## _040915 — Executive summary and key proposals ## Source details **Canonical URL:** [_040915 — Executive summary and key proposals](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_040915.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_040915.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_040915.pdf.json) --- ### Background - Follow-up to the June 2014 Board discussion of the staff paper The Fund’s Lending Framework and Sovereign Debt—Preliminary Considerations. - Executive Directors broadly supported introducing more flexibility into the Fund’s exceptional access framework. - Views varied on eliminating the systemic exemption introduced in 2010. - Paper offers: - specific proposals on changing the Fund’s policy framework; - staff analysis on managing contagion; and - implementation issues. - No Board decision proposed at this stage. - Work program consistent with the Executive Board’s May 2013 endorsement focused on strengthening market-based approaches to resolving sovereign debt crises. ### Increasing flexibility in the exceptional access framework (staff proposal) - Objective: allow the Fund to lend in “gray zone” cases where debt is considered sustainable but not with high probability. - Key features: - Allow lending with a less definitive debt restructuring (reprofiling) than currently required if it improves debt sustainability and sufficiently enhances safeguards for Fund resources. - Rationale for reprofiling: - Give breathing space to a liquidity-constrained sovereign and allow for a less constraining adjustment path, supporting growth and improving debt sustainability. - Help catalyze domestic support for the program. - Maintain non-senior creditor exposure, providing safeguards and the option for a more definitive restructuring later. - Normally reduce the level of access to Fund resources needed by the member. - Support market re-access prospects relative to a bail-out. - A reprofiling would not be required if: - the member retains market access, or - creditor exposure is maintained in other ways (including through new financing). - Proposed text for the sustainability criterion (summary of key sentences): - First sentence: “A rigorous and systematic analysis indicates that there is high probability that the member’s public debt is sustainable in the medium term.” (no substantive change for this category) - Second sentence: exceptional access only where non‑Fund financing restores debt sustainability with a high probability if debt is clearly unsustainable. - Third sentence (key modification): where debt is considered sustainable but not with high probability, exceptional access justified if non‑Fund financing, although it may not restore sustainability with high probability, improves debt sustainability and sufficiently enhances safeguards for Fund resources; “financing provided from sources other than the Fund may include, inter alia, financing obtained through any intended debt restructuring.” - Two inter-related requirements for acceptable less definitive restructurings: - (a) improves debt sustainability; and - (b) sufficiently enhances the safeguards for Fund resources. - Reprofiling defined: relatively short extension of maturities, normally without reduction of principal or interest. - Caveats: - Reprofilings should not be relied upon where a more definitive restructuring is needed. - Repeat reprofilings generally inappropriate. ### Design and modalities of restructuring - Sovereign debtor, in consultation with creditors, determines precise modalities. - Fund assessment of where the member lies on the sustainability continuum determines how much debt relief is needed; delivery method may vary. - In uncertain cases a reprofiling implies a relatively short maturity extension, but actual length may vary. - For clear unsustainability, restructuring would normally involve an explicit write-down of principal. - Menus of creditor instruments can include long reschedulings that effectively deliver the same debt relief as upfront reduction; scope of coverage will account for financial stability impacts. ### Implementation guidance (conditionality and timing) - Implementation of a reprofiling would not delay provision of Fund support; program design and conditionality follow the same legal framework and guidelines as deeper restructurings. - Guiding principles for orderly debt operations: - Restructuring should be undertaken promptly once judged necessary to: (i) reduce financial risk to the Fund; (ii) strengthen incentives for creditor participation and minimize bail-out risk; (iii) ease program financing requirements and adjustment; and (iv) reduce uncertainty. - Completion of needed debt reprofiling before Fund arrangement approval should be considered if feasible; flexibility may be warranted where delaying first disbursement would cause disorderly default. - Lending into arrears policy allows continued support so long as the member is “making a good faith effort to reach a collaborative agreement with its creditors.” - A review of the lending into arrears policy, including operational implications of the "good faith" criterion, is envisaged after Board deliberations. *Prepared by IMF staff; document dated April 9, 2015.* ### Questions for Directors (staff issues for discussion) - Do Directors agree that the proposed changes to the second criterion of the Fund’s exceptional access policy (¶11) strike the right balance between flexibility and preserving adequate safeguards? - Do Directors support staff’s view that spillovers can only be effectively managed if the underlying source of market concerns—including about debt sustainability—are addressed, and complementary defensive measures put in place (¶22–34)? - Do Directors agree that the systemic exemption is not a coherent solution to addressing contagion concerns, does not address debt sustainability concerns, and should be eliminated (¶35–38)? - Do Directors agree that, in rare “tail event” situations, a more effective approach would combine Fund lending with official bilateral support on appropriate terms as described in ¶39–43? - Do Directors agree with the timing of the remaining work program on sovereign debt restructuring issues (staff intends to complete the work stream by fall 2015 and circulate a paper with proposed decisions in fall 2015)? --- ### Spillovers from sovereign debt crises — nature, channels, and management ### Understanding spillovers (primary insights) - Primary source of spillovers is market concerns over the member’s solvency. - A restructuring decision that credibly addresses debt vulnerabilities may be less contagious than a bail-out that leaves debt problems unresolved. - Some spillovers reflecting realignment of risk pricing with fundamentals are desirable and should be allowed to play out. - Nature, intensity, and timing of spillovers depend on how anticipated the decision is by markets and the clarity of the policy framework; policy-framework uncertainty aggravates volatility and spillovers. ### Spillover channels (four broad headings) - Financial channels: - Direct exposure: institutions’ holdings of the affected debt; CDS on that debt; debt used as collateral. - Indirect exposure: e.g., impairment of domestic banks funded in international markets leading foreign funding institutions to reduce credit supply elsewhere. - Spillovers may be severe if debt shock leaves domestic banks undercapitalized or triggers deposit runs. - Risk aversion and confidence channels: - Unclear exposures and informational asymmetries can lead to generalized “risk off” behavior and a “wake-up call” phenomenon. - Less discriminating investors may re-price the entire asset class. - Portfolio reallocation channels: - Losses on one sovereign can force institutional investors to liquidate assets in other countries to meet margin calls or rebalance. - Cross-market hedging and secondary market trading can precipitate broader sell-offs. - Policy channels: - Policy responses (or lack thereof) can generate uncertainty and trigger panic-selling (example: Deauville declaration effects on Irish spreads). ### Managing spillovers — policy options and measures - Ex-ante systemic measures: - Clear “rules” of the game: Fund’s policy frameworks for exceptional access and debt sustainability assessments; bank resolution frameworks; regional financing/support arrangements. - Measures in the crisis country: - Calibrate scope of sovereign debt included in the reprofiling operation. - Backstops for the financial system, including from the central bank. - Early policy adjustment and, where needed, earlier restructuring to lower costs and limit market disruption. - Defensive measures outside the crisis country: - Standard policy tools: central bank liquidity support, foreign exchange intervention, steps to ensure domestic financial institutions capitalized, temporary regulatory forbearance, capital flow measures. - Backed by supra-national firewalls and safety nets: swap lines, Fund resources, and regional financing arrangements. - Optimal approach: combine a debt operation, where needed, with policy interventions aimed at resisting market fluctuations not rooted in fundamentals. ### Empirical and historical observations - Spillovers from a reprofiling are, and have been, much smaller than those arising from a debt reduction operation involving principal haircuts. - Portfolio reallocation and risk‑aversion channels have produced modest but widespread impacts historically; direct exposures have often been limited except in specific linkages. - Significant historical policy responses include LTRO, Target 2, ESM, OMT, bilateral packages (e.g., U.S. for Mexico, Japan for Thailand), and regional RFAs and swap lines. --- ### Systemic exemption, moral hazard, and alternative “tail-event” approach ### Critique of the systemic exemption - Systemic exemption problems: - Does not address underlying market concerns about debt vulnerabilities. - Reduces safeguards for Fund resources because later restructuring would have fewer private sector claims to absorb losses. - Severing link between debtor risk and yields encourages moral hazard and over-borrowing ex-ante. - Aggravates market uncertainty in periods of sovereign stress as traders speculate on activation rather than sustainability fundamentals. - The systemic exemption can impair program country prospects and substitution of private claims with public debt may hamper future market re-access. ### Tail-event (extreme event) alternative proposed by staff - In very rare “tail” events where contagion concerns make any private restructuring undesirable, exceptional access could be made available provided other official bilateral creditors are willing to provide financing on terms sufficiently favorable to address sustainability concerns. - Key features: - Official financing must “improve debt sustainability and sufficiently enhance the safeguards for Fund resources,” or restore sustainability with high probability if debt is clearly unsustainable. - Official creditors would need to assure they would change terms of their claims if the Fund later assesses deterioration in debt sustainability, or provide sufficiently generous upfront terms (long tenors, concessional rates, grants, or other instruments). - Flexibility in implementation: political commitments to backstop debt sustainability could suffice without all modalities fully specified. - Staff view: this approach, while creating moral hazard, would be more effective than the systemic exemption in helping members address problems, mitigating contagion, and safeguarding Fund resources. - Staff recommendation: remove the systemic exemption and implement increased flexibility together as a coherent package. ### Market participants’ informal outreach views (summarized) - Subordination problem: systemic exemption can replace private claims with more senior official claims, adversely affecting private creditors. - Contagion concerns: some market participants view contagion worries as overstated and see credible financing and adjustment packages as necessary to address contagion. - Predictability: the exemption undermines predictability of the Fund’s framework. - Institutional option: Board could re-introduce an escape clause by majority vote in extremis, which may weaken market discipline less than maintaining an exemption as standard policy. --- ### Implementation issues: assessing market access, securing creditor participation, and conditionality ### Assessing market access (market-access criterion clarifications) - Market access assessment definition: member’s "ability to tap international capital on a sustained basis through the contracting of loans and/or issuance of securities across a range of maturities ... and at reasonable interest rates." - Indicators useful historically and in road-testing: - spreads, - credit ratings, - nonresident holdings of debt, - changes in maturity and currency composition of sovereign debt/borrowing. - Other market indicators that could be considered: CDS spreads, country risk premia, market positioning, option-implied volatility and skewness, and the shape of the yield curve. - Operational guidance: judgments case-by-case; indicators inform but do not substitute for staff judgment. ### Empirical findings on loss of market access (ANNEX III and related) - Empirical sample: 45 frontier, emerging and advanced markets between 1990 and 2013. - Findings: - Out of 45 countries, 31 had lost market access at least once; 14 lost market access more than once. - Spreads start to rise faster 10 months prior to LMA for the median country, with steepest increase occurring 2 months prior. - Credit ratings decline starting around 6 months prior to LMA. - Nonresident debt holdings decline prior to LMA. - Share and maturity of local currency debt falls prior to LMA. - Road-testing on selected case studies (Argentina, Mexico, Brazil, Portugal, Greece) produced encouraging results. - Empirical caveat: indicators are forward-looking and must be applied with judgment. ### Securing creditor participation and contractual/legal aspects - Most international sovereign bonds now incorporate collective action clauses (CACs) with typical qualified majority thresholds (typically 75 percent). - Legacy stock of weaker legal provisions remains; recent legal developments (e.g., Argentine litigation) underscore need to strengthen contractual framework. - Fund might play a more active role in incentivizing creditor participation in reprofilings; limited, targeted incentives could include: - ensuring all creditors receive cash payment of accrued interest up to a common point; - providing incentives for investors holding short residual maturities to participate in reprofilings; - structuring incentives so that if a definitive restructuring is later required, a limited portion of principal of shorter-maturity claims that voluntarily participated would be excluded. - Duration and speed: foreign-law governed debt exchanges historically take longer (median 11.2 months) than local-law governed debt (median 4.5 months) from initial default to exchange date. ### Conditionality on restructuring implementation and “good faith” - Under the Fund’s Guidelines on Conditionality, conditionality related to debt restructuring can take the form of prior actions or structural benchmarks. - Under the financing assurances policy, adequate assurances include credible restructuring processes, engagement of advisors, launching of creditor consultations, and design of the restructuring strategy. - Past practice (1998–2014): - Review covers 17 Fund arrangements in 13 countries. - Seven arrangements involved pre-default restructurings; about half of reviewed cases included a debt reduction. - Of the 17 arrangements, 11 included conditionality related to the restructuring. - Prior actions were commonly used in pre-default cases (examples: Jamaica 2010 and 2013; Greece 2012). - In post-default cases, programs allowed more time and conditionality often focused on intermediate steps. - The decision to restructure sovereign debt is the member’s; the Fund cannot require restructuring until the member has announced its intention. --- ### Annexes and empirical/statistical highlights ### Box 1 — Earlier crisis episodes with official sector financing (selected figures) - Aggregate program financing data (as foreseen at time of IMF arrangement request; amounts in billions of US$ unless noted): - Mexico SBA (Mar 1995): Total 51.8; IMF 17.8; IFIs 31.0; Bilateral and EU 3.0; Other 3/3; IMF share 4/34.4; Non-IFI share 65.6. - Thailand SBA (Aug 1997): Total 16.0; IMF 4.0; IFIs 3.0; Bilateral and EU 9.0; Other 25.0; IMF share 56.3; Non-IFI share 56.3. - Indonesia SBA (Nov 1997): Total 33.0; IMF 10.0; IFIs 8.0; Bilateral and EU 15.0; IMF share 30.3; Non-IFI share 45.5. - Korea SBA (Dec 1997): Total 55.0; IMF 21.0; IFIs 14.0; Bilateral and EU 20.0; IMF share 38.2; Non-IFI share 36.4. - Brazil SBA (Nov 1998): Total 42.0; IMF 18.0; IFIs 9.0; Bilateral and EU 15.0; IMF share 42.9; Non-IFI share 35.7. - Iceland SBA (Nov 2008): Total 10.2; IMF 2.0; IFIs -; Bilateral and EU 8.2; IMF share 4/19.6; Non-IFI share 80.4. - Latvia SBA (Dec 2008): Total 2/7.5; IMF 1.7; IFIs 0.5; Bilateral and EU 5.3; IMF share 22.7; Non-IFI share 70.7. - Greece SBA (May 2010): Total 2/110.0; IMF 30.0; IFIs 80.0; IMF share 27.3; Non-IFI share 72.7. - Ireland EFF (Dec 2010): Total 2/67.5; IMF 22.5; IFIs 45.0; IMF share 33.3; Non-IFI share 66.7. - Portugal EFF (May 2011): Total 2/78.0; IMF 26.0; IFIs 52.0; IMF share 33.3; Non-IFI share 66.7. - Greece EFF (Mar 2012): Total 2/172.7; IMF 28.0; IFIs 144.7; IMF share 16.2; Non-IFI share 83.8. - Jordan SBA (Aug 2012): Total 4.2; IMF 2.0; IFIs 0.4; Bilateral and EU 1.8; IMF share 47.6; Non-IFI share 42.9. - Notes: 2/ Billions of Euros. 