concerns. ### Dataset, taxonomy, and scope (1980–2020) - The dataset covers public debt restructuring events recorded during 1980–2020 for 89 countries (all EMDEs except Greece and Cyprus). - Counts and episode types in the dataset: - 63 domestic-law debt restructuring events (DDRs). - 135 external debt restructuring events (EDRs). - 80 high-inflation/financial repression episodes (IFRs). - 71 standalone EDRs. - 36 standalone DDRs. - 27 combined EDR/DDRs. - 37 EDRs accompanied by high inflation/financial repression (EDR/IFRs). - 43 episodes of high inflation/financial repression not accompanied by external or domestic debt restructuring. - Historical references: - Reinhart and Rogoff (2011): 68 cases of de jure domestic debt defaults in 64 economies for 1914–2010 versus 250 cases of external debt defaults for 1800–2010. - Erce and Mallucci (2018): 64 domestic default episodes and 118 external default episodes in 60 countries between 1980 and 2017. - The dataset builds on Reinhart and Rogoff (2011) and was expanded and revised using multiple sources, including a March–April 2021 survey of country authorities. ### Five types of public debt restructuring/reduction events (definitions preserved) 1. High inflation/financial repression episodes (IFRs): periods of persistent high inflation (at least 3 consecutive years of inflation at over 20 percent per annum, often in the context of financial repression). 2. Standalone domestic-law debt restructuring events (DDRs): changes to contractual payment terms on domestic-law public debt (including amortization, coupons, and any contingent or other payments) to the detriment of creditors, either through legislative/executive acts or through negotiations with creditors, or both. 3. Standalone external debt restructuring events (EDRs): restructuring of the foreign-law public debt. 4. EDRs accompanied by high inflation/financial repression (EDR/IFR): an EDR that coincides with an IFR (some EDR/IFR events were also accompanied by high inflation). 5. EDRs accompanied by domestic-law debt restructurings (EDR/DDR): events which include both external and domestic-law debt restructurings launched within a 3-year interval from each other, with the starting point corresponding to the starting point of the first event. ### Trends over time and drivers of restructuring choices - The relative frequency of DDRs has increased over time compared to IFRs and EDRs. - During 1980–89, high incidence of EDRs and EDR/IFRs reflected financial repression, high inflation, heavy reliance on external debt, and widespread external debt defaults. - Since the mid-1990s, the rise in domestic-law debt restructurings is linked to financial liberalization and greater reliance on marketable domestic debt, which makes de facto debt reduction via inflation and financial repression harder to implement. - In the three decades between 1990 and 2020, there are as many standalone DDRs (30) as standalone EDRs (27). - During 2000–20, both the relative frequency and duration of EDRs decline; the average duration of DDRs has been relatively short (2.2–2.5 years). ### Macro-financial patterns and triggers - Roughly 70 percent of all public debt restructuring events during 1980–2020 were preceded or accompanied by sharp recessions (real crises), external shocks (sudden stops and exchange rate pressures), or banking crises. - DDRs were often preceded by recessions and/or external shocks but very rarely by banking crises. - Over half of all EDR/DDRs were preceded or accompanied by banking crises and about a third by triple (real, external, and banking) crisis events. - Pre-restructuring growth rates were, on average, lower for comprehensive restructurings (EDR/DDRs) than for DDRs or EDRs, suggesting comprehensive restructurings tended to occur under more stressed economic conditions. - Crisis-driven DDRs and EDR/DDRs saw sharper output declines, with the worst GDP declines observed in EDR/DDRs where banking crises occurred in the same year as the public debt restructuring. - Public debt/GDP tended to rise more sharply in crisis episodes, especially when recessions were compounded by external pressures and currency depreciations. ### Historical methods to reduce domestic debt and policy implications - Historically used strategies to reduce domestic debt burdens include: high inflation, retroactive withholding taxes, financial repression, and overt debt restructurings by law or executive acts or through negotiations with creditors. - Financial repression can take many forms, including directing state-owned banks and enterprises or government-controlled entities to hold government securities; running interest-free arrears with domestic suppliers for extended periods; and setting interest rates on government securities below market rates. - While high inflation combined with financial repression can reduce the real burden of domestic public debt, it tends to have longer-term negative consequences for financial development and growth. - Engineering high inflation is less viable for countries with liberalized financial systems and established inflation targeting frameworks; it is also not something that can be done quickly in crisis conditions. - Therefore, the paper focuses on standalone EDRs, DDRs and comprehensive (EDR/DDR) restructurings, and on factors influencing restructuring choices and outcomes. *Source: ISSUES IN RESTRUCTURING OF SOVEREIGN DOMESTIC DEBT—BACKGROUND PAPER (excerpts from chapter 4).* ### 15. The post-restructuring outcomes tend to be worse when both domestic and external ### 15. The post-restructuring outcomes tend to be worse when both domestic and external ### Post-restructuring macro-financial overview - Output contractions in EDR/DDRs were generally sharper than in stand-alone DDRs or EDRs, and—unlike stand-alone DDRs or EDRs—both domestic and external financing channels were negatively affected. - When debt restructuring events were preceded/accompanied by external shocks (but no banking crises), cumulative output decline, credit contraction and the impact on capital flows were, on average, worse in EDR/DDRs than in DDRs or EDRs. - When debt restructuring events were preceded/accompanied by banking crises: - The impact on the domestic financial channel was stronger for EDR/DDRs. - The impact on the external financing channel was relatively stronger for EDRs. - Overall: macro-financial consequences of shocks that led to debt restructurings tend to be more severe when both domestic and external financial channels become impaired. ### Sample-size and robustness caveats - Given the small sample size, it is difficult to fully disentangle effects of shocks from impacts of restructuring choices on outcomes. - Controlling for factors (per capita output growth, credit, imports, inflation, US Treasury rate, exchange rate and income per capita), Erce and Mallucci (2018) conclude: - The impact of domestic and foreign defaults on growth is negative and similar in size. - Output contractions around combined domestic and external defaults are more pronounced. ### Banking crises interaction and timing - Output contractions during debt restructurings were more severe when debt exchanges occurred in the context of a weak domestic financial system (true for DDRs, EDRs and EDR/DDRs occurring either after or in parallel with banking crises). - Immediate growth impact tended to be worse when banking crises broke out in the same year as debt restructurings. - Over a four-year horizon since the start of debt restructuring, growth sometimes rebounded strongly (supported by debt relief and favorable external conditions); in the worst case, longer-term impact appears comparable to an average output contraction following a typical banking crisis. - Note: The median cumulative output loss for EMDEs that experienced a banking crisis