3/ Financing provided by banking consortium. 4/ Financing earmarked for payments in relation to the foreign branch deposits of the Icelandic banks. ### Box 2 — Assessing Market Access Loss: key findings and empirical results - Indicators that signaled LMA: spreads, credit ratings, nonresident holdings, changes in maturity and currency composition of sovereign debt/borrowing. - Empirical sample: 45 countries (1990–2013); 31 lost market access at least once; 14 lost market access more than once. - Spreads: start to rise faster 10 months prior to LMA; steepest increase 2 months prior. - Credit ratings: decline starting around 6 months prior to LMA. - Nonresident holdings: decline prior to LMA. - Recommendation: indicators inform but do not substitute for staff judgment; consider additional indicators (CDS, option-implied volatility, yield-curve shape). ### Annex — scope of sovereign debt for reprofiling (salient statistics) - EM government debt with maturity < 12 months: average about 9 percent of total public debt as of Q3 2014; for AEs average share about 4 percent. - For EMs, share of total sovereign bonded debt issued under foreign law: about 88 percent. - Total outstanding sovereign bonds under foreign law amounted to about US$900 billion in mid-2014. - Sample of 25 restructurings (20 countries) during 1998–2013: share of debt covered in total averaged 29.5 percent. - Pakistan restructured instruments equivalent to 2.8 percent of its total debt (1999). - Argentina included more than 90 percent of its outstanding debt (2001). - Duration from initial default to exchange date (Median; in Months): - Foreign law-governed debt: 11.2 - Local law-governed debt: 4.5 --- ### Directors’ conclusions, next steps, and timeline ### Directors’ conclusions (summary) - Not necessary to hold up Fund support until complete clarity on contemplated debt financing. - Directors broadly concurred with staff’s analysis on spillovers and that some spillovers reflecting repricing in line with fundamentals should be accommodated. - In a rare tail-event where reprofiling poses unmanageable risks, the reformed framework allows exceptional access without such restructuring, provided official sector partners are willing to provide necessary financing on favorable terms. - The Fund’s DSA and judgment on debt sustainability remain central to exceptional access determinations. - Market access criterion should be met even in cases involving open-ended official support beyond the program; market access should be regained within a timeframe that facilitates repayment of all obligations to the Fund. ### Conditions and modalities for official financing as an alternative (directors’ guidance) - Official financing in lieu of private restructuring would need to be: - on terms sufficiently favorable to improve sustainability and enhance safeguards for Fund resources; and - backed by assurances that terms could be modified in future if debt sustainability deteriorates. - Forms of favorable official support could include loans with long tenors and concessional rates, grants, or other instruments. - Implementation to be flexible; political commitments to backstop debt sustainability may suffice. ### Timeline and deliverables (staff work plan) - If Board supports proposals, staff intends to complete the work stream on the Fund’s exceptional access framework by fall 2015. - Staff will circulate a paper with proposed decisions in fall 2015 for Board consideration, including proposed changes to the second exceptional access criterion and possible complementary modifications to the third criterion on market access. - Staff will commence work on: - clarifying the framework for official sector involvement given changing bilateral official lending; and - reviewing the Fund’s Lending-Into-Arrears policy. - Staff expects to bring papers addressing these issues to the Board in late-2015/early 2016. *Italic: Source: THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS (excerpt). * ### EXECUTIVE SUMMARY ### _040915 - EXECUTIVE SUMMARY ### Background - Follow-up to the June 2014 Board discussion of the staff paper The Fund’s Lending Framework and Sovereign Debt—Preliminary Considerations. - Executive Directors broadly supported introducing more flexibility into the Fund’s exceptional access framework to reduce unnecessary costs for the member, its creditors, and the overall system. - Views varied on eliminating the systemic exemption introduced in 2010: many Directors favored removal; some preferred retention and requested further consultation with stakeholders on managing contagion. - This paper: - offers specific proposals on changing the Fund’s policy framework; - presents staff’s analysis on managing contagion; and - addresses implementation issues. - No Board decision is proposed at this stage. - Consistent with the Executive Board’s May 2013 endorsement of a work program focused on strengthening market-based approaches to resolving sovereign debt crises. ### Increasing flexibility in the exceptional access framework - Objective: allow the Fund to lend in “gray zone” cases where debt is considered sustainable but not with high probability. - Key features of the staff proposal for such cases: - Allow lending with a less definitive debt restructuring (reprofiling) than currently required if it improves debt sustainability and sufficiently enhances safeguards for Fund resources. - Rationale for reprofiling: - Give breathing space to a liquidity-constrained sovereign and allow for a less constraining adjustment path, thus supporting growth and improving debt sustainability. - Help catalyze domestic support for the program. - Maintain non-senior creditor exposure, providing safeguards and the option to implement a more definitive debt restructuring later if downside risks materialize. - Normally reduce the level of access to Fund resources needed by the member. - Support market re-access prospects relative to a bail-out because creditors are more likely to re-engage when a larger share of the debt is non-senior claims. - A reprofiling would not be required if: - the member retains market access, or - creditor exposure is maintained in other ways (including through new financing). ### Dealing with spillovers from a sovereign debt crisis - Staff analysis comprises two parts: - Understanding the nature and type of spillovers: - Primary source of spillovers is market concerns over the member’s solvency. - A restructuring decision that credibly addresses debt vulnerabilities may be less contagious than a bail-out that leaves debt problems unresolved and raises default risk on remaining private claims. - Managing spillovers from a reprofiling: - Spillovers from a reprofiling would be—and have been in previous cases—much smaller than those arising from a debt reduction operation involving principal haircuts. - Some spillovers reflecting realignment of risk pricing with fundamentals are desirable and should be allowed to play out. - An optimal approach combines a debt operation, where needed, with policy interventions aimed at resisting market fluctuations not rooted in fundamentals. - Options identified to prevent and manage spillovers: - Ex-ante systemic measures: clear “rules” of the game (including the Fund’s policy frameworks for exceptional access and debt sustainability assessments), bank resolution frameworks that minimize taxpayer subsidies, and regional financing/support arrangements. - Measures in the crisis country: careful calibration of the scope of sovereign debt included in the reprofiling operation; backstops for the financial system, including from the central bank. - Defensive measures outside the crisis country: standard policy tools for mitigating capital flow and financial market volatility in affected countries, backed by supra-national firewalls and safety nets such as swap lines, Fund resources, and regional financing arrangements. ### Removing the systemic exemption and addressing “tail events” - Staff recognizes rare cases where cross-border spillovers are so severe that defensive measures may be inadequate and restructuring private claims must be avoided. - Critique of the systemic exemption: - Not an effective remedy in such circumstances because it does not address the underlying market concerns about debt vulnerabilities. - Reduces safeguards for Fund resources since, if restructuring is later needed, a smaller pool of private sector claims would be available to absorb losses. - Severing the link between underlying debtor risk and yields encourages moral hazard and over-borrowing ex-ante. - Exacerbates market uncertainty in periods of sovereign stress, as traders focus on whether the exemption will be activated rather than on sustainability fundamentals. - Alternative in extreme tail-risk events: - Make exceptional access available provided other official bilateral creditors are willing to provide financing on terms sufficiently favorable to address sustainability concerns. - This approach, while creating moral hazard, would be more effective than the systemic exemption in helping members address problems, mitigating contagion, and safeguarding Fund resources. - Could be implemented flexibly; Fund lending could proceed on the basis of political commitments to backstop debt sustainability without necessarily requiring specifics to be spelled out. - Staff’s view: given the proposed increased flexibility and options to deal with spillovers and “tail events” within that framework, there is a compelling case for removal of the systemic exemption. ### Conclusion - The two proposals—increased flexibility (allowing reprofiling in gray-zone cases) and removal of the systemic exemption—constitute a coherent package. - In staff’s view, the package should be adopted together. *Prepared by IMF staff; document dated April 9, 2015.* ### 10. The above text recognizes that a debt restructuring may not be the only means of ### _040915 - 10. The above text recognizes that a debt restructuring may not be the only means of ### Background and rationale - The term “inter alia” recognizes that restoring debt sustainability with high probability may be achieved through financing from sources other than the Fund if those terms are sufficiently favorable. - The proposals take into account the 2014 paper’s considerations on introducing greater flexibility into the exceptional access framework. ### Proposed text for the sustainability criterion - “A rigorous and systematic analysis indicates that there is high probability that the member’s public debt is sustainable in the medium term. Where the member’s debt is assessed to be unsustainable ex ante, exceptional access will only be made available where the financing being provided from sources other than the Fund restores debt sustainability with a high probability. Where the member’s debt is considered sustainable but not with a high probability, exceptional access would be justified if financing provided from sources other than the Fund, although it may not restore sustainability with high probability, improves debt sustainability and sufficiently enhances the safeguards for Fund resources. For purposes of this criterion, financing provided from sources other than the Fund may include, inter alia, financing obtained through any intended debt restructuring. This criterion applies only to public (domestic and external) debt. However, the analysis of such public debt sustainability will incorporate any potential contingent liabilities of the government, including those potentially arising from private external indebtedness.” ### Coverage by first, second, and third sentences (framework logic) - First sentence: - Covers cases where debt is sustainable with high probability in the absence of restructuring (includes temporary loss of market access with sound underlying debt dynamics). - No substantive change proposed for this category. - Second sentence: - Covers cases where debt is clearly unsustainable. - Exceptional access provided only where action is sufficiently definitive to restore debt sustainability with high probability. - Explicitly allows up-front debt restructuring or sufficiently favorable non-Fund financing: “For purposes of this criterion, financing provided from sources other than the Fund may include, inter alia, financing obtained through any intended debt restructuring.” - Third sentence (key modification): - Covers cases where debt is considered sustainable but not with high probability (referred to as “uncertainty” or “uncertain cases”). - Exceptional access available only “if the financing provided from sources other than the Fund, although it may not restore sustainability with high probability, improves debt sustainability and sufficiently enhances the safeguards for Fund resources.” ### Treatment of uncertain cases and role of reprofiling - Objective: introduce greater flexibility compared with the 2002 framework by allowing external financing that does not have to restore sustainability with high probability. - Two inter-related requirements for acceptable less definitive restructurings: - (a) Improves debt sustainability. - (b) Sufficiently enhances the safeguards for Fund resources. - Reprofiling (relatively short extension of maturities, normally without reduction of principal or interest) typically sufficient because: - It generally improves debt sustainability prospects by smoothing repayments or shifting them to periods with greater payment capacity; can facilitate restoration of market access. - It enhances safeguards for Fund resources by providing “insurance” against need for a deeper restructuring later—maintaining non-Fund creditor exposure over the program increases the pool able to absorb future burden. - It normally reduces the level of access needed from the Fund. - Caveats: - Reprofilings should not be relied upon where a more definitive restructuring is needed. - Repeat reprofilings would generally be considered inappropriate as they indicate deeper solvency issues that maturity extensions will not solve.10 ### Other forms of external financing in uncertain cases - External financing may not always involve debt restructuring: - If market access continues, private creditors may continue financing the program without a debt operation.9 - If market access is lost, the repayment profile could nonetheless leave sufficient private or non-Fund official sector exposure during the program period to mitigate risks. - Official bilateral creditors may prefer to contribute via new financing commitments rather than restructuring. ### Design and modalities of restructuring - Sovereign debtor, in consultation with creditors, determines precise modalities. - Fund assessment of where the member lies on the sustainability continuum determines how much debt relief is needed; the delivery method may vary by circumstances. - In uncertain cases a reprofiling implies a relatively short maturity extension, but actual length may vary. - For members needing significant debt relief (clear unsustainability), restructuring would normally involve an explicit write-down of principal. - Menus of creditor instruments can include long reschedulings that effectively deliver the same debt relief as upfront reduction; scope of debt coverage will also account for financial stability impacts. ### Systemic exemption and proposal for rare “tail” events - Under the proposed approach, the systemic exemption would be eliminated. - Rationale: the systemic exemption can leave a distressed member with a debt burden that impedes recovery and return to market access. - In very rare cases (“tail” events) where contagion concerns make any debt restructuring undesirable, Fund support could instead be conditional on financing from official bilateral sources that meets the revised framework’s criteria (outlined in Section III.C). - Staff view: proposals to (i) increase flexibility of the general framework and (ii) remove the systemic exemption should be implemented as a “package.” Retaining the systemic exemption while increasing general flexibility would create an excessively permissive framework. ### Addressing spillover effects from debt restructuring (overview) - Fund policy must address both the distressed member’s problems and potential cross-border/domestic spillovers. - Spillovers build progressively as confidence in debt sustainability deteriorates; expectations about policymakers’ crisis-resolution actions influence market behavior. - If a plan credibly addresses debt vulnerabilities, market volatility and spillovers typically subside as uncertainties diminish. - Key observations on spillovers from restructuring decisions: - Channels that trigger spillovers operate throughout a sovereign debt distress episode, whether or not it culminates in restructuring. - Nature, intensity, and timing of spillovers depend on how anticipated the decision is by markets and the clarity of the policy framework; policy-framework uncertainty aggravates volatility and spillovers. - A widely anticipated restructuring that credibly resolves debt vulnerabilities is more likely to settle markets; conversely, a decision not to restructure may cause market pressures and spillovers if markets view the alternative as inadequate. *Italic: Source: THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS (excerpt).* ### 25. Spillover channels are numerous and complex. Broadly speaking, they can be grouped ### 25. Spillover channels are numerous and complex. Broadly speaking, they can be grouped ### Spillover channels - Four broad headings: - Financial channels. - Operate through banks or other financial intermediaries abroad. - Direct exposure: institutions’ holdings of the affected debt; protection through credit default swaps (CDS) on that debt; debt used as collateral. - Indirect exposure: e.g., financial institutions in the crisis country funded in international markets; if local institutions are impaired by a sovereign debt operation, losses on foreign funding institutions may cause those foreign funding institutions to reduce the supply of credit in other countries. - Spillovers may be especially severe if the debt shock (and, possibly, related currency depreciation) leaves domestic banks undercapitalized, or triggers deposit runs. - Risk aversion and confidence channels. - Unclear exposures and informational asymmetries can lead to generalized “risk off” behavior with asset sales across countries and retrenchment to safe havens. - Investors may re-evaluate countries with similar economic characteristics or perceived common vulnerabilities (“wake-up call” phenomenon). - Less discriminating investors may re-price the entire asset class, adversely affecting even countries with solid fundamentals. - Portfolio reallocation channels. - Significant losses on one sovereign may force institutional investors to liquidate assets in other countries to meet margin calls or cash requirements, or to rebalance portfolios. - Trade strategies exploiting assumed correlations (“cross-market hedging”) can precipitate broader sell-offs. - Secondary market trading may shift debt instruments from investors holding higher-rated sovereign claims toward investors with greater tolerance for risk, altering yield patterns and possibly market volatility. - Policy channels. - A country restructuring debt may take complementary policy measures that create cross-border spillovers (e.g., extending guarantees on bank liabilities). - Responses (or lack thereof) of policymakers, including supra-national levels, can generate uncertainty and trigger panic-selling. - Example: the Deauville declaration (after the May 2010 Greece bail-out) proposing private creditor burden-sharing sent Irish spreads soaring; subsequent decision not to bail in creditors of Irish banks generated speculation about the “rules of the game.” ### Nature of spillovers and role for policy - Not all cross-border spillovers are unhealthy: - Adjustments in capital flows, prices, and balance sheets that reflect proper repricing of risk in line with fundamentals are beneficial and should be allowed. - Role for policy intervention: - Moderate pace of adjustment, avoid overshooting, and resist adjustments not related to fundamentals (e.g., herd behavior, imperfect information), where distinguishable. - Fund’s role: - Improve transparency of lending framework and tools to inform debt sustainability judgments to mitigate investor uncertainty. - Clarify policies regarding bail-in of bank creditors to make market responses more orderly. ### Managing spillovers and stability risks — Systemic measures - Preemptive articulation of policy frameworks for debt restructuring and financial distress resolution is important. - Adoption of the exceptional access policy in 2002 clarified criteria governing Fund lending decisions. - Further proposed reforms and dissemination of Fund tools will make the framework more transparent. - Major reforms in the US and Europe since the global financial crisis have clarified “rules of the game” on bail-ins. - Financial safety nets: - Fund resources scaled up and facilities overhauled to provide an expanded range of actual and precautionary support to members facing cross-border spillover risks. - Eurozone: establishment of the European Stability Mechanism (ESM) and ECB’s commitment to large-scale liquidity support have created credible firewalls. - Development and intensification of regional financial arrangements (RFAs) and networks of bilateral swap lines—in Asia, Latin America, and BRICS—since the crisis. - There is scope to strengthen these safety net mechanisms further to guard against future adverse spillovers. - Footnote references: IMF Policy Paper, May 31, 2011; IMF Policy Paper, January 27, 2014. ### Measures in the crisis country - Prompt action by the country limits severity and international fallout. - Policy adjustment should begin early, if necessary with Fund and partner support—preferably well before concerns trigger loss of market access. - If adjustment alone unlikely to ensure debt sustainability, restructure sooner rather than later to lower costs and limit market disruption. - Footnote reference: IMF Policy Paper, April 26, 2013. - Design of debt operations to mitigate domestic financial stability impact: - Early action increases likelihood of reprofiling rather than significant up-front debt reduction; reprofilings tend to be less disruptive with muted spillovers. - Debtor and creditors can exercise discretion over scope of debt treated and establish backstops to avoid undue financial disruption; apply cost-benefit principles case-by-case. - Examples of categories often excluded or treated differently: - Short-term debt instruments (by original maturity): difficult to capture, essential for interbank markets; generally excluded from past restructurings, with a few exceptions (Russia (1998); Ukraine (1998); Côte d’Ivoire (2011)). - Trade credits, guarantees, and complex instruments of limited size: hard to restructure or yield modest benefits. - Domestic currency-denominated debt: real value may be reduced through currency devaluation or ongoing inflation; often held disproportionately by domestic financial institutions; limited net contribution to financing needs and possible adverse financial stability effects. In a sample of 16 restructurings since 1998 (excluding currency union cases), only five included domestic currency debt. - No standard blueprint: scope and supporting measures tailored to country circumstances and market conditions (examples: Cyprus and Jamaica reprofilings). ### Measures in countries affected by spillovers - Integrated economies must manage externally induced volatility using standard tools: - Central bank liquidity support. - Foreign exchange market intervention. - Steps to ensure domestic financial institutions remain adequately capitalized. - Temporary regulatory forbearance and capital flow management measures when stresses are severe. - Sources of cross-border financial support: - Bilateral swap lines, RFAs, and Fund facilities—main components of the global financial safety net have been progressively strengthened and used in past systemically significant crises. ### Addressing ‘Tail’ Events - In rare tail-risk events, restructuring (even reprofiling) may be considered too costly if contagion and financial stability risks are extreme. - Some argue the systemic exemption acts as an implicit guarantee that may mitigate contagion by facilitating a bail-out; staff’s view is that even in such cases, the systemic exemption and bail-out are not appropriate solutions. - Problems with the systemic exemption: - Impairs the program country’s prospects for success: - If invoked and a debt reprofiling is ruled out, benefits from reprofiling are foregone, diminishing prospects for program success. - Without reprofiling financing, significantly more official sector resources would be required to accommodate a less stringent adjustment path. - Replacement of private claims with public debt results in greater subordination of remaining (and future) private creditors, hampering re-access to capital markets. - Fund should account for spillover effects but not impose undue burden on a distressed member. - Unclear that systemic exemption mitigates contagion: - Contagion is driven primarily by market concerns about crisis country vulnerabilities and uncertainty about how they will be addressed; lending under a systemic exemption does not address these concerns. - Euro area 2010–12 example: bailout bought time to build firewalls but was impaired by lingering concerns about Greece’s solvency and did not avert perceptions of eventual restructuring. - Only after mid-2012 commitments by European institutions (notably the ECB) perceived as credible firewalls did sovereign and bank spreads abate throughout the euro zone. - Policymakers later accepted that terms of official financing needed improvement to bolster Greece’s debt sustainability. - The text notes an alternative approach is set out below (¶39 et seq.) that could have addressed concerns about debt sustainability even without a debt operation. *Source: THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS (excerpt).* ### 38. Third, the systemic exemption aggravates moral hazard in the international financial ### _040915 - 38. Third, the systemic exemption aggravates moral hazard in the international financial ### Systemic exemption and moral hazard - The systemic exemption "aggravates moral hazard in the international financial system and may exacerbate market uncertainty in periods of sovereign stress." - Perception of insurance against downside risk fueled by implicit bail-out guarantees can encourage excessive debt accumulation as creditors’ decisions become disconnected from underlying fundamentals. - Retention of the exemption could be perceived as a perpetuation of a sovereign bail-out guarantee, leading to an ex-ante under-pricing of sovereign risk. - Ex-post, during sovereign stress, the exemption can distort market prices and contribute to uncertainty because market participants may bet on whether the exemption will be activated rather than focusing on underlying sustainability. ### Tail-risk (extreme event) approach and role of official creditors - In an extreme tail-risk event where rescheduling of private claims is considered too hazardous, Fund support could be warranted if accompanied by assurances from other official creditors of support on terms sufficiently favorable to address sustainability concerns. - This approach addresses the source of the member’s vulnerabilities and would be called upon only very rarely, reducing—but not eliminating—the moral hazard concern. - The Fund has extensive experience catalyzing supplementary official support; past arrangements show official creditors often committed a large share of rescue packages and have tailored terms (including euro area programs and Jordan (2012)). ### How the tail-event approach fits the proposed framework - First scenario (uncertainty): - If other official bilateral creditors are willing to provide or maintain financing during the program on terms that "improve debt sustainability and sufficiently enhance the safeguards for Fund resources," restructuring could be avoided. - Official creditors would need to assure they would change terms of their claims if the Fund later assesses deterioration in debt sustainability. That commitment provides the "insurance" usually provided by reprofiling private claims. - If official creditors are unwilling to provide such assurances, financing terms must be sufficiently generous upfront to restore debt sustainability with high probability. - Second scenario (clear unsustainability): - Financing provided by other bilateral creditors must be sufficiently favorable to restore debt sustainability with high probability. - Favorable terms could include loans with long tenors and concessional rates, grants, or other instruments. - Flexibility and speed of implementation: - "Favorable terms" need not require lending below the creditor’s cost of funds; the key is that terms are better than the debtor could obtain elsewhere, including from the Fund. - Fund support need not be held up until full clarity on financing terms; creditors can provide assurances to modify loan terms if a definitive restructuring is needed. - Forms of financing could include concessional rescheduling of existing claims, new money on favorable terms, or guarantees enabling cheaper borrowing. ### Fund’s role and coordination - The approach enables the Fund to "step forward" with financial assistance with confidence the program will work and to continue coordinating bilateral official financing in support of a member’s adjustment program. - When financing from official creditors, coupled with the adjustment program, addresses underlying sustainability concerns, Fund support will help address balance of payments problems and contribute to global financial stability. ### Market participants’ views from informal outreach - Subordination problem: relying on the systemic exemption can replace private claims with more senior official claims, adversely affecting private creditors unable to exit due to maturity structure. - Contagion concerns: some market participants view contagion worries as overstated and argue contagion will only be addressed if credible financing and adjustment packages are in place. - Predictability: the exemption undermines predictability of the Fund’s lending framework by introducing a variable unrelated to sustainability and subject to potential abuse (e.g., invoked for geopolitical reasons). - Institutional option: even if the exemption is removed, the Executive Board can, by a majority of votes, re-introduce an escape clause if deemed necessary; using such an option in extremis may weaken market discipline less than retaining an exemption as standard policy. ### Implementation issues — Assessing market access - Reprofiling is appropriate where a member has already lost market access and where debt is considered sustainable though not with high probability. - If market access is preserved and debt is deemed sustainable (even if the "high probability" threshold is not met), the Fund would be willing to lend without a debt operation. - Market access assessment must determine whether a member has the "ability to tap international capital on a sustained basis through the contracting of loans and/or issuance of securities across a range of maturities, regardless of the currency denomination of the instruments, and at reasonable interest rates." - Assessment requires judgment on a case-by-case basis and should be guided by indicators that have signaled market access loss historically. - Indicators noted as particularly useful include spreads, credit ratings, nonresident holdings of debt, and changes in maturity and currency composition of sovereign debt and/or borrowing. - Other market indicators that could be considered in future cases include CDS spreads, country risk premia, market positioning, option-implied volatility and skewness, and the shape of the yield curve. ### Implementation issues — Securing creditor participation - Most international sovereign bonds now incorporate collective action clauses (CACs) allowing modification of key terms upon support of a qualified majority (typically 75 percent) of outstanding principal of a series. - Recent legal developments (e.g., Argentine litigation in US courts) underscore the need to strengthen the contractual framework; the Executive Board endorsed strengthened CACs and modified pari passu clauses, but legacy stock of weaker legal provisions remains. - The Fund might consider playing a more active role