is nearly 14 percent (cumulative over four years) (Laeven and Valencia (2020)). ### Scale and design of restructuring - A larger scale of restructured debt and greater losses imposed on creditors may lead to worse macro-financial outcomes, at least in the short run. - Granular information on scale/losses is available for relatively few recent cases and is explored further in qualitative case studies. ### Pre-restructuring public debt levels and composition (medians, recorded one year before restructuring) - Pre-restructuring median public debt levels relative to GDP: - DDRs: 70 percent - EDRs: 79 percent - EDR/DDRs: 88 percent - Median domestic debt/GDP ratios: around 20 percent for both DDRs and EDR/DDRs. - Median share of domestic debt in total public debt: - DDRs: 37 percent - EDRs: 27 percent - External public debt held by private creditors (median share of total public debt): - Prior to DDRs: 9 percent - Prior to EDRs: 28 percent - Prior to EDR/DDRs: 65 percent - Interpretation: A larger stock of domestic debt makes its inclusion in a restructuring more likely; stand-alone DDRs often occurred where external public debt to private creditors was very low. ### Pre-restructuring financial system indicators (medians, recorded one year before restructuring) - Domestic bank credit to the private sector (percent of GDP): - DDRs median: 15 percent of GDP - EDR/DDRs median: 38 percent of GDP - Pre-DDR median bank profitability (ROA) was stronger than for other cases. - Bank holdings of sovereign bonds were somewhat larger in DDRs than in EDRs (data on bank holdings of govt debt available only for about 1/3 of restructuring cases). - Private sector reliance on external financing: - Gross capital inflows scaled by domestic credit to the private sector tended to be lower in countries that experienced DDRs or EDR/DDRs compared to those that had EDRs. ### Probit regression findings on determinants of restructuring choices - Larger economic deteriorations in the run up to public debt restructurings make inclusion of domestic debt in a restructuring more likely. - Both DDRs and EDR/DDRs are more likely during periods of economic downturns. - EDRs are more likely in the context of increased fiscal liquidity pressures (deterioration of the primary fiscal balance) and less favorable external financing conditions (higher US Treasury bond yields). - EDRs are also more likely in countries with lower nominal per capita GDP. - Conditional on a restructuring occurring, choice between EDR and DDR largely determined by debt composition: - Unconditional probit results: - EDRs more likely when public debt/GDP ratio and the share of external debt to private creditors are higher. - Both EDRs and EDR/DDRs are more likely when domestic public debt/GDP is lower. - Conditional probit results: - A DDR is more likely when domestic debt/GDP is higher, while the share of external debt to private creditors is lower. - Strength of domestic financial transmission channels matters: - Unconditional probit results show EDR/DDRs are more likely in countries with larger banking systems. - Likelihood of a DDR increases in countries with relatively more resilient banking systems (proxied by banking system ROA). - Robustness: Baseline findings are robust across subsamples (pre- and post-2000 periods, EMs and LICs, and when including inflation rate proxying monetary policy regime). *Source: ISSUES IN RESTRUCTURING OF SOVEREIGN DOMESTIC DEBT—BACKGROUND PAPER (excerpt).* ### 22. These results highlight the role of the composition of public debt and the domestic ### ppea2021071 - 22. These results highlight the role of the composition of public debt and the domestic ### Lessons from the country case studies — overview - Review covers 12 public debt restructuring episodes involving domestic-law debt (Annex III provides details for each episode). - Case-study selection objective: include domestic-law debt restructurings representative in geography and income level and novel in restructuring characteristics. - Discussion focuses on: backdrop; perimeter/process/terms; financial stability considerations; outcomes; market access following restructurings. ### Context: common preconditions and shocks - In all 12 case studies, restructurings were preceded by significant deterioration in economic conditions and increased fiscal pressures. - Primary drivers: - External shocks and pre-existing vulnerabilities (including prior fiscal mismanagement). - Difficulties servicing public debt obligations and/or sharp rise in sovereign financing costs due to concerns about sovereign creditworthiness or credit rating downgrades. - Examples of shocks and amplifiers: - Post-global financial crisis episodes: Greece (2011-2012), Cyprus (2013), Jamaica (2010, 2013), St. Kitts and Nevis (2011), Grenada (2013). - Persistent balance of payments pressures (e.g., slow recovery in tourism in St. Kitts and Nevis, Grenada, Jamaica). - Financial spillovers/contagion (e.g., Cyprus from Greece; Russia from Asian crises; Ukraine from Russian crisis; Uruguay from Argentine crisis). - Natural disasters (Grenada and Jamaica). - Pre-existing vulnerabilities: macro-financial imbalances, fiscal vulnerabilities, fixed exchange rate contexts, public debt rising well beyond prudent levels; several cases experienced dramatic currency devaluations (Russia, Ukraine, Argentina, Uruguay). - Public debt pre-restructuring domestic stocks (post-GFC cases) ranged from 36 percent of GDP (Grenada) to 97 percent of GDP (Barbados). ### Perimeter, process, and terms - Process: - Many recent DDRs and EDR/DDRs were preemptive rather than post-default. - Stand-alone DDRs in case studies: Nicaragua, Jamaica (2010, 2013), Cyprus — all preemptive. - About half of EDR/DDRs were preemptive (Ukraine, Uruguay, Greece, St. Kitts and Nevis). - Post-default restructurings in sample: Russia, Argentina, Barbados, Grenada. - Comparative finding: studies on external debt restructurings find notably worse outcomes in post-default cases. - Data (4 preemptive and 3 post-default EDR/DDRs) indicate pre-restructuring GDP contractions and the rise of public debt/GDP tend to be more pronounced in preemptive cases than in post-default cases; post-restructuring growth patterns do not provide clear evidence favoring preemptive approaches for domestic-law debt restructurings. - Perimeter: - Short-term instruments often excluded. Short-term T-bills with maturity of less than 12 months were excluded in Grenada, St. Kitts and Nevis, Cyprus, Jamaica, and Uruguay. - Where T-bills were a large share (Barbados, Russia, Ukraine) they were included in exchanges. - Longer-term domestic bonds (local currency or FX denominated or linked, fixed or floating rate) were included in all cases. - Net present value (NPV) losses and haircuts: - NPV losses were deeper when face value haircuts accompanied coupon reductions and maturity extensions; on average lower in DDRs than in EDR/DDRs. - No face value haircuts examples: - Barbados: private creditors’ NPV loss of 30 percent due to interest reductions and maturity extensions. - Jamaica (2010): NPV loss about 10–15 percent without face value haircuts. - Cyprus: restructuring involved only maturity extensions, leading to an NPV loss of 36 percent. - Nicaragua (2008): combination of interest rate reductions and maturity extensions. - Face value haircuts examples: - Grenada: NPV loss of 50 percent due to lengthening of maturities, lower coupon rates, and face value haircuts. - St. Kitts and Nevis: average NPV loss 65 percent (including both EDR and DDR components). - Greece: deep face value reductions led to NPV losses of 65-78 percent. - Argentina (2001): initial restructuring did not include face value haircut, but conversion of foreign currency debt into local currency resulted in additional NPV loss of 45 percent for