in providing incentives for creditor participation in reprofilings, though in the current low-interest environment such enhancements may have limited effect and could trigger negative pledge clauses. - Limited, targeted incentives could still be helpful; examples include: - Ensuring all creditors receive cash payment of accrued interest up to a common point to resolve inter-creditor equity issues when substantial debt reduction is sought. - In reprofilings, providing incentives for investors holding claims with relatively short residual maturities to participate (these investors are least willing to extend maturities). - Structuring incentives so that, if a definitive restructuring is subsequently required, the Fund and sovereign would exclude a limited portion of the principal of shorter-maturity claims that voluntarily participated in the initial reprofiling. ### Implementation issues — Conditionality on restructuring implementation - Implementation of a reprofiling would not delay provision of Fund support; program design and conditionality for reprofiling follow the same legal framework and general guidelines as deeper restructurings. - Guiding principles for orderly debt operations: - A restructuring should be undertaken promptly once judged necessary, with advantages including: (i) reducing financial risk to the Fund; (ii) strengthening incentives for creditor participation and minimizing bail-out risk for private creditors; (iii) easing program financing requirements and adjustment, enhancing program success prospects; and (iv) reducing uncertainty for creditors and investors. Completion of needed debt reprofiling before Fund arrangement approval should be considered, if feasible. - Flexibility may be warranted in some cases where delaying first disbursement until reprofiling would cause a disorderly default; completion of debt restructuring may be contemplated by the time of the first review. Country-specific circumstances (including preserving financial sector stability) may justify extended timelines. - Even in absence of high creditor participation, the Fund's policy provides flexibility to continue support. If inadequate participation leads to arrears to private creditors, the Fund’s lending into arrears policy allows continued support so long as the member is "making a good faith effort to reach a collaborative agreement with its creditors." - The lending into arrears policy provides private creditors an incentive to participate because holdouts risk default and losing the possibility of continued Fund-supported financing—subject to the "good faith" criterion. - A review of the lending into arrears policy, including operational implications of the "good faith" criterion, is envisaged after Board deliberations on possible modifications to the exceptional access framework. *Source: _040915 - 38. Third, the systemic exemption aggravates moral hazard in the international financial (PDF chapter/section).* ### 54. The Fund’s flexible application of conditionality on debt restructuring, confirmed by a ### _040915 - 54. The Fund’s flexible application of conditionality on debt restructuring, confirmed by a ### Flexible application of conditionality on debt restructuring - Completion of a debt operation has not always been a pre-requisite for the Fund to begin disbursing. - Under appropriate circumstances, flexibility was exercised in pre-default cases when there were urgent financing needs that could not be postponed until the completion of the reprofiling. - In such cases, conditionality has been set on intermediate steps towards the completion of the debt operation. - The decision to restructure sovereign debt lies solely with the member; a requirement to restructure debt can only be established after an announcement by the authorities of their intention to do so. ### Next steps and work program on exceptional access and sovereign debt - Paper elaborates on June 2014 proposals to introduce greater flexibility in the general exceptional access framework and remove the systemic exemption. - Provides analysis of nature and channels of spillovers in a sovereign debt crisis and how spillovers could be better managed without the systemic exemption. - For extreme “tail events” where restructuring private claims is considered too risky, proposes combining Fund lending with official bilateral support on appropriate terms to address debt sustainability concerns. - Staff views proposals as essential for the Fund to fulfill its mandate and safeguard Fund resources. - Timeline and deliverables: - If Board supports proposals, staff intends to complete the work stream on the Fund’s exceptional access framework by fall 2015. - Staff will circulate a paper with proposed decisions in fall 2015 for Board consideration, including proposed changes to the second exceptional access criterion and possible complementary modifications to the third criterion on market access. - Staff will commence work on the remaining two items on the sovereign debt-related work program endorsed by the Board in May 2013: - Clarifying the framework for official sector involvement in light of the growing role and changing composition of bilateral official lending. - Reviewing the Fund’s Lending-Into-Arrears policy in light of recent experience and increased complexity of the creditor base. - Staff expects to bring papers addressing these issues to the Board in late-2015/early 2016. ### Questions for Directors (issues for discussion) - Do Directors agree that the proposed changes to the second criterion of the Fund’s exceptional access policy (¶11) strike the right balance between flexibility and preserving adequate safeguards? - Do Directors support staff’s view that spillovers can only be effectively managed if the underlying source of market concerns—including about debt sustainability—are addressed, and complementary defensive measures put in place (¶22–34)? - Do Directors agree that the systemic exemption is not a coherent solution to addressing contagion concerns, does not address debt sustainability concerns, and should be eliminated (¶35–38)? - Do Directors agree that, in rare “tail event” situations, where any restructuring of private claims is considered too risky, a more effective approach to resolving the crisis would combine Fund lending with official bilateral support on appropriate terms as described in ¶39–43? - Do Directors agree with the timing of the remaining work program on sovereign debt restructuring issues? ### Box 1 — Earlier Crisis Episodes with Official Sector Financing: key findings - Analysis covers exceptional access Fund programs with official financing between 1994 and 2012, focusing on cases where non-multilateral creditors provided sufficient financing to form a firewall (non-multilateral share exceeded one-third of total financing needs). Selected cases include: Mexico (1995), Thailand (1997), Indonesia (1997), Korea (1997), Brazil (1998), Iceland (2008), Latvia (2008), Greece (2010, 2012), Ireland (2010), Portugal (2011), and Jordan (2012). - Common themes: - Official sector contribution in earlier crisis episodes was as large as in the euro area crisis countries; the Fund’s share of the financing package ranged from ¼ to ½ at the time of the program requests. - In Korea, some financing was contingent and provided as a second line of defense; ex-ante Fund share was small but de facto share was significantly larger as contingent bilateral lines were not activated. - In 1998 Brazil program, bilateral financing was provided as a first line of defense. - Presence of a large member willing to move rapidly (e.g., Clinton administration for Mexico; Japan for Thailand) was a key factor in early cases; later cases required broader coalitions amid financing fatigue. - Terms of financing packages were tied to creditor funding costs in earlier programs: - U.S. loan in Mexican crisis provided on terms equal to US funding costs (91-day treasury bills); Mexican authorities repaid loans three years ahead of schedule after crisis resolution. - Thailand bilateral loans provided as six-month swaps disbursed with Fund disbursements. - Iceland financing bulk provided at a spread of about 300 bps over mid-swaps. - Euro-area program lending (especially Greece) provided at low interest rates (creditor funding cost plus small margin), with maturities extended by up to 30–40 years and long grace periods (e.g., 10 years in Greece). - In non-euro-area programs, concessionality took different forms (e.g., Jordan: GCC grants and U.S. Eurobond guarantees). - Aggregate program financing data (as foreseen at time of IMF arrangement request; amounts in billions of US$ unless noted): - Mexico SBA (Mar 1995): Total 51.8; IMF 17.8; IFIs 31.0; Bilateral and EU 3.0; Other 3/3; IMF share 4/34.4; Non-IFI share 65.6. - Thailand SBA (Aug 1997): Total 16.0; IMF 4.0; IFIs 3.0; Bilateral and EU 9.0; Other 25.0; IMF share 56.3; Non-IFI share (blank in table) 56.3. - Indonesia SBA (Nov 1997): Total 33.0; IMF 10.0; IFIs 8.0; Bilateral and EU 15.0; IMF share 30.3; Non-IFI share 45.5. - Korea SBA (Dec 1997): Total 55.0; IMF 21.0; IFIs 14.0; Bilateral and EU 20.0; IMF share 38.2; Non-IFI share 36.4. - Brazil SBA (Nov 1998): Total 42.0; IMF 18.0; IFIs 9.0; Bilateral and EU 15.0; IMF share 42.9; Non-IFI share 35.7. - Iceland SBA (Nov 2008): Total 10.2; IMF 2.0; IFIs -; Bilateral and EU 8.2; IMF share 4/19.6; Non-IFI share 80.4. - Latvia SBA (Dec 2008): Total 2/7.5; IMF 1.7; IFIs 0.5; Bilateral and EU 5.3; IMF share 22.7; Non-IFI share 70.7. - Greece SBA (May 2010): Total 2/110.0; IMF 30.0; IFIs 80.0; IMF share 27.3; Non-IFI share 72.7. - Ireland EFF (Dec 2010): Total 2/67.5; IMF 22.5; IFIs 45.0; IMF share 33.3; Non-IFI share 66.7. - Portugal EFF (May 2011): Total 2/78.0; IMF 26.0; IFIs 52.0; IMF share 33.3; Non-IFI share 66.7. - Greece EFF (Mar 2012): Total 2/172.7; IMF 28.0; IFIs 144.7; IMF share 16.2; Non-IFI share 83.8. - Jordan SBA (Aug 2012): Total 4.2; IMF 2.0; IFIs 0.4; Bilateral and EU 1.8; IMF share 47.6; Non-IFI share 42.9. - Notes: - 2/ Billions of Euros. - 3/ Financing provided by banking consortium. - SBA = Stand-By Arrangement. EFF = Extended Fund Facility. IFI = International Financial Institution. - 1/ All amounts are as foreseen at the time of the IMF arrangement request and may differ from actual disbursements. - 4/ Financing earmarked for payments in relation to the foreign branch deposits of the Icelandic banks. ### Box 2 — Assessing Market Access Loss: key findings - Market access was judged to have been lost in a number of recent Fund-supported programs that involved debt restructuring, as well as in all recent euro area programs that invoked the systemic exemption. - Indicators cited to signal loss of market access included: widening spreads, rating downgrades, lack of investors’ interest in government bonds, cancellations of planned bond issuances, and falling participation of foreign investors in domestic markets. - Empirical exercise: - Sample of 45 frontier, emerging and advanced markets between 1990 and 2013 using the signaling approach and a risk zone classification approach. - Out of 45 countries, 31 had lost market access at least once; 14 lost market access more than once. - Results suggest spreads, credit ratings, nonresident holdings of debt, and changes in maturity and currency composition of sovereign debt/borrowing performed well in signaling loss of market access (LMA). - Spreads start to rise faster 10 months prior to LMA for the median country, with steepest increase occurring 2 months prior. - Credit ratings decline starting around 6 months prior to LMA, with decline becoming abruptly steeper after initial LMA. - Nonresident debt holdings decline prior to LMA. - Share and maturity of local currency debt falls prior to LMA as sovereigns find it difficult to place longer term local currency instruments even in domestic markets. - Caveats and recommendations: - Market access is a forward-looking concept; judgments cannot be based mechanically on indicators. - Depending on country type, some indicators may be more relevant than others. - A broader range of indicators could be considered in future cases (e.g., CDS spreads, country risk premia, market positioning, option-implied volatility and skewness, shape of the yield curve). - Empirical work was road-tested on selected case studies of Argentina, Mexico, Brazil, Portugal, and Greece and proved encouraging. ### Supplementary information — Analysis of the ‘market access’ criterion under the EAP - The third criterion of the EAP reads: “(c) The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.” - Intent of the criterion: help achieve two objectives of Fund financing under Article V, Section 3(a): - (i) “assisting members to solve their balance of payments problems”; and - (ii) providing “adequate safeguards for the temporary use of the general resources of the Fund.” - Two issues raised in 2013 and 2014 papers regarding assessment of the third criterion: - 1) Situations where official lenders offer commitments of support that extend into the post-program period: question whether, if official lenders provided or assured financing sufficient to repay the Fund, a separate market access criterion remains necessary at arrangement approval and reviews. Euro area experience prompted this question. - 2) Timeframe in which market access needs to be established: literal reading could be interpreted as requiring the member to regain market access only by the time the last repurchase is made, which would not assure earlier repayments and could allow market access to be delayed for an unreasonably long timeframe (e.g., for an EFF, this could be 10 years after arrangement approval). *Italicized source attribution: Content from “THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS” (supplementary information), IMF.* ### 5. This supplement offers further analysis of these two issues. Specifically, staff argues that ### _040915 - 5. This supplement offers further analysis of these two issues. Specifically, staff argues that ### Staff’s analysis of the issues raised - On official support and the market-access (third) criterion: - Commitments of official support extending into the post-program period could help strengthen safeguards for Fund resources by boosting the member’s ability to meet its obligations to the Fund, and could thus mitigate risks to Fund resources. - Such commitments would not address the first objective of Fund financing—assisting a member to resolve its balance of payments problem—because resolution requires that the member be able to finance its balance of payments deficit without the need for exceptional financing; i.e., achieve “medium term external viability”. - The ability to regain market access is central to determining external viability. Reliance on financing from other official creditors well into the post-program period would not be consistent with this standard. - What matters for external viability is the “ability” to tap private capital markets, not just the “need” to do so: official commitments could reduce a member’s need to tap private capital markets, but a member cannot be considered to have achieved external viability until it has the ability to do so. - Official financing commitments do not render the market access criterion moot. Official support can, case-by-case, either: - moderate rollover needs or reduce “tail” risks and thereby make private capital markets more willing to lend; or - deter private investors if expected substantial official support would subordinate their claims to mounting senior official claims. - These effects must be weighed alongside other factors—such as debt levels and growth prospects—that affect market access and external viability. - On timeframe ambiguity for regaining market access: - Despite ambiguous prior language, the Fund has generally required that the member regain market access within a timeframe that facilitates the repayment of all of its obligations—not just the last one that is due. - Example: in the typical 3-year extended arrangement under the EFF, where repayments to the Fund commence around 4½ years after the first disbursement, the member would be expected to achieve market access (external viability) no later than the fifth year from the start of the program. - Note: Market access may need to be restored sooner if there are Fund obligations coming due at the beginning of the post-program period because of purchases made under an earlier arrangement. - Empirical examples of market re-access in selected recent exceptional access cases (first international issuance in the post-program period, from Dealogic and/or staff reports): - Sri Lanka — SBA — Start: Jul 2009 — End: Jul 2012 — quota 400 — re-access Oct 2010 — $500 million, 5-year bond, with a coupon of 7.4 percent - Ukraine — SBA — Start: Jul 2010 — End: Dec 2012 — quota 729 — re-access Sep 2010 — Dealogic reports issuances throughout 2010-12 - Ireland — EFF — Start: Dec 2010 — End: Dec 2013 — quota 322 — re-access Jul 2012 — Return to the Tbill market. Dealogic reports a bond issuance in Jan 2012 - Portugal — EFF — Start: May 2011 — End: May 2014 — quota 2306 — re-access Jan 2013 — Re-opening of a 5-year bond at about 5 percent yield - Greece — EFF — Start: Mar 2012 — End: Mar 2016 — quota 2159 — re-access Apr 2014 — Access was not long-lasting - Jordan — SBA — Start: Aug 2012 — End: Aug 2015 — quota 800 — re-access Nov 2015 — Issuance of eurobond without guarantees ### Staff’s proposal (policy recommendation) - Retain the third criterion on market access under the Exceptional Access Policy (EAP) for cases involving open-ended commitments of official support. - Clarify the ambiguity on the “timeframe” within which market access should be gained/regained by amending the third criterion’s wording to align with the Fund’s practice that market access be regained within a timeframe and on a scale that would enable the member to meet its obligations falling due to the Fund. ### Proposed decision text (key amended criteria) - Proposed amendment to Paragraphs 3(b) and 3(c) of Decision No. 14064-(08/18), February 22, 2008, as amended: - (b) A rigorous and systematic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term. Where the member’s debt is assessed to be unsustainable ex ante, exceptional access will only be made available where the financing being provided from sources other than the Fund restores debt sustainability with a high probability. Where the member’s debt is considered sustainable but not with a high probability, exceptional access would be justified if financing provided from sources other than the Fund, although it may not restore sustainability with high probability, improves debt sustainability and sufficiently enhances the safeguards for Fund resources. For purposes of this criterion, financing provided from sources other than the Fund may include, inter alia, financing obtained through any intended debt restructuring. This criterion applies only to public (domestic and external) debt. However, the analysis of such public debt sustainability will incorporate any relevant contingent liabilities, including those potentially arising from private external indebtedness. - (c) The member has prospects of gaining or regaining access to private capital markets within a timeframe and on a scale that would enable the member to meet its obligations falling due to the Fund. ### Implementation and contextual guidance (from Executive Board assessment) - Rationale behind related framework reforms: - Elimination of the “systemic exemption” introduced in 2010. - Increased flexibility where debt is assessed to be sustainable but not with high probability, allowing exceptional access when other financing sources improve debt sustainability and enhance safeguards. - Clarification to the market-access criterion to remove ambiguity on timeframe. - Director guidance on options when debt is sustainable but not with high probability: - Maintain sufficient private exposure where the member retains market access or where private claims falling due during the program are small. - Use reprofiling (short extension of maturities, normally no reduction in principal or coupons) when loss of market access makes private claims during the program a significant drain. - Consider financing from official bilateral creditors via extensions of maturities on existing claims and/or new financing commitments. - Ideally, any needed reprofiling should be undertaken before Fund arrangement approval, though circumstances may warrant more flexibility. *Source: IMF staff supplement and proposed decision text contained in the PDF chapter.* ### conclusion of the debt operation is contemplated at a later date. Against this background, it ### THE FUND'S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS—ANNEXES ### Directors’ conclusions on debt operations and Fund support - It would not be necessary to hold up Fund support until there is complete clarity regarding the terms of contemplated debt financing. - Directors broadly concurred with staff’s analysis on the nature and type of cross-border spillovers that could result from a debt restructuring. - Some spillovers that reflect a repricing of risk "in line with fundamentals" should be accommodated; complementary policy actions should be taken if necessary to counter market fluctuations that are not rooted in fundamentals. - If a rare tail-event arises where any restructuring of private claims, even a reprofiling, is judged to pose unmanageable risks for domestic financial stability or in terms of possible cross-border spillovers, the reformed framework allows flexibility for the Fund to approve exceptional access to Fund resources without such a restructuring, provided official sector partners are willing to provide the necessary financing. ### Conditions and modalities for official financing as an alternative - Official financing provided in lieu of private restructuring would need to be: - on terms sufficiently favorable to improve sustainability and enhance safeguards for Fund resources; and - backed by assurances that the terms could be modified in future if the outlook for debt sustainability were to deteriorate significantly. - If official creditors are unwilling to provide such assurances, financing terms would need to be sufficiently generous upfront to restore debt sustainability with high probability. - In circumstances where debt is unsustainable, financing provided by official bilateral creditors would similarly need to be sufficiently favorable to restore debt sustainability with high probability; such support could take the form of: - loans with long tenors and concessional rates, - grants, or - other instruments. - These requirements would be implemented flexibly; the Fund could proceed on the basis of political commitments to backstop debt sustainability without necessarily requiring all modalities to be fully specified. - Directors noted that this alternative approach for rare tail-risk cases does not allay moral hazard concerns but would be more effective than the systemic exemption because it helps the member address its debt problems, mitigate contagion at its source, and provide safeguards for Fund resources. - Some Directors expected the approach to be used only rarely and emphasized that decisions to resort to this approach should be made in an evenhanded manner; a few Directors viewed the approach as potentially feasible even in less extreme circumstances. ### Debt sustainability assessments and judgment - The Fund’s assessment of debt sustainability will continue to play a central role in the exceptional access framework. - Determinations of where a country’s debt prospects lie on the spectrum of probabilities will continue to involve a significant element of judgment. - The inherently forward-looking determination would take into account all relevant information, including: - country-specific information on prospects for policy implementation, - growth opportunities, - contingent liabilities, - the nature of the creditor base, - indicators of investor confidence, and - the outlook for the global economic environment. - Taking these considerations into account, levels of debt consistent with sustainability could vary significantly across programs. ### Market access criterion and official support - Directors supported staff’s view that the market access condition (the third criterion under the exceptional access framework) needs to be met even in cases involving open-ended commitments of official support beyond the program period. - Resolution of a member’s balance of payments problem and achievement of medium-term external viability is a key objective of Fund lending; a member’s ability (as distinct from its need) to access private capital markets is inherent to this resolution. - Official financing commitments can provide a useful backstop against downside risk but do not render the market access criterion moot. - Staff should take into account the positive impact that commitments of official support may have on a member’s ability to access markets, on a case-by-case basis, when assessing whether the third criterion is met. - Directors clarified that the Fund has generally expected that a member gain or regain market access within a timeframe that facilitates the repayment of all of its obligations to the Fund—not just the last one that is due. ### Implementation, timing, and next steps - The changes to the Fund’s exceptional access framework will enter into effect immediately and will apply to all future completion of reviews under existing arrangements or approval of new Fund arrangements. - Directors called on staff to continue work to ensure the Fund’s lending toolkit is effective in addressing systemic crises and contagion. - Directors looked forward to the upcoming review of issues relating to debtor-creditor engagement, including the Fund’s lending into arrears policy, to complete the program of work aimed at facilitating the timely and orderly resolution of sovereign debt problems. *Source: THE FUND'S LENDING FRAMEWORK AND SOVEREIGN DEBT—FURTHER CONSIDERATIONS—ANNEXES (April 9, 2015).* ### 7. The portfolio reallocation channel arises from the behavior of portfolio investors. An ### _040915 - 7. The portfolio reallocation channel arises from the behavior of portfolio investors. An ### Portfolio reallocation channel: mechanism and evidence - A shock idiosyncratic to one country reduces the value of investors’ portfolios, forcing sales of assets in other countries to meet margin calls, cash requirements, or to rebalance portfolios. - Empirical support: - Kaminsky and others (2004): mutual fund managers engage in “contagion trading”, selling assets in other countries when asset prices collapse in a given country. - Fratzscher (2009) and Raddatz and Schmukler (2012): detailed fund-level studies document substantial contagion via portfolio investors. - Boyson, Stahel, and Stulz (2010): liquidity shocks are important drivers of contagion across hedge funds, beyond fundamentals. - Theoretical channels: - Increased risk aversion after negative shocks, informational asymmetries, and inability to distinguish idiosyncratic shocks from informed trading cause cross-country sales and “overreaction.” - Herding behavior is reinforced when investors are evaluated relative to an index or when it is less costly to follow others. - Models allow for self-fulfilling expectations and multiple equilibria, amplifying contagion. ### Policy channel: uncertainty over policy frameworks and shifts - Policy uncertainty arises when markets are unsure whether sovereigns will be supported, and on what terms vis-à-vis private creditors. - Example: prior to the Greek sovereign debt crisis, markets implicitly assumed euro area sovereigns would not default despite the Maastricht Treaty “no bailout” clause; statements after the Greek program cast doubt on this assumption and triggered contagion to similar euro area countries. - Sudden domestic or international policy shifts (financial, fiscal, monetary, or real) can trigger reassessment of risks and contagion. - Guaranteeing domestic bank liabilities in one country can pressure other policymakers to follow suit. - Bail-ins in one jurisdiction can signal a change in the “rules of the game” and induce panic exits. - Chen (1999): generous financial support for one country could be interpreted as evidence that other countries might receive less support if funds are limited. ### Financial integration, vulnerability, and empirical patterns - Forbes (2012): risk of contagion has increased since the 1980s due to increased financial integration and global interdependence, especially within the euro area. - Country vulnerability factors (empirical findings): - More vulnerable if: more levered banking system, greater trade exposure, weaker macroeconomic fundamentals, larger international portfolio investment liabilities. - Less vulnerable if: larger international portfolio investment assets and greater reliance on equity rather than debt for international financing (Forbes, 2012). ### Financial contagion in sovereign debt restructurings - Sovereign restructurings tend to occur in clusters (Reinhart and Rogoff, 2011). - Multicountry models: - Lizarazo (2009): default in one country raises default likelihood elsewhere via common investors—negative wealth shocks, higher risk aversion, and portfolio rebalancing lead to contagion. - Arellano and Bai (2014): common lenders and simultaneous renegotiation generate joint default incidence and positive correlation of spreads. - Historical empirical evidence: - Contagion effects through direct exposures from sovereign debt crises have tended to be modest for foreign investors and banks. - Huizinga and Sachs (1987): markets priced in sovereign defaults during the 1980s developing country debt crisis; discounts observed in secondary market prices and bank stock pricing. - Lee and others (2000): banks with exposures to a crisis country were adversely affected by currency events and positively by bailouts; other banks mostly unaffected. - Sovereign debt reprofilings tend to be much less damaging to banks than upfront debt haircuts (Box 3, IMF 2014). - Eurozone crisis empirical studies with mixed findings: - Brutti and Saure (2011): cross-border financial exposures to sovereign debt were important transmission channels; exposure to sovereign risk accounted for most transmission. - Mink and De Haan (2013): news about Greece did not lead to abnormal bank returns, but news about a bailout did—even for banks without exposure; CDS spreads around eurozone program approvals were unaffected or worsened. - Beirne and Fratzscher (2013): contagion in 2008–11 euro area crisis mainly driven by deterioration in countries’ own fundamentals rather than by regional spillovers or herding. ### Country experiences and channels in six major crises (Mexico 1995; Thailand 1997; Russia 1998; Brazil 1999; Argentina 2001; Greece 2010) - General observations: - These six crises are recognized as significant contagion events; some were inter-linked in reality (e.g., Russia → Brazil → Argentina). - Analysis abstracts from concurrent global events (e.g., U.S. monetary tightening 1994–95; LTCM collapse 1998; dot-com bubble burst 2000–01). - Channels identified across case studies: - Direct exposures: usually not a dominant source of cross-country contagion; notable exceptions include Latvia→Russia, Uruguay→Argentina, Cyprus→Greece (larger exposures tended to be small neighboring countries). - Indirect financial channels: in Europe, after spread to Ireland and Portugal and threat to Italy and Spain, bank exposures in non-stressed countries to sovereign and private debt of stressed countries reached around 30 percent of GDP (Constâncio, 2013), putting strain on core European sovereigns and banks. - Portfolio reallocation/channel-specific findings: - Difficult to find individual countries particularly affected by “contagion trading”; some emerging markets (Brazil, Mexico, Hong Kong SAR) were hit more during the Russian crisis due to liquidity and large mutual fund/hedge fund holdings. - Overall, the portfolio reallocation channel had a relatively modest but widespread impact. - Risk aversion and confidence channel: - Critical in Mexico, Thailand, and Greece; to a lesser extent in Russia, Brazil, and Argentina (wake-up call contagion). - Mexico crisis triggered large capital outflows in Latin America, especially Argentina and Brazil; stock markets and (Brady) bond prices fell significantly. - East Asian crises: fixed exchange rates plus high private sector indebtedness led to currency crises with maturity and currency mismatches. - Euro area: countries with competitiveness issues and high debt/fiscal deficits faced increased market pressure; deterioration in own fundamentals played a key role (Beirne and Fratzscher, 2013). - Greek uncertainty led to selloffs of sovereign bonds of Italy and Spain in a self-fulfilling fashion. - Policy uncertainty channel: primarily significant for the euro area crisis. - Market implicit assumption of no-default was undermined by statements after the Greek program (e.g., Deauville Summit), triggering contagion among similar-fundamentals countries. - Resolved when policy actions diminished uncertainty—Mr Draghi’s “whatever it takes” speech and the OMT facility reduced contagion risks. ### Policy responses to contain contagion - Domestic policy responses: - Foreign exchange interventions to defend pegs and protect balance sheets with foreign-currency liabilities were often the first line of defense (e.g., East Asia 1997; Brazil 1998) but often unsuccessful. - Significant monetary policy tightening used to defend pegs and contain contagion (East Asian, Russian, Argentine crises). - Fiscal consolidation prevalent in the euro area and, to a lesser extent, during Mexican and Asian crises. - Measures to enhance competitiveness (tax relief, lower tariffs) used when trade was a major channel (e.g., Argentina and Uruguay responding to Brazilian devaluation). - Banking-sector firewalls and buffers helped: Argentina (1999) averted deposit runs via firewalls; Chile shielded by strong buffers and low exposure to Argentine clients (2001). - Prudential measures implemented during crises: liquidity provision in foreign currency (Korea 1997); higher bank capital and liquidity requirements (Argentina 1999); liquidity provision to systemically important banks (Uruguay 2002). - Domestic financial policies were more effective when combined with international support (e.g., Uruguay 2002). - International community and Fund involvement: - Fund-supported programs deployed in the countries worst hit by contagion; sometimes alongside resources from other sources. - East Asian crisis: World Bank and Asia Development Bank provided resources in Korea and Indonesia; several bilateral donors committed contingent supplemental financing roughly similar to the total disbursed by the Fund but these contingent lines were not activated. - Official sector coordinated rollovers of private debt exposures in Korea; successful rollover and maturity extensions plus reforms improved market views. - Only Ukraine required IMF support following the Russia crisis, indicating limited fall-out in that episode. - Brazil and Argentina episodes required Fund-supported programs in several countries but no systematic support from other donors; the World Bank and Inter-American Development Bank aided Uruguayan bank recapitalization in 2002. *Source: THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—ANNEXES (excerpt).* ### 25. The euro area crisis required significant intervention by European authorities. Initially, ### _040915 - 25. The euro area crisis required significant intervention by European authorities. Initially, ### Contagion episodes and policy responses (paragraphs 25–31) - The IMF/European support packages for Greece, Ireland and Portugal initially appeared insufficient to stem contagion. - Banking-sector policies that helped limit bank-sovereign feedback included: - LTRO - Target 2 system - Resources designated for future rescue packages (mainly through the EFSF and SMP) were generally viewed as insufficient to support larger euro area countries. - Contagion was contained only when the ECB offered resources from its substantial balance sheet via the OMT facility, which targeted tail-risk associated with a perceived disorderly break-up of the euro area and went beyond providing a larger bail-out fund for sovereigns. - In the Mexican and Asian crises: - The United States mobilized resources for Mexico long before the SBA approval and committed resources that exceeded the amount of Fund financing. - Japan assembled a financing package for Thailand and coordinated bilateral donors for Korea and Indonesia. - The presence of a large member willing to move rapidly to mobilize financing may have reduced intensity and duration of contagion. - Severity of contagion correlated with scale of international policy support: - East Asian crisis and euro area crisis triggered unprecedented levels of international support at the time. - Crises in Brazil and Argentina, which generated less contagion, received more orthodox policymaker treatment. - Size of international response did not vary systemically by crisis type (sovereign debt, banking/financial, balance of payments); severity of contagion was a more important determinant. - Form of policy response varied by crisis type: - Sovereign debt crises: often very large traditional Fund-supported programs (e.g., Greece, Russia). - Banking/financial crises: often required coordinating private debt roll-over (Korea) or large-scale central bank liquidity support (Ireland). - Sovereign debt levels prior to crises were often low to moderate for affected emerging countries; sharp debt increases occurred from currency devaluations (examples: Indonesia 1997–98, Ukraine 1998–2000, Uruguay 2001–02). - Advanced euro area countries affected by Greek contagion had varied initial debt levels (examples: Cyprus, Spain and Ireland low to moderate; Portugal and Italy higher). - International support was driven by considerations beyond sovereign debt sustainability, including: - preventing disruption of a policy framework (e.g., Argentina in 1994–95) - containing a bank run (e.g., Uruguay in 2001–02) - dealing with spillovers from private sector leverage (e.g., Korea in 1997) - Contagion channels and policy implications: - Most pervasive channel: risk aversion and confidence channel via ‘wake-up call’ shocks and increased uncertainty. - Policies to reduce information asymmetries are likely useful (e.g., greater information disclosure, especially in the financial sector). - Markets need incentives to better analyze and differentiate sovereign fundamentals. - The systemic exemption clause in the Fund’s lending framework may dull market incentives by implying an implicit bail-out subsidy; removing this clause may reduce risk from this channel. - Policy uncertainty channel was mainly important for the euro area crisis; early crisis resolution regime lacked credibility and policymakers were slow to provide an adequate regime—policies need credibility and robustness to extreme states. - Direct financial linkages with crisis-source countries were often modest, but once contagion spread, financial exposures multiplied; policies to stop spread must be rapid and decisive. ### Table AI1 — Severity of Contagion Episodes and Size of Official Sector Financing and Private Sector Involvement (selected figures) - Mexico (1995) — Moderate: - Total: 52.0 - IMF: 18.0 - Other Official: 34.0 - PSI: 0.0 - Argentina (1995): - Total: 5.0 - IMF: 2.4 - Other Official: 2.6 - PSI: 0.0 - Brazil (1995): - Total: 0.0 - IMF: 0.0 - Other Official: 0.0 - PSI: 0.0 - Asia (1997) — High (country breakdown): - Total: 16.0 | IMF: 4.0 | Other Official: 12.0 | PSI: 0.0 - Korea: Total 55.0 | IMF 21.0 | Other Official 34.0 | PSI 0.0 - Indonesia: Total 33.0 | IMF 10.0 | Other Official 23.0 | PSI 0.0 - Philippines: Total 2.1 | IMF 1.4 | Other Official 0.7 | PSI 0.0 - Asia Total: 106.1 | IMF 36.4 | Other Official 69.7 | PSI 0.0 - Russia (1998) — Moderate: - Russia: Total 11.2 | IMF 11.2 | Other Official 4.9 - Ukraine: Total 3.1 | IMF 2.2 | Other Official 0.9 | PSI 0.7 - Poland: Total 0.0 | IMF 0.0 | Other Official 0.0 | PSI 0.0 - Brazil (related): Total 42.0 | IMF 18.0 | Other Official 24.0 | PSI 0.0 - Russia-related Total: 56.3 | IMF 31.4 | Other Official 24.9 | PSI 5.6 - Brazil (1999) — Low: - Total: 0.2 | IMF 0.2 | Other Official 0.0 | PSI 0.0 - Argentina (2001) — Low: - Argentina: Total 12.2 | IMF 7.8 | Other Official 4.4 | PSI 71.0 - Uruguay: Total 2.6 | IMF 1.5 | Other Official 1.1 | PSI 5.4 - Argentina/Uruguay Total: 14.8 | IMF 9.3 | Other Official 5.5 | PSI 76.4 - Greece (2010) — High: - Greece: Total 283.0 | IMF 58.0 | Other Official 225.0 | PSI 260.0 - Ireland: Total 67.5 | IMF 22.5 | Other Official 45.0 | PSI 0.0 - Portugal: Total 78.0 | IMF 26.0 | Other Official 52.0 | PSI 0.0 - Cyprus: Total 13.1 | IMF 1.4 | Other Official 11.7 | PSI 0.0 - Greece-related Total: 441.6 | IMF 107.9 | Other Official 333.7 | PSI 260.0 - Notes captured from table: - PSI = Voluntary treatment of debt held by domestic and/or external private creditors. - In Argentina, PSI figures refer to the "mega swap" operation and "Phase 1 Exchange" before the December 2001 outright default. - In Ukraine, PSI includes reschedulings of 1998-99. - In Russia, PSI only includes the GKOs exchange in 1999. - Brazil had an ongoing program with the Fund that started by the time of the Russian crisis in 1998. ### Annex II — Analytical note on the scope of sovereign debt for reprofiling (opening summary) - Main objective of sovereign debt treatment in distress: improve sovereign debt sustainability by distributing adjustment burden among stakeholders to preserve or restore financial stability and economic growth. - No preferred fixed hierarchy among types or holders of sovereign debt instruments for inclusion in restructurings; fixed rules could impede solutions. - A case-by-case approach based on a comprehensive cost-benefit analysis should guide instrument choice for reprofiling and mitigating policies. - The note presents: - underpinnings for the broad conclusion favoring case-by-case approach, - main characteristics of debt instruments in reprofilings, - evidence of past practice, - major financial stability considerations given increased interconnectedness and cross-border holdings. ### A. Dimensions of the scope of debt (key points) - Maturity: - Inclusion guided by objective of improving debt sustainability and program horizon. - Possible exclusion of very short original maturity instruments (e.g., treasury bills) to preserve functioning of short-maturity debt markets, unless their size necessitates inclusion. - Type of creditor: - Different renegotiation mechanisms for private and bilateral official credit. - Good reasons to include bilateral official debt to encourage private sector participation. - Official involvement modalities could vary, including provision of new lending instead of modifying existing loans. - Institutional status of domestic debt holder: - Reprofiling sovereign holdings of financial institutions may have adverse financial stability implications. - June 2014 paper found effects of reprofilings on domestic financial institutions have been small and not caused significant financial disruption. - Nonfinancial institutions can better handle reprofiling, especially when NPV losses are limited; indirect effects still matter. - Type of instrument: - Sovereign liabilities include loans, trade credit, guarantees, bonds, possibly state-contingent instruments and customized instruments (e.g., 30-year maturity for pension funds). - Technically possible to include all instruments, but complex or nonstandard instruments (e.g., guarantees without well-designated maturity) may be impractical to suspend and could delay reprofiling. - Type of law: - Domestic law-governed debt reprofiling may be easier via domestic legislation changes. - Foreign law-governed debt may be facilitated by contractual provisions such as collective action clauses (CACs). - Strengthening CACs, as recently endorsed by the Board, and including such provisions in international sovereign bonds will help reach timely agreements among creditors. - Type of currency: - Both local and foreign currency debt may be included. - For local-currency debt, options exist to reduce real value (contract changes, moral suasion, financial repression, higher inflation). - For foreign-currency debt or countries in a currency union, those tools are unavailable to the country itself; all debt may need similar treatment, though access to common backstops/facilities could help. - Residency of the debt holder: - Including resident holders in reprofiling redistributes adjustment domestically but does not reduce overall adjustment needs. - Excluding residents may be politically tempting but may harm future market access and reintegration; it may also limit NPV gains (less concern for reprofiling which is not meant to achieve significant NPV relief). - Excluding nonresidents could be considered to preserve relations with international markets. - The parallel between residency of holder and type of governing law is fading (see Section E in source). *Source: THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—ANNEXES (excerpts).* ### 2. Obtaining information on the various compositions of sovereign debt will need to ### _040915 - 2. Obtaining information on the various compositions of sovereign debt will need to ### Information needs and timeliness - Obtaining information on the various compositions of sovereign debt will need to occur in real time. - Along several dimensions (law, currency composition, type of instrument, maturity), information about the composition of sovereign debt is routinely known and publicly available. - Information on holders of the debt is not readily available because sovereign debt is actively and continuously traded in secondary markets. - Broad compositions between foreign and domestic holdings and between financial and nonfinancial sectors can be indirectly obtained, for example, through custodian entities, for advanced economies (AEs) and many emerging markets (EMs). - For an effective and timely reprofiling, speed is of the essence. The more time it takes to collect information on the holders of sovereign debt instruments, the higher the probability that defaults cannot be avoided, with associated adverse consequences, such as selected default ratings and the operation of cross-default clauses. - Governments, through their Debt Management Offices (DMOs), should regularly acquire information about their investor base, including via their custodian entities. ### Salient facts and key statistics - By original maturity, EM government debt with a maturity of less than 12 months amounted to an average of about 9 percent of total public debt as of Q3 2014, while for AEs the average share was about 4 percent (Figure AII1). - The reported figures refer to general government bonded debt, not including government guarantees, while the average shares mask wide variations of individual country shares. - Sovereign debt owed to official creditors (multilateral and bilateral) is a small overall component of debt outstanding, generally declining, but with significant variation across countries (Figure AII2). - For EMs, the share of total sovereign bonded debt issued under foreign law is significant, at around 88 percent, with considerable cross-country variation (Figure AII3). - Total outstanding sovereign bonds under foreign law amounted to about US$900 billion in mid-2014, with the lion share issued under New York and English law (Figure AII4). - Of these instruments the majority has been issued with CACs. - The share of foreign currency debt of EMs is about 40 percent of total (Figure AII5). It has been steadily diminishing, though the share has been rising for a number of lower income countries that have been recent first time issuers in international markets. - Domestic banks typically hold a substantial share of their own sovereign’s debt, with variations depending inter alia on the size of the banking system in financial intermediation (Figure AII6). - For a selected sample of 25 restructurings (20 countries) during 1998–2013, the share of debt covered in total averaged 29.5 percent (see Table AII2). - Pakistan restructured instruments equivalent to only 2.8 percent of its total debt (1999). - Argentina included a very broad range of instruments covering more than 90 percent of its outstanding debt (2001). - Of the 25 restructurings in the sample, the majority included foreign currency debt only (13), or common currency debt of currency union countries (7); three covered both domestic and foreign currency debt (Argentina, Russia, and Ukraine); two involved domestic currency bonds only (Jamaica 2010 and 2013). - Duration from initial default to exchange date (Median; in Months): - Foreign law-governed debt: 11.2 - Local law-governed debt: 4.5 ### Observed practices and determinants of scope in restructurings - Four main determinants of the scope of sovereign debt included in restructurings: - amount of adjustment needed; - currency denomination of the instrument; - residency of the holders; - linkages between the sovereign and the domestic financial system. - Instruments with short-term original maturity tend to be excluded from restructurings; exceptions include Cote d’Ivoire (2011), Russia (1998), and Ukraine (1998). - The type of debt included has varied from a single external bond to many external and domestic law instruments; in rare occasions governments defaulted on T-bills and short-term loans. - Restructurings of domestic and foreign law debt have often been done separately; domestic law restructuring can be expedited by the sovereign’s authority to impose new contract terms, while foreign law restructurings have been relatively more drawn out. - Residency of the debt holder is essential in the distribution of adjustment burden; restructurings and reprofilings have tended not to discriminate by holder or collateral, though notable exceptions exist (e.g., Russia, Ukraine, Belize, Ecuador, Jamaica). ### Inclusion of special instruments - There is limited experience with inclusion of guarantees and warrants; examples: - Venezuela temporarily defaulted