domestic banking sector. ### Financial stability considerations and policy tools - Stress tests and regulatory/crisis management measures were used to assess and manage financial stability implications. - Bank stress tests: - Used to calibrate debt restructuring parameters and assess potential recapitalization needs in Barbados, St. Kitts and Nevis, Jamaica (2010, 2013). - Financial stability funds: - Established in several cases to provide liquidity or solvency support. - Jamaica: Financial Sector Stability Fund (FSSF) established in 2010; provided short-term liquidity and in special cases capital support; remained operational during 2013 exchange; remained untapped but helped maintain confidence. - St. Kitts and Nevis: Banking Sector Reserve Fund (BSRF) established under a Fund-supported program. - Greece: significant resources set aside in EU/ECB/IMF-supported program to help banks cope with recession and sovereign restructuring. - Uruguay: Fund for Fortifying the Banking System (FFBS) set up ahead of restructuring. - Bank recapitalization or restructuring: - Before restructuring: - Russia: several banks lost licenses; three major regional banks restructured during 1999 before second GKO swap. - Uruguay: comprehensive banking system cleanup (liquidations/restructurings) ahead of sovereign restructuring. - After restructuring: - Cyprus: authorities intervened and restructured two large banks, bailing in bank creditors. - Greece: several rounds of recapitalizations needed to restore viability. - Argentina: banks recapitalized via specially issued government bonds after restructuring and peso devaluation. - No recapitalization required: - Barbados, Grenada, St. Kitts and Nevis, Jamaica: debt exchange design features and favorable global conditions allowed financial institutions to absorb losses without material liquidity or capital shortfalls. - Note: in Barbados, Grenada, Jamaica domestic commercial banks were not the largest holders of domestic government bonds. - Regulatory flexibility and forbearance: - Nicaragua: regulator temporarily waived requirement to apply NPV accounting standards to restructured bonds, extended use of new bonds for liquidity purposes, allowed bonds to be used as dividend payments. - Argentina: banks temporarily allowed to decrease capital charge on interest rate risk; losses due to court injunctions could be booked as assets to be amortized over a 5-year period. ### Outcomes: participation, instrument design, and program context - Creditor participation: - Generally high in domestic debt exchanges: - Barbados: 100 percent participation. - Grenada: 100 percent participation. - St. Kitts and Nevis: 100 percent participation. - Jamaica: 99.2 percent (2010) and 99 percent (2013). - Greece (Greek law bonds): 100 percent participation (foreign law bonds participation 75 percent). - Uruguay: 99 percent participation for domestically issued bonds. - Russia (second restructuring): 95 percent participation for residents and 89 percent participation for nonresidents. - High participation achieved via combination of “carrots” and “sticks”: - Carrots: - Greece: “sweeteners” — creditors entitled to receive 15 percent of value of old bonds in cash-like short-term EFSF bonds. - Russia: participants received package of cash and short-term instruments plus longer-term new bonds. - Jamaica: participating financial institutions eligible to access FSSF. - Sticks: - Barbados and Greece: retrofitted collective action mechanism requiring parliamentary approval. - Uruguay: regulatory disincentives—old securities effectively became non-tradable and not accepted as collateral in central bank liquidity facilities. - Jamaica: tax surcharge on interest income acted as disincentive to hold out. - Nicaragua: legal uncertainty and potential invalidation of old domestic bonds provided strong holdout incentive to accept exchange. - Ukraine: central bank indicated only domestic banks participating in exchange would have access to short-term emergency financing. - New instruments: - Designed to restore debt sustainability, reduce vulnerabilities, ensure high participation, and provide additional commitment mechanisms. - Typical features: lengthened maturities, reduced near-term rollover risks, FX hedge (Russia), inflation hedge (Jamaica). - Barbados and Grenada: new instruments included natural disaster clauses. - St. Kitts and Nevis: some new bonds included claw-back feature granting creditors additional bonds if authorities failed to implement IMF-supported reform program. - Program context: - In all case studies, restructurings occurred in context of IMF-supported programs as part of broader policy response including significant fiscal adjustment and structural reforms. ### Future market access and borrowing costs - (Section heading appears in source; detailed outcomes on future market access and borrowing costs follow in the source material beyond the extracted content.) *Source: ISSUES IN RESTRUCTURING OF SOVEREIGN DOMESTIC DEBT—BACKGROUND PAPER (excerpt).* ### 29. The average speed of the post-restructuring normalization of market access, credit ratings ### 29. The average speed of the post-restructuring normalization of market access, credit ratings and borrowing costs ### Market access - In most cases, sovereigns regained access to domestic and international markets within 2 years after the public debt restructuring. - Average time to re-access domestic market: 1.7 years. - Average time to re-access international market: 0.6 years. - Three sovereigns have not yet tapped either domestic or international markets following their most recent debt restructurings: Barbados, Grenada, and St. Kitts and Nevis. - Re-access to domestic or international markets is defined as the date of the first medium- and long-term bond (maturity longer than 1 year excluding Treasury bills) issuance after completing a restructuring. - Variation in time to re-access is likely linked to global financial market conditions and may depend on losses imposed on creditors and whether the restructuring was preemptive or post-default (insufficient data to test these hypotheses for DDRs and EDR/DDRs). ### Credit ratings - Local currency (LC) and foreign currency (FC) credit ratings tended to cluster within the single-B range at the 2-year mark after debt restructuring, regardless of the type of restructuring or the level of pre-restructuring ratings. - In most cases, credit ratings did not recover to pre-restructuring levels within 2 years after restructuring. - LC and FC ratings tended to move in tandem in both DDRs and EDRs. - Rating agencies assign domestic and foreign currency bond ratings regardless of the jurisdiction of issuance. - Sovereign borrower is considered in default in local currency debt if it missed a payment on at least one financial obligation or if an exchange is seen as distressed (accompanied by a reduction in coupon, principal, or increase in maturity). ### Borrowing costs - Real long-term domestic bond yields tended to rise sharply around restructurings and, except in the case of Cyprus, did not revert to their pre-crisis levels within the subsequent 2 years. - External bond spreads (the difference between yields on external sovereign USD bonds and US Treasury bond yields) also rose but reverted to pre-restructuring levels faster than domestic bond yields in some cases, reflecting favorable global financial conditions. - Real long-term domestic bond yields correspond to yields of domestic bonds (domestic currency-denominated) whose remaining maturity is close to 10 years at each specified period minus CPI inflation rate. - Cyprus bond spread corresponds to the difference between Cyprus bond yields denominated in euro and German bond yields denominated in euro. ### Key takeaways (summary of broader findings) - Increased debt sustainability concerns in countries with large domestic debt stocks raise the potential for more domestic debt to be part of future public debt restructurings; restructurings of domestic debt have become more frequent since the mid-1990s. - The decision to restructure domestic debt and outcomes are influenced by: - the extent of the public debt problem, - the composition of public debt, - the severity of shocks that led to restructuring, - the strength of the domestic financial transmission channel. - Domestic debt-only restructurings tended to occur in countries with low external debt to private creditors and shallow financial systems, and typically entailed smaller losses for creditors and milder post-restructuring economic contractions than other restructuring operations. - Comprehensive restructurings (both domestic and external) occurred in countries with larger financial systems, were often triggered or accompanied by severe crises (including banking crises), involved larger losses for creditors and deeper economic and credit contractions. - Design of public debt restructuring matters to achieve required debt relief while minimizing financial stability risks: - Depth of restructuring depends on the extent of the debt problem, loss absorption capacity of domestic financial institutions, and effectiveness of accompanying policies (including fiscal adjustment). - A well-designed restructuring should internalize its impact on the financial system, ensure high creditor participation, and include new instruments to reduce key debt vulnerabilities. - Impact on the domestic financial system was managed in practice through ex ante stress tests, regulatory and crisis management measures, and establishment of financial stability funds. - Post-restructuring market access and borrowing costs appear to depend more on the effectiveness of the overall policy response and global financial conditions than on specific debt restructuring modalities (e.g., preemptive vs post-default; DDRs vs EDR/DDRs). - Empirical analysis and lessons will be further refined as more data become available. *Source: ISSUES IN RESTRUCTURING OF SOVEREIGN DOMESTIC DEBT—BACKGROUND PAPER (excerpt).* ### Annex I. Data Issues ### Annex I. Data Issues ### A. Sample Description - Dataset coverage: 89 countries that experienced a public debt restructuring event involving either external or domestic-law debt between 1980 and 2020. - Country composition: Most countries in the sample are EMDEs, except Cyprus and Greece. - Visualization: Figure I.1 presents countries/years with high inflation (above 20 percent per annum), as well as domestic-law or external public debt restructurings. - Sources compiled from: Reinhart and Rogoff (2011), Asonuma and Trebesch (2016), IMF staff reports, credit rating agencies, and a survey of the country authorities conducted by IMF staff during March-April 2021. - Formal identification of different types of debt restructuring events is discussed in paragraph 8. ### B. Data Sources - General government gross debt (billion, national currency): IMF World Economic Outlook - General government external debt (billion, national currency): IMF World Economic Outlook - Official external debt (billion, US dollar): IMF World Economic Outlook - Gross external debt including arrears and other short-term debt (billion, US dollar): IMF World Economic Outlook - External debt stocks, public and publicly guaranteed (billion, US dollar): WB International Debt Statistics - Private external public debt (percent of public debt): WB International Debt Statistics - Domestic bank holding of total government debt (percent of total debt): Sovereign investor base estimates by Arslanalp and Tsuda (2014) - GDP (constant 2010 US dollar): WB World Development Indicators - Primary balance (percent of GDP): IMF World Economic Outlook - Domestic credit to private sector (percent of GDP): WB World Development Indicators - Deposit money banks' assets (percent of GDP): WB Global Financial Development - Bank return on assets (percent, before tax): WB Global Financial Development - Bank credit to private non-financial sector (percent of GDP): Bank of International Settlements - Gross capital inflows to the private sector (percent of GDP): IMF World Economic Outlook - Nominal exchange rate against US dollar, end of period: IMF World Economic Outlook - Nominal GDP per capita (thousand US dollar): WB World Development Indicators - Banking crisis indicator (binary): Laeven and Valencia (2020) - External crisis indicator (binary): IMF Vulnerability Exercise Database - Real crisis indicator (binary): IMF Vulnerability Exercise Database - US 10-year Treasury Bond Yields (percent): Financial Sector Database - Domestic bond yields: Financial Sector Database - Consumer price index (CPI, percent): IMF World Economic Outlook - External bond spreads (percent): Financial Sector Database - Bond issuance: Perfect Information - Credit rating on local and foreign currency denominated debt: Standard and Poor’s ### C. Crisis Events — Identification Methodology - Real, external, and banking crisis shocks identification is based on the IMF Vulnerability Exercise methodology (IMF, 2021). - External crisis events: - Include (i) sudden stops (net private capital inflows as a percentage of GDP are at least 2 percentage points lower than in the previous year and two years before, as well as when the country gets approved for large IMF support) with growth impact (when the changes in growth relative to the previous five-year average growth rate lie in the lower 10th-percentile of the whole panel) and (ii) exchange market pressure events (defined as occurring when the Exchange Market Pressure (EMP) index lies in the lower 15th-percentile of the whole panel, as well as when the country gets approved for large IMF support). - Data on external crises for 1990–2017 used in this paper come from the IMF Vulnerability Exercise database. - Data on currency crises during the 1980s come from the Reinhart and Rogoff database. - Real crisis events: - Defined based on four different GDP series and four different thresholds: - (i) a country’s annual growth rate, - (ii) its cumulative growth rate over the past three years, - (iii) its growth performance relative to the most recent five-year average, - (iv) its average GDP level relative to the previous three-year average. - Focus is on GDP per working-age person. - Values are flagged as being in a crisis if they fall below the 10th percentile of observations in one of these groups: - (i) all countries in the sample, - (ii) all countries in the same income group – advanced economies (AEs), emerging markets (EMs), and low income and developing economies (LICs) according to the current WEO classification, - (iii) by income group according to the WEO classifications in 1980 with an additional category of countries with a population below one million, - (iv) countries in the same tercile of the total sample for year-on-year growth volatility. - Data on real crises for 1990–2018 used in this paper come from the IMF Vulnerability Exercise database. - Banking crisis events: - Sourced from Laeven and Valencia (2020), which covers 117 countries from 1980 to 2017. *Annex I. Data Issues — ppea2021071.* ### 6. Context: Ukraine’s debt crisis in 1998–2000 followed immediately after the Russian financial ### 6. Context: Ukraine’s debt crisis in 1998–2000 followed immediately after the Russian financial ### Context - The crisis followed the Russian financial crisis in August 1998. - The market for government debt dried up when large repayments on Treasury bills were coming due, and Ukraine faced serious problems of rolling over its debt. - The National Bank of Ukraine (NBU) devalued the Hryvnia in September 1998—by adjusting its fluctuation band—and eventually floated the currency in March 1999. - The NBU closed the interbank market for foreign exchange, forcing all transactions onto the official market. - The Ukrainian government announced a restructuring of both domestic and external debt in August 1998 and completed it in August 1999. ### Perimeter, process, and terms - Sovereign debt eligible for restructuring comprised: - domestic treasury bills (OVDPs) of US$4.9 billion, and - external commercial loans (Chase and ING loans) of US$0.3 billion in total. - Treasury bills issued under domestic law (US$4.9 billion) were held by: - domestic commercial banks (US$4.5 billion) and - non-residents (US$0.4 billion). - The restructuring exchanges in sequence: - In August 1998, T-bills held by local commercial banks (OVDPs-resident) were exchanged for long-term local currency-denominated debt with maturity of 3-6 years. - T-bills held by non-residents (OVDPs-nonresidents) were exchanged for local currency-denominated bonds or US$-denominated bonds. - The government restructured a US$109 million loan issued through Chase Manhattan in October 1998, and the ING loan (US$163 million) in August 1999. - NPV haircuts: - OVDPs-residents: 6.9 percent - OVDPs-nonresidents: 56.3 percent - Chase loan: 30.7 percent - ING loan: 38.0 percent ### Financial stability considerations - Authorities’ banking sector reform under the IMF-supported program included banking sector restructuring and measures to strengthen bank supervision. - Under the financial sector reform program, two state-owned banks, Savings Bank and State Export-Import Bank, underwent major rehabilitation programs. - The NBU indicated that all domestic banks participating in the exchange would have access to short-term emergency financing, while banks that refused to participate would not be eligible to receive any emergency financing. ### IMF-supported program - The IMF-supported program envisaged: - a reduction of the overall fiscal deficit, - regaining credibility in monetary policy to contain inflation and maintain a stable exchange rate, - elimination of deficit financing by the NBU, and - structural reform agenda. ### Outcomes - Participation: - Participation of OVDPs-residents was 84 percent. - Participation of OVDPs-nonresidents was 82 percent. - Participation in the restructuring of the Chase and ING loans was 100 percent. - New instruments: - At OVDP debt exchange in August-September 1998, domestic residents were offered long-term hryvnia-denominated bonds (maturity of three to six years). - Non-residents were offered a choice between a hryvnia-denominated bond with a 22 percent hedged annual yield or a two-year zero-coupon dollar-denominated Eurobond with a yield of 20 percent. - Debt relief: - The estimated (nominal) debt relief was about US$240 million in total. - The restructurings in 1998–99 provided immediate cash flow relief but created large payment obligations for 2000–01, resulting in an external debt restructuring in 2000. - Ukraine regained access to the international market in October 2005. *International Monetary Fund — Issues in Restructuring of Sovereign Domestic Debt — Background Paper (excerpt).* ### 25. Context: In 2008, in an environment of slow growth and high inflation resulting from a ### 25. Context: In 2008, in an environment of slow growth and high inflation resulting from a ### Nicaragua (2008) - Context: - In 2008, in an environment of slow growth and high inflation resulting from a commodity price shock, the current account widened, and Nicaragua reached out to external stakeholders for financial assistance. - Nicaragua reached an agreement for a 3-year PRGF program with the IMF. - The second review of the program was delayed among other factors (e.g., the global financial crisis and a commodity price shock) due to a domestic debt default triggered by a court injunction that stopped the payment on the outstanding bonds, due to allegations of governance issues. - Perimeter, process, and terms: - During the 2001 banking crisis, the Central Bank of Nicaragua issued approximately US$400 million (about 10 percent of GDP) in domestic bonds, CENIs (Certificados Negociables de Inversion) backed by the government. - The bonds were issued to cover the shortfall in performing assets vs liabilities for insolvent banks. - They were dollar indexed and had maturities of up to 3 years. - In 2003, the banks holding CENIs agreed to provide debt service relief to the government by accepting new bonds (bonos bancarios) with maturities up to 10 years. - The bonos bancarios had a long and mired legal history and in 2008 the courts temporarily halted debt service to banks. - Under the shadow of legal challenges, banks agreed to restructure their bonos bancarios, the outstanding amount of which was US$190 million (about 2.2 percent of GDP). - The new instruments had 20-year maturities, lower interest rates, but were allowed to be used for liquidity and dividend payment purposes. - Financial stability considerations: - The 2008 restructuring impacted banks’ capital levels, liquidity and market indicators as well as the concentration limits. - Nevertheless, all but two banks managed to keep capital level above the required 10 percent following the restructuring. - The IMF program included a financial strategy for banks to achieve prudential compliance as well as an agreement to provide some regulatory forbearance. - IMF-supported program: - Completion of the domestic debt exchange and the judicial consent to make scheduled bond payments were part of the program. - The multilateral support package provided substantial financial support, facilitating external and fiscal adjustment. - Outcomes: - Participation: - Participation during the domestic debt restructuring was limited to banks holding CENIs. - All the securities held by banks were tendered at the exchange. - The largest incentive was the legal uncertainty of the old bonds. - New instruments: - New instruments were issued twice as the CENIs were restructured, and the circumstances around the issuance of the new instrument was a key basis for the legal disputes. - Debt relief: - The domestic debt restructuring was critical to continuing the IMF program and is estimated to have provided debt relief of about US$50 million in NPV terms, but no face value reduction. - The restructuring of domestic securities was in addition to a broader debt restructuring strategy that was taking place, which included a voluntary debt buy-back of commercial debt (facilitated by the World Bank’s Debt Reduction Facility) as well as a debt restructuring agreement with official bilateral creditors. ### F. Jamaica (2010) - Context: - The global financial crisis added significant balance of payments pressures on the Jamaican economy already struggling with low growth and high public debt. - Jamaica’s debt, held mainly by domestic creditors, was subject to mounting exchange rate, interest rate, and refinancing risks. - By end-2009, Jamaica’s public debt at nearly 140 percent of GDP appeared unsustainable, with interest payments accounting for more than half of fiscal revenues, forcing the government to undertake a debt exchange (launched on January 14, 2010 and completed on February 3, 2010). - Perimeter, process, and terms: - The restructuring— the Jamaica Debt Exchange (JDX)—covered all government of Jamaica’s domestically issued debt, including local currency (fixed, variable, and US$-indexed) securities and locally issued US$-denominated debt, totaling 65 percent of GDP. - Externally issued bonds were excluded from the transaction. - The operation involved no face value haircuts but reduced the securities’ coupons and extended their maturities. - Investors were given an option of selecting from a menu of new fixed, floating, and inflation- and US$-indexed securities, subject to allocation rules to reduce the share of variable rate and US$-denominated and to increase maturity. - Financial stability considerations: - To safeguard financial stability, the government established a liquidity facility—Financial Sector Support Fund (FSSF)—funded by the IMF, the Inter-American Development Bank (IDB), and the World Bank for solvency and liquidity needs of eligible financial institutions. - The FSSF received no applications and remained untapped because the financial institutions with exposure to the government debt managed the stress on their own. - The Bank of Jamaica conducted iterative stress-tests to help calibrate the design of the debt restructuring. - IMF-supported program: - Completion of the debt restructuring was a prior action for IMF Executive Board approval of Jamaica’s 2010 Stand-By Arrangement (SBA). - Following the completion of the debt exchange, the SBA was approved, catalyzing support from other multilateral creditors. - Outcomes: - The multilateral assistance and the debt exchange significantly reduced Jamaica’s liquidity risks. - The operation secured fiscal saving of about 3.5 percent of GDP and extended the average maturity of domestic debt by 3.6 years. - Despite these achievements, the 2010 debt operation did not lead to a gradual reduction of public debt and debt sustainability as expected—the 2010 SBA went off track after the completion of just 3 quarterly reviews owing to fiscal slippages. - Participation: - The debt exchange recorded a high participation rate (99.2 percent). - Participation was supported by a mix of “carrots” and “sticks”, including tax surcharge on interest income earned from the old bonds, the threat of exercising the call option embedded in old bonds, and temporary regulatory forbearance. - New instruments: - Allocation rules separated fixed-rate, variable-rate, and US$-denominated old instruments. - Holders of fixed-rate instruments were permitted to swap only into other fixed-rate instruments; holders of variable rate and US$-denominated instruments were required to swap into some new fixed-rate and inflation-indexed bonds; only holders of old US$-denominated debt were allowed to acquire new US$-denominated securities. - Coupon rates on variable bonds were fixed for the first 3 to 12 months. - Except for variable-rate bonds, the new instruments were stripped off the call options. - Market structure outcome: - The new (benchmark) bonds—25 in total, comprised of 11 fixed, nine variable, three US$-denominated, and two CPI-indexed bonds—replaced over 350 different securities in circulation. ### G. Greece (2011-2012) - Context: - Greece requested official financial assistance in April 2010 and agreed to implement a three-year economic adjustment program co-financed by the EU, the IMF, and the ECB totaling €110 billion (48 percent of GDP). - Reform efforts slowed, market sentiment deteriorated, and expectations of an impending debt restructuring rose. - Perimeter, process, and terms: - On February 24, 2012, the Greek Ministry of Finance announced the terms of the debt exchange and invited bondholders to tender by March 8. - Sovereign bonds issued under Greek law and foreign law, as well as 36 sovereign-guaranteed bonds issued by public enterprises were eligible. - 85.8 percent of bonds issued under the Greek law and 69 percent of bonds issued under foreign law (€177 billion and €28 billion of eligible stock of debt, respectively) were tendered, totaling €202 billion. - The debt exchange was completed preemptively on March 12, 2012. - Holders exchanged securities for new discount bonds with a face value of 31.5 percent of the original claim; maturities between 10 and 30 years; and a step-up coupon starting at 2 percent and averaging 3.85 percent over the life of the bonds. - Bondholders received short-term EFSF notes amounting to 15 percent of the face value of the original claim. - The face value reduction amounted to 53.5 percent with NPV haircuts in the range of 65-78 percent depending on the exit yield and computational convention applied. - IMF-supported program: - The economic adjustment was supported by a 4-year Fund program targeting a combination of private and official sector involvement to deliver enough debt relief to place public debt on a trajectory to reach 120 percent of GDP by 2020. - Financial stability considerations: - Greek banks were heavily exposed to the government via holdings of public debt securities and faced mounting non-performing loans. - Significant resources (€50 billion) were set aside in the program to help banks cope with the impact of the recession and the restructuring of government debt. - The private ownership of banks was to be maintained to the extent possible and the framework for bank resolution, recapitalization, and oversight were to be strengthened. - The debt restructuring dramatically impaired the value of banking sector assets and added to strains from deposit withdrawals and non-performing loan losses. - An additional €50 billion out of the new rescue package was set aside to recapitalize the banks. - Two subsequent rounds of injections in 2014 and 2015 were necessary to fully recapitalize the Greek banks. - Outcomes: - Participation: - High participation was achieved through application of CACs retrofitted by an act of the Greek parliament, raising weighted average participation of Greek-law bondholders to 97 percent (100 percent for Greek law bonds and 75 percent for foreign law bonds). - Debt relief: - Overall, the debt restructuring reduced public debt by €106 billion (54 percent of GDP) but generated new debt of €30 billion to the EFSF and an estimated €36 billion for recapitalizing banks. - Net debt reduction amounted to about €40 billion (20 percent of GDP). - On December 11, 2012, the Public Debt Management Agency conducted a debt buyback for eligible (€62 billion in face value) new GGBs; €31.9 billion were tendered at a cost of €11.3 billion (including accrued interest) in exchange for six-month EFSF notes. - Greece regained access to the Euro-zone market in April 2014. ### H. St. Kitts and Nevis (2011–2012) - Context: - At end-2010, real GDP had fallen by a cumulative 3 1/3 percent since 2008, and public debt had become unsustainable at 135 percent of GDP. - Perimeter, process, and terms: - A comprehensive debt restructuring targeting all public debt except for T-bills and debt to multilateral creditors was announced in June 2011 and proceeded in phases. - First, a debt exchange with external commercial creditors was completed in April 2012 (par and discount bond options with maturity extension and face value haircut). - Second phase involved restructuring of domestic debt (roughly 70 percent of total) held largely by the local banking sector, with shareholder agreements signed in April 2012. - Much of this debt was collateralized by public land, and the restructuring included a debt-for-land swap implemented in tranches over 2013-14, placing lands in a special purpose vehicle (SPV) to settle creditor banks’ claims with funds from subsequent land sales. - Final phases included rescheduling of official bilateral credit with highly concessional rates; agreement with Paris Club creditors concluded in May 2012. - Financial stability considerations: - With roughly a half of the domestic debt held by local commercial banks, restructuring involved close monitoring of financial stability, including frequent stress testing by the Eastern Caribbean Central Bank (a quarterly structural benchmark under the SBA). - Authorities established a banking sector reserve fund as a liquidity backstop mechanism, ultimately unwound unutilized in 2014. - IMF-supported program: - In July 2011, a Stand-By Arrangement (SBA) was approved to support front-loaded fiscal adjustment along with measures to safeguard financial stability and boost growth. - A public debt restructuring announcement was a prior action for the SBA. - Outcomes: - Participation: - External commercial creditor participation (initially at 97 percent) increased to 100 percent after introduction of collective action clauses and bilateral agreements with all Paris Club creditors. - New instruments: - About one third of creditors opted for a par bond: an EC$ denominated 45-year mortgage style bond with a 15-year grace period and 1.5 percent coupon. - Two thirds chose a US$ denominated 20-year mortgage-style discount bond taking a 50 percent cut in face value; the discount bond included a step down coupon (6 percent for first four years stepping down to 3 percent), a partial guarantee by the Caribbean Development Bank (CDB), and a claw-back feature providing creditors additional bonds equal to 40 percent of the face amount of discount bonds if authorities failed to implement the IMF reform program. - Making the size of the haircut contingent on reform implementation supported sustained post-restructuring fiscal prudency. - Debt relief: - The restructuring delivered a large aggregate NPV haircut of 65 percent. - By end-2014, total public debt stood at 69 percent of GDP, reflecting a 55 percentage points of GDP reduction in domestic debt and 11 percentage points reduction in external debt. - Revenue injections from the Citizenship-by-Investment (CBI) program supported output growth and fiscal surpluses that allowed further reductions in public debt, which reached 52 percent of GDP by end-2019. - A significant portion of the domestic debt reduction was achieved through the debt-for-land swap, where only a small fraction of the swapped lands has so far been successfully divested in private sales. ### I. Cyprus (2013) - Context: - By end-2011, bank loans to Greek residents and holdings of Greek government bonds reached 130 and 30 percent of Cyprus’ GDP, respectively. - As the Greek crisis unfolded, Cyprus’ sovereign debt spreads widened dramatically, and by mid-2011 the sovereign lost market access with public debt under 70 percent of GDP. - The economy fell into recession in late 2011, exacerbating a housing market correction that had started in 2009. - In combination with Greek debt restructuring in March 2012, this had a devastating impact on banks’ balance sheets and created negative feedback loops that weakened public finances. - By end-2012, public debt reached 86 percent of GDP. - In March 2013 a financial assistance package was agreed between the Republic of Cyprus and the troika (the IMF, the European Commission and the ECB). - As part of that package the authorities took on the obligation to execute an exchange of €1 billion of domestic bonds maturing in the period 2013-2016 to a future date beyond March 2016 when the program would be completed. - The government of Cyprus launched a restructuring proposal on June 13, 2013 and announced an exchange on June 27, 2013. *International Monetary Fund — Issues in Restructuring of Sovereign Domestic Debt — Background Paper (excerpt).* ### 48. Perimeter, process, and terms: Sovereign debt eligible for exchange comprised only ### 48. Perimeter, process, and terms: Sovereign debt eligible for exchange comprised only ### Cyprus — Perimeter, process, and terms - Sovereign debt eligible for exchange comprised only domestic bonds maturing in 2013-15, in a total of €1 billion out of a total of €3.6 billion of domestic bonds maturing in that period. - Neither domestic T-bills—maturity at issue less than 12 months—nor external debt were included in the perimeter. - Domestic bonds were held predominantly by banks. - A debt exchange with bond holders was completed preemptively on July 1 with: - a maturity extension of 6.3 years on average, - no face value reduction, - NPV haircuts of 36 percent (Asonuma, Papaioannou and Tsuda 2021). ### Cyprus — Financial stability considerations - Bank resolution started earlier and was completed before the announcement of the debt restructuring in May 2013. - Financial sector reforms included banking sector recapitalization and restructuring of the two largest and insolvent banks (assets of 400 percent of GDP). - Three key steps: - the Greek branches of Cypriot banks were sold to a Greek bank; - Cyprus Popular Bank (CPB) was resolved and its insured deposits were transferred to the Bank of Cyprus (BoC); - BoC entered into resolution and the recapitalization process started with the participation of bank creditors. - As a result, the banking system shrunk by about 200 percent of GDP. - To safeguard financial stability, the authorities introduced capital controls, restrictions on deposit withdrawals (which were lifted in April 2015) and a 6-day bank holiday during the implementation of the bank resolution and restructuring. - Note: The Bank of Cyprus recapitalization process through a bail-in of depositors (i.e., a deposit–to–equity conversion) was completed on July 30, 2013. ### Cyprus — IMF-supported program - The IMF approved a three-year €1 billion (US$1.33 billion) arrangement under the Extended Fund Facility (EFF) on May 13, 2013 in support of the authorities’ economic adjustment program. - The EFF arrangement was part of a combined financing package with the European Stability Mechanism (ESM) amounting to €10 billion. - From the €10 billion made available under the program, only €7.3 billion was used as the economic recovery was both faster and stronger than expected. - The EFF aimed to place the banking system on a sustainable footing to restore financial intermediation and support economic activity; the Fund program also entailed a well-paced fiscal adjustment balancing short-run cyclical concerns and long-run sustainability objectives, while protecting vulnerable groups. ### Cyprus — Outcomes - Participation: - The participation rate was almost 100 percent of €1.0 billion offered. - Neither CACs nor exit consent were used. - Only domestic debt maturing over 2013-16 and held by domestic banks was included in the exchange. - The authorities pro-actively reached out to banks before making the formal offer (“market sounding”) to ensure high participation. - New instruments: - Financial and legal terms on the new instruments were identical to those of the old instruments except that the average maturity was extended to 6.8 years from 0.3 years. - Market access: - Cyprus was upgraded to a non-default rating (B-) from Standard and Poor’s in November 2013, 4 months after completion of the exchange. - Moody’s reassigned a non-default rating (B3) in November 2014 and Fitch (B-) in April 2014. - Cyprus regained access to the Eurobond market in June 2014, less than 12 months after completion of exchange. - Repurchase at market terms: - During 2015-16, €578.4 million of those bonds were repurchased by the authorities at market terms, resulting in a significant benefit for bond holders. ### J. Jamaica (2013) — Context and perimeter - Context: - Following the JDX, Jamaica continued to experience difficult macroeconomic conditions, owing to the slow recovery of tourism following the global financial crisis and the impact of hurricane Sandy in 2012. - Annual real GDP growth averaged -0.1 percent between 2010 and 2013. - Perimeter, process, and terms: - The National Debt Exchange (NDX) targeted local currency bonds (with fixed, variable and CPI-indexed interest rates) as well as domestically issued US$-denominated bonds amounting to approximately 64 percent of GDP in total. - The exchange did not include bonds issued in foreign jurisdictions or held by nonresidents. - The exchange served the dual purpose of rolling over a large portion of short-term debt and securing a gradual reduction in the stock of debt through lower coupon rates. ### Jamaica — Financial stability considerations and IMF program - Financial stability considerations: - The NDX was designed through iterative processes that involved stress tests of the resilience of domestic financial institutions holding Jamaica’s government debt. - Results of these tests were used to design the debt exchange proposal to limit its adverse impact on the financial sector, and to put in place appropriate contingency plans. - The FSSF, established in 2010, remained operational during the NDX and offered liquidity and solvency support to eligible financial institutions (with broadly similar eligibility requirements as in the JDX). The FSSF remained untapped during the NDX. - IMF Program: - The NDX was a prior action for a new IMF program (approved by the Executive Board on May 1, 2013). - A domestic monitoring mechanism led by the Economic Program Oversight Committee helped broaden public support for the economic reform program. ### Jamaica — Outcomes - Participation: - The NDX recorded a high participation rate of 99 percent. - Authorities stressed the voluntary nature of the exchange but emphasized willingness for retroactive use of legal and regulatory measures, if necessary. - Holders of fixed and variable rate bonds were offered a 2040 inflation-indexed bond with stepped up coupon and a fixed rate accreting bond. - Holders of locally issued US$-denominated bonds were offered only a 2040 inflation-indexed bond option. - Debt relief: - The NDX significantly lengthened the maturity and reduced the interest payments on domestic debt. - In total, the exchange was consistent with a reduction in the public debt-to-GDP ratio by 2020 equivalent to 8.6 percent of GDP. - The debt restructuring was part of an economic reform program that entailed ambitious fiscal consolidation and structural reforms, leading to a reduction in public debt to below 100 percent of GDP in 2020. - Terms details (from footnote): - For variable-rate bonds, coupon reductions ranged from 0.75 to 1.125 percentage points and maturity extensions of 3-8 years. - For fixed-rate bonds, coupon reductions ranged from 1 to 5 ppt and maturity extensions of 3-10 years. - Locally issued US$-indexed bonds saw coupon reductions of 1.5-2 ppt and maturity extensions of 4-7 years. - Locally issued inflation-indexed saw coupon reductions of 1 ppt and 3 years of maturity extensions. ### K. Grenada (2013–2015) - Context: - At the end of 2012, Grenada’s public debt exceeded 100 percent of GDP. - A drying up of multilateral financing and reluctance of domestic banks to maintain their sovereign exposures led to a debt restructuring announced on March 8, 2013. - Perimeter, process, and terms: - The restructuring covered public debt to both private and official creditors except for T-bills, overdraft facilities, and debt to multilaterals. - The bulk of the restructured debt (75 percent of total 26 percent of GDP) was debt to external bondholders. - Agreement with private creditors was reached in March 2015, with the formal closing completed in November 2015. - Deals involved an estimated haircut of 50 percent in NPV terms, achieved either through an equivalent face value haircut or a combination of reduced interest rates and longer maturities. - Domestic debt eligible for domestic restructuring did not include T-bills. - Monitoring of program implementation was conducted by a Homegrown Monitoring Committee with broad stakeholder participation. - Financial stability considerations: - About half of the restructured domestic debt represented claims held by the public pension fund. - Banks and other financial institutions were able to absorb the losses given the limited exposure and sizable capital buffers. - IMF-supported program: - A 36-month Extended Credit Facility (ECF) arrangement was approved by the IMF Executive Board in June 2014. - The authorities’ program targeted significant up-front fiscal consolidation accompanied by reform of the legislative framework (including a fiscal responsibility law). - Outcomes: - Participation: - The exchange offer specified a minimum overall participation requirement of at least 75 percent of the total principal outstanding of eligible claims. - Securities representing around 94 percent of external bonds and 100 percent of domestic bonds were tendered before the expiration date of the offer. - Consistent with collective action clauses (CAC), the entirety of those bonds was exchanged for new bonds. - New instruments: - New debt instruments included a clause allowing deferral of debt service payments on the restructured debt for up to 12 months in the event of a qualifying hurricane. - The deal with private external bondholders also included a contingent revenue-sharing provision should proceeds from the country’s Citizenship-by-Investment program exceed a threshold of US$15 million. - Debt relief: - The 50 percent face value haircut was delivered in two equal steps: first half upon closing of the debt exchange in 2015 and the second half after completion of the last review of the ECF in 2017. ### L. Barbados (2018) - Context: - In 2018-19, Barbados’ sovereign debt was restructured for the first time in the country’s history. - By March 2018, public debt had reached around 160 percent of GDP (excluding arrears of 19 percent of GDP). - On the eve of the debt restructuring international reserves had been reduced to US$220 million, or 5-6 weeks of import coverage. - The timing of the government’s June 2018 announcement to seek debt restructuring was driven by large external debt payments due in early June 2018. - Perimeter, process, and terms: - The restructuring initially focused on domestic debt, given that the bulk of Barbados’ debt was domestic. - The exchange offer for the domestic debt restructuring was launched in September 2018 and finalized in November 2018. - The NPV loss incurred by private domestic creditors was around 30 percent, a result of interest reduction and maturity extension (a similar NPV loss was achieved in the external debt restructuring, completed in December 2019). - To ensure adequate burden sharing and reduce gross financing needs, the exchange also included T-bills (39 percent of GDP prior to the restructuring). - Financial stability considerations: - Financial sector supervisors conducted extensive stress tests to ensure the proposed debt restructuring would not jeopardize financial stability. - Old debt securities were not subject to face-value haircuts, but NPV losses from maturity extensions and interest rate reductions led to capital losses, which were booked immediately. - No financial entity experienced major liquidity or solvency issues as a result of the restructuring. - IMF-supported program: - The launch of the domestic debt exchange offer was a prior action for approval of an arrangement under the Extended Fund Facility (EFF). - Debt restructuring targeted a gradual reduction of public debt from about 160 percent of GDP in March 2018 to 60 percent of GDP in 2033. - A Monitoring Committee with private sector and labor union participation was set up in October 2018 and has since issued quarterly press releases. - Outcomes: - Participation: - To achieve high participation, the authorities retrofitted domestic securities with a collective action mechanism through parliamentary legislative action, which ultimately secured 100 percent participation in the exchange. - New instruments: - Most new debt instruments included natural disaster clauses to allow capitalization of interest and deferral of amortization falling due over a two-year period following a major event. - Debt relief: - The debt restructuring lengthened the maturity profile of public debt, dramatically reducing gross financing needs. *ISSUES IN RESTRUCTURING OF SOVEREIGN DOMESTIC DEBT—BACKGROUND PAPER (excerpt).* --- _Source: https://www.imf.org/-/media/files/publications/pp/2021/english/ppea2021071.pdf_