on its oil warrants due to delays in the official payment calculation (2005). - Nigeria missed a couple of oil warrant payments (2004). - Ghana did not honor the government guarantee on Ashanti Gold. - Trade credits have generally been excluded, except in the post default case of bank loan restructuring of Pakistan (1998). ### Financial stability considerations and policy implications - Financial stability concerns may constrain the scope of sovereign debt included in the restructuring or necessitate mitigating measures. - Preventive measures recommended to limit adverse feedback loops between the financial system and the sovereign: - effective resolution regimes, including bail-in options; - sufficient loss absorbency capacity of financial institutions; - funded deposit guarantee and resolution funds; - correct risk treatment of sovereign holding in the financial system; - limits to sovereign guarantees on certain (implicit or explicit) financial activities (e.g., mortgage finance). - Crisis management measures may be included to jointly achieve the preservation of financial stability and sovereign sustainability (examples: liquidity backstops to the banking system as in Jamaica; freezing of deposits and capital controls as in Cyprus and Iceland). - Considerations when assessing financial stability implications of including different instruments: - Reprofiling of medium- or long-term instruments held outside the domestic and foreign financial system is least likely to cause financial instability, systemic risk, and contagion; concentrated holdings can make reprofiling more time-efficient but raise fairness concerns. - Indirect effects: default on widely held retail instruments perceived as close substitutes to cash or deposits could jeopardize debt servicing ability of economic agents, with adverse repercussions on the financial system and potential social unrest. - Nonbank holdings (insurance companies and other financial intermediaries) may be used to satisfy regulatory or mandatory requirements or liquidity precautions; pledged government securities used as collateral and margin calls could have nonlinear adverse effects. - Reprofiling of instruments held by nonresidents shifts the initial adjustment burden abroad but may affect international market access for the sovereign and private sector balance sheets; domestic banks reliant on foreign wholesale funding could face higher funding costs. - Reprofiling of domestic currency short-term instruments may have higher costs than benefits because these instruments are close substitutes for cash and used for liquidity management, yield-curve benchmarks, and interbank collateral; most sovereigns have limited difficulties rolling over domestic currency debt with very short original maturities even in distress. - Reprofiling of trade credit, guarantees, and hard-to-restructure instruments of limited size may on balance have more drawbacks than advantages because of adverse effects on the real economy, limited benefits, and costly delays. *THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT—ANNEXES* ### 14. Interconnectedness has increased. The type of law, the currency of issuance and the ### _040915 - 14. Interconnectedness has increased. The type of law, the currency of issuance and the ### Interconnectedness and holder composition - The type of law, the currency of issuance and the residency status of holders of sovereign debt instruments are no longer neatly aligned. - Foreigners hold foreign currency and foreign law instruments as well as domestic currency and domestic law instruments. Conversely domestic agents also hold foreign currency and foreign law instruments. - This cross-holding complicates discrimination among different holders and instruments and complicates assessment of financial stability implications of restructuring options. - Foreign holdings of EM debt have more than doubled over the past decade, a trend only briefly interrupted in the immediate aftermath of the global financial crisis. - In terms of holders: - Nonbanks have been the main driving force in EMs. - AEs’ sovereign debt is held mostly by foreign central banks, whose share has increased the most over the past decade. - Foreign banks’ holdings of AE sovereign debt have been stable. ### Currency unions, contagion, and regional linkages - The euro zone is a region with very strong cross-border connections; the potential for contagion required development of common policy tools to preserve financial stability. - As common policy tools were put in place, contagion diminished. - Countries highly interconnected with the euro zone but not sharing the same currency (Switzerland and the U.K.) experienced less contagion. - Some other currency unions, such as the ECCU and CFA zones, experienced virtually no contagion from sovereign defaults of their members. - The CFA zone defaults were synchronized in 1994 largely due to the large common CFA franc devaluation rather than contagion from fellow CFA zone members. ### Central bank interventions and domestic sovereign bond markets - Central banks have been increasingly active in domestic currency sovereign bond markets. - Several central banks have stepped up interventions in sovereign debt markets to achieve monetary policy objectives with implications for financial stability. - Interventions include liquidity facilities using sovereign debt as collateral and other backstops (example cited: OMT by the ECB). - These interventions have relieved stresses on the financial system and on sovereigns. ### Financial system sophistication and derivatives exposure - Financial systems have become more sophisticated. - The gross market value of derivatives has sharply increased over the past 10 years, though its growth has slowed recently. - Many derivatives may be linked directly or indirectly to sovereign debt. ### Regulatory context and bank incentives - Updated financial regulations tend to favor bank holdings of short-term domestic currency debt. - Sovereign debt is often the only qualifying asset to meet these regulations (example given: the net stable funding ratio). - The impact on long-term holdings of sovereign debt will depend on the outcome of the ongoing regulatory debate on the leverage ratio and the debate on sovereign risk weights, though these debates are unlikely to overturn the relative attractiveness of sovereign debt as an asset. ### Concluding analytical considerations and policy implications - The overarching consideration in selecting instruments to include in a sovereign debt reprofiling must be improvement in the sovereign’s debt sustainability. - Past experience demonstrates that reprofilings have not adversely affected financial stability, but complexity of domestic and cross-border financial linkages can change that assessment. - A sovereign debt reprofiling including all liabilities could potentially adversely impact the capitalization of financial institutions, domestically and abroad, if proper shareholders cannot be found to restore capital adequacy. - If recapitalization by shareholders is not feasible, the government may need to: - recapitalize institutions through fresh capital injections, - divest noncore assets, - or restructure the institutions’ own liabilities, starting with unsecured debt and proceeding to uninsured deposits. - Various backstops may need to be put in place. - Feedback loops between sovereign debt reprofiling and financial stability need to be incorporated into debt sustainability analysis and decisions on the scope and extent of reprofiling. - Past practice shows these considerations have guided the approach to cases involving apparent tradeoffs between sovereign debt restructuring and financial stability. ### Case studies: Cyprus (2013) and Jamaica (2010, 2013) - Common features: - Bond exchanges included domestic bonds. - No nominal haircut was imposed. - Exchanges were designed to limit impact on the financial system; many affected domestic holdings were treated as Hold-to-Maturity (HTM). - Cyprus (2013): - Voluntary sovereign bond exchange amounted to €1 billion of domestically-held (local law) bonds exchanged for new bonds with the same coupon and extended maturities through 2019-23. - Authorities also restructured a €2.5 billion Russian loan maturing in 2016 by extending repayments over 2018–21 and reducing the interest rate from 4.5 to 2.5 percent. - Cyprus faced a banking crisis in 2012–13: the two largest banks’ joint assets comprised 400 percent of GDP; actions shrank the banking system by 200 percent of GDP. - A government bond of €1.9bn was used in 2012 to inject capital into Laiki Bank; it was rolled over in 2013 and partially repaid in 2014 with proceeds from an international bond issuance. - No nominal haircut on domestic creditors; the average coupon payment remained at around 5 percent, with the weighted average interest rate at 4.75 percent. - Shorter-term domestic bond yields increased by about 300bps following announcement; some deposit outflows occurred but yields and deposits stabilized thereafter. - Cypriot banks did not have to book losses during the bond exchange because they held affected sovereign bonds as HTM and, with regulator consent, assessed there was no impairment event. - Following the debt exchange announcement, Cypriot sovereign debt was temporarily downgraded to selective/restricted default; the downgrade was reversed after the operation concluded. - Jamaica (2010 JDX; 2013 NDX): - The 2010 Jamaica Debt Exchange (JDX) was seen as a quick and orderly debt restructuring designed to balance debt sustainability and financial sector stability. - Annual interest payments had reached 60 percent of fiscal revenue, or 16 percent of GDP, prior to restructuring. - 65 percent of direct government debt was held by domestic financial intermediaries. - The JDX exchanged all domestically issued sovereign bonds (local currency, USD-indexed, and USD-denominated) for newly issued bonds with reduced coupons and extended maturities. Externally issued bonds were excluded. - The 2013 National Debt Exchange (NDX) included local currency (fixed, variable and CPI-indexed bonds) and locally-issued USD-denominated bonds amounting to approximately J$876bn, or 64 percent of GDP. - NDX main features: exchange locally issued bonds into new longer-maturity and lower-coupon bonds of the same type, or into alternative options such as a 2040 CPI bond with a stepped coupon (1–3 percent). - Reasons for excluding foreign law bonds included: (1) to maintain access to international markets, (2) lack of CACs and imperfect knowledge of bondholders making participation difficult, and (3) 40 percent of foreign law bonds were held domestically, so restructuring foreign law bonds would have required further recapitalization and hit domestic creditors harder. - Contingency measures included establishment of the Financial Sector Support Fund (FSSF) and stress tests to identify bank vulnerabilities and tailor the exchange. - FSSF features and conditions: - Financial institutions qualified to access the FSSF if they at least exchanged 90 percent of their old bonds. - Banks also had access to the Bank of Jamaica temporary discount window subject to liquid collateral. - Affected banks were subject to a maximum liquidity maturity (6 months) or increased regulatory intervention. - No Jamaican bank drew on the FSSF liquidity support in the end. - In both exchanges, most affected domestic debt was primarily held by banks as HTM; with no impairment event, banks did not take immediate additional provisioning or capital hits from the debt reprofiling exercise. *Source: _040915 - 14. Interconnectedness has increased. The type of law, the currency of issuance and the* ### ANNEX III. ASSESSING LOSS OF MARKET ACCESS ### ANNEX III. ASSESSING LOSS OF MARKET ACCESS ### Summary findings - Market access was judged to have been lost in a number of recent Fund-supported programs that involved debt restructuring or reprofiling, as well as in all recent euro area programs that invoked the systemic exemption. - Indicators cited in Fund documents as associated with LMA include: - cancelations of planned bond issuances, - lack of investors’ interest in government bonds, - rating downgrades, - widening spreads, - withdrawal of foreign investors from domestic markets. - Empirical work on a wide sample of emerging markets (EM) and advanced economies (AE) used the signaling approach and a risk zone classification approach and suggests the following indicators performed well in signaling LMA: - spreads, - credit ratings, - nonresident holdings of debt, - changes in maturity and currency composition of sovereign debt and/or borrowing. - Road testing the four key indicators on Argentina, Mexico, Brazil, Portugal, and Greece produced encouraging results. - Emphasis: indicators inform, but do not substitute for, staff judgment. Staff assess whether indicators have crossed into a zone of elevated or high risk, how many indicators show distress, and compare indicators with historical norms. Real-time assessment will include a wider information set, including market intelligence. ### Definition and operational measurement of LMA - Reference definition (May 2013 staff paper): market access is “the ability to tap international capital on a sustained basis through the contracting of loans and/or issuance of securities across a range of maturities, regardless of the currency denomination of the instruments, and at reasonable interest rates.” - LMA triggers (practical criteria differ by issuer type): - For regular issuers, LMA can be defined as an expected issuance (based on an auction calendar, previous patterns of issuance, or rollover and financing needs) of international or domestic securities; or a syndicated loan with long-term maturity that either did not happen or was cancelled; or an announcement of a default or restructuring (whichever is sooner); and/or yield increases in primary/secondary markets resulting from a perceived deterioration in credit fundamentals to such an extent that, if permanent, would render current patterns and amounts of borrowing unsustainable. - For sporadic (infrequent) issuers, LMA can be defined as predicted issuance (based on rollover and financing needs) of a long-term security or a syndicated loan that did not happen; or an announcement of default or restructuring (whichever is sooner); and/or yield increases in secondary markets resulting from a perceived deterioration in credit fundamentals to such an extent that, if permanent, would render borrowing programs unsustainable. - Operational definition used in empirical work: LMA defined as unexpected lack of issuance of bonds or loans or announcement of default/restructuring, whichever is earlier. This augments prior literature by identifying LMA episodes not associated with defaults or restructurings. ### Indicators to inform staff judgment (from June 2014 paper) - Significant adverse deviations in recent primary bond issuance practices from “normal” in terms of: - Volume: compare with (i) total financing needs; and (ii) announced bond auction schedule. - Frequency: compare with (i) average frequency of issuances; and (ii) bond auction schedule (e.g., if auctions are cancelled or delayed). - Maturity: compare with recent average original maturity of instruments. - Financing terms: compare recent financing terms with past placements (e.g., shift from fixed interest rates to variable rates). - Government bond rollover rates: sustained falls not explained by reduced financing needs; increased reliance on nontradable instruments or placements with public sector financial enterprises. - Government cash balances: abnormal decline in cash balances or greater reliance on direct central bank financing (note: be careful with seasonality/idiosyncratic patterns). - Nonresident holdings of public debt: significant and sustained fall. - Sovereign credit ratings: observe changes and assess whether the country has lost creditworthiness. - Sovereign spreads: changes well above historical levels that, if persistent, are incompatible with debt sustainability. - Bond trading activity: thinner trading volumes and wider bid-ask spreads. ### Methodological approach to identifying LMA historically - Avoid circularity: cannot define LMA in terms of the same indicators used to explain it. Solution: define LMA in terms of primary issuance behavior (lack of primary debt issuance that cannot be explained by other factors). - Stepwise decision rule (summary of flow chart logic): - Step 1: Has there been an announcement of sovereign default or restructuring? - If YES: LMA from announcement until next issuance of a long-term bond or syndicated loan in markets accessible by foreign investors. - If NO: proceed to evaluate gross issuance data of long-term securities/loans for systematic patterns (need at least 3 years of data for annual issuers, at least 18 months for quarterly issuers, and at least 12 months for monthly issuers). - Identify suspect LMA periods where sovereign does not tap the market (ignore 1-month blips for monthly issuers). - Narrow suspects by determining whether lack of issuance can be explained by: - fiscal surpluses, - gross funding need smaller than, say, 15 percent of GDP, - sizeable prefunding early in the year (issuance large enough to cover amortization needs and/or 2 stdev. higher than the previous 12-month historical average). - If lack of issuance cannot be explained by these factors, classify as LMA based on significant deviation from prior pattern. ### Historical sample and key statistics - Sample: 45 advanced, emerging and frontier market economies using monthly data for 1990–2013. - Data sources: BEL database (gross issuances and amortizations), de Broeck-Guscina (2012) database for euro area countries, WEO and VEE for fiscal fundamentals. - Sample results: - Out of 45 countries in the sample, 31 had lost market access at least once over the observation period. - Out of those 31, 13 lost market access more than once. - Average duration of market access loss: - 39 months for countries that had one LMA episode, - 26 months for countries that had two LMA episodes, - 26 months for countries that had three or more LMA episodes. - LMA duration is heterogeneous: - Short-lived episodes often associated with contagion from other countries and typically lasted a few months. - LMA episodes due to concerns over fiscal fundamentals, debt sustainability, or outright default typically last much longer. - Argentina is an outlier with post-default LMA lasting more than a decade; issuance-based LMA can precede default/restructuring (Argentina example: issuance-based LMA in March 2001 that preceded default in November 2001). ### Practical caveats and real-time assessment considerations - Historical identification of LMA is complicated by: - incomplete availability of primary bond issuance data for some cases/periods, - difficulty in inferring with certainty whether deviations from issuance patterns are explained by non-LMA factors. - In real time, staff can better probe authorities about cancelled/postponed auctions and will have higher-frequency fiscal data than annual series used in the empirical exercise. - Indicators are forward-looking and should be applied with judgment; only deterioration (shorter maturities or higher spreads) is concerning—improvements beyond historical norms are not a concern. - Definition flexibility: accommodate cases where governments issue treasury bills with maturity of 18 months (longer than 1 year) and still be considered in a state of LMA (example: Portugal). *Source: IMF staff annex “ANNEX III. ASSESSING LOSS OF MARKET ACCESS,” prepared by Anastasia Guscina, Sheheryar Malik, Gabriel Presciuttini, Jeff Williams (MCM); Marcos Chamon (RES); Heiko Hesse; and Xiong Yi (SPR). Publication references include the May 2013 staff paper on sovereign debt and the June 2014 staff paper “The Fund’s Lending Framework and Sovereign Debt—Preliminary Considerations.”* ### 15. Due to data availability constraints, the focus is on more readily available indicators. ### _040915 - 15. Due to data availability constraints, the focus is on more readily available indicators. ### Overview and scope - Due to historical data limitations, empirical focus is on readily available indicators: spreads, credit ratings, nonresident holdings of government debt, and composition of borrowing by currency, maturity, and interest rate structure (fixed vs. floating). - Other market indicators (CDS, country risk premia, market positioning, option implied volatility and skewness, yield curve shape) are noted as useful in real time but were not always available historically. ### Stylized facts of LMA indicators - Spreads: - Spreads start to rise faster 10 months prior to LMA for the median country in the sample, with the steepest increase occurring 2 months prior. - Markets price in probability of restructuring/reprofiling prior to LMA: spreads are generally higher for countries that were restructured/reprofiled versus those that avoided restructuring. - Spreads of sovereigns that avoided restructuring/reprofiling are lower prior to LMA, rise faster than restructuring cases in some periods, but come down quicker. - Credit ratings: - Credit ratings decline starting around 6 months prior to LMA, with a steeper decline after the initial LMA. - Credit ratings series refers to the average of S&P, Moody’s and Fitch and covers 22 emerging and advanced economies in the sample. - Nonresident holdings: - Nonresident shares decline prior to LMA. - Data on nonresident holdings came from Arslanalp and Tsuda (2013) database, which starts in 2004, limiting the analysis to a subsample of countries that lost market access in recent years. - Portugal’s very small decline is noted as an outlier in the sample. - Composition (currency and maturity): - Shares of local currency long-term debt decline prior to LMA as sovereigns find it difficult to place longer-term local currency instruments even in the domestic market. - Data sources used include Jeanne-Guscina EM Debt Database (2014) and de Broeck-Guscina (2012). ### Road-testing indicators: signaling approach - Sample and rationale: - Indicators were road-tested using a signaling approach on a sample of 45 advanced and emerging market countries. - The sample includes countries that had never lost market access to control for missed cases and false alarms. - The determination of market access loss is separate from determination of debt sustainability; loss of market access may be temporary and not necessarily involve a request for a Fund-supported program. - Signaling approach features: - Advantages: data gaps are less constraining; easy to understand and interpret; better out-of-sample performance than some multivariate probit models. - Disadvantage: cannot test conditional statistical significance of individual predictive variables; feedback effects between variables are not captured—potential to over- or underestimate the significance of individual factors. - For all empirical exercises, spreads in levels are used (monthly changes in spreads display very low signaling power). - Main empirical result: - Spreads, credit ratings, nonresident debt share, and changes in composition of borrowing (currency and maturity) perform well in signaling loss of market access (LMA). ### Risk zone classification approach (supplement to signaling) - Purpose and method: - Implemented on a country-by-country basis to account for heterogeneity between countries. - Uses empirical distributions and percentiles to flag whether an indicator is in a zone of high, elevated, or low risk relative to historical norms. - Findings: - In most cases, examined indicators were in the high or elevated risk zones at the time of LMA. - Countries in an elevated risk zone at the time of LMA had been within this zone for a minimum period of 3 months prior to LMA. - The maximum period of staying within the elevated risk zone before LMA was six months across all countries. - There have been no instances of LMA in the sample where indicators were in the low risk zone; only a handful of instances where indicators were in the depressed risk zone at the time of LMA. - Definitions preserved from the source: - Depressed risk zone refers to a range between 5th–25th percentile. - Low risk zone refers to below 5th percentile. ### Additional indicators and yield-curve monitoring - Additional market indicators to consider in real time (not fully analyzed historically due to data limits) include CDS spreads; option implied volatility and skewness; expectations embedded in derivative contracts more generally. - Yield curve behavior: - Typical yield curve is upward sloping (longer-term yields > shorter-term yields). - If investors expect near-term economic downturn or distress, they may increase holdings of shorter-maturity bonds, leading to curve flattening and possible inversion. - Empirical examples (Portugal and Greece) show yield curves evolving over the year prior to LMA: positive slopes → flattening → inversion (maturities 2 to 10 years considered). - Implication: short- and medium-maturity yields may increase (corresponding bond prices compressed), with an upward shift and flattening of the curve and possible inversion as selling pressure at the short end increases. - Recommendation: - Regular monitoring of the shape of the yield curve is proposed as a leading indicator of sovereign debt problems and LMA. ### Data and sample notes - Samples and counts: - Behavior of sovereign spreads around LMA: sample includes 21 emerging and advanced economies (figure note). - Behavior of credit ratings around LMA: covers 22 emerging and advanced economies (figure note). - Road-testing signaling analysis: sample of 45 advanced and emerging market countries. - Data sources explicitly cited in analysis: - Arslanalp and Tsuda (2012, 2014) for nonresident holdings (database starts in 2004). - Jeanne-Guscina EM Debt Database (2014). - De Broeck-Guscina (2012) dataset on composition of borrowing in the euro area. - Bloomberg, BEL, rating agencies, and Fund staff calculations/estimates. ### Legal and policy framework excerpts on reprofiling and Fund lending - Fund’s Articles and exceptional access policy: - The Fund is precluded from providing financing to a member if its debt is judged to be unsustainable. - Financing may be provided only if there are reasonable prospects that an anticipated restructuring would restore debt sustainability and close financing gaps within the macroeconomic parameters of the program. - Under the current exceptional access policy such scrutiny is heightened and requires a “high probability” of debt remaining sustainable except in cases where there are high risks of international systemic spillovers. - Member decision and Fund role: - The decision to restructure sovereign debt rests solely with the member. - The Fund cannot require a member to restructure and cannot set conditionality related to a debt restructuring until the member has publicly announced its intention to restructure or committed to it. - In programs that envisage a debt restructuring, the Fund’s role is to set achievable macro, financing, and policy parameters to restore debt sustainability; the Fund’s DSA identifies financing requirements to anchor debtor–creditor deliberations. - Negotiations and arrears: - The Fund does not negotiate between debtor and creditors and generally advises members to remain current on obligations and avoid actions that could lead to default. - In post-default cases, Fund lending is guided by the Lending into Arrears (LIA) policy. Under LIA, financing to a member with sovereign arrears to external private creditors is possible only if: - Prompt Fund support is considered essential for successful implementation of the member’s adjustment program. - The member is pursuing appropriate policies and making good-faith efforts to reach a collaborative agreement with creditors. - Progress toward elimination of arrears is monitored through financing assurances reviews by the Executive Board. *Source: _040915 - 15. Due to data availability constraints, the focus is on more readily available indicators. (PDF chapter/section).* ### 5. The good faith criterion is assessed against several principles to strike a balance ### 5. The good faith criterion is assessed against several principles to strike a balance ### Good faith principles guiding debtor–creditor dialogue - Members, after determining that a restructuring is necessary, should: - engage in an early dialogue with creditors until the completion of the restructuring. - share relevant, non confidential information with all creditors on a timely basis. - provide creditors with an early opportunity to give input on the design of restructuring strategies and the design of individual instruments. - Under the LIA policy, when an organized negotiating framework is warranted and creditors have formed a representative committee on a timely basis, there is an expectation the member would enter into good faith negotiations with this committee; judgments about the sufficiency of representation are required. ### Modalities of conditionality related to debt restructuring - Conditionality governed by the Fund’s Guidelines on Conditionality (Decision No. 12864–(02/102), September 25, 2002, as amended). - Two types of conditionality observed related to debt restructuring: - Prior actions: - defined as measures expected to be adopted prior to the Fund’s approval of an arrangement or the completion of a review when it is “critical for the successful implementation of the program that such actions be taken to underpin the upfront implementation of important measures.” - Structural benchmarks: - may be established when a measure “cannot be specified in terms that may be objectively monitored or where its non-implementation would not, by itself, warrant an interruption of purchases or disbursements under an arrangement.” - intended as “clear markers” in assessing progress in implementation of critical structural reforms in the context of a program review. - Note: Until 2009 the Fund could also set structural performance criteria (SPC), but no conditionality related to restructuring of debt was set as an SPC before 2009 for the cases reviewed. ### Financing assurances policy and judgments for private sector contribution - Under the Fund’s financing assurances policy, if a contribution from the private sector in the form of a debt restructuring is needed to restore debt sustainability, the Fund may provide financing only if it has adequate assurances that the restructuring will be successful. - Adequate assurances = judgment that a credible process for restructuring is underway and will result in sufficient creditor participation to restore debt sustainability and close financing gaps within the macroeconomic parameters of the program, after taking into account official sector commitments. - Relevant considerations to form such judgment include: - engagement of legal and financial advisors by the member; - launching of consultations with creditors; - design of the debt restructuring strategy, including terms of new instruments and use of inducements for creditor participation. ### Decision factors for setting debt-restructuring conditionality - Conditionality and program design should “reflect the member’s circumstances and the provisions of the facility under which the Fund’s financing is being provided”. - Specification and sequencing of policy adjustment and time required to correct the problem may vary depending on causes of balance of payments difficulties and other differences in circumstances. - The member’s past performance in policy implementation should be taken into account. - Staff judgment when proposing conditionality should be based on: - the circumstances of the member; - the macro-criticality of the measure; - an assessment of the member’s commitment to complete the debt restructuring. ### Past practice: overview (1998–2014) - Review covers 17 Fund arrangements in 13 member countries during 1998–2014. - Seven of these arrangements involved restructurings conducted on a pre-default basis (pre-default defined as those cases where the member was not subject to the Fund’s LIA policy). - Of the pre-default cases, four arrangements were approved subject to the Fund’s exceptional access policy. - About half of all cases included a debt reduction (face value cut). - Of the 17 arrangements reviewed, 11 included conditionality related to the restructuring. - Four observed types of conditionality across cases: - (i) a prior action to finalize the debt restructuring; - (ii) one or several prior actions to take intermediate measures towards a restructuring; - (iii) structural benchmarks to finalize the restructuring; - (iv) structural benchmarks to take intermediate measures towards a restructuring. - Key observation: the Fund used flexibility under its policy to adapt program design and conditionality to country-specific circumstances; pre-default cases tended to have stronger conditionality relative to post-default cases. ### Pre-default cases: practice and examples - Most pre-default cases included conditionality on completion of a debt restructuring; exceptions: Argentina 2001 and Greece 2011. - Conditionality in pre-default cases typically required completion before either: - approval of the arrangement (Jamaica 2010 and 2013, Greece 2012); or - completion of a subsequent review (Uruguay, Cyprus). - Prior actions were the form of conditionality in all arrangements except Cyprus, where a structural benchmark was set. - Examples of prior-action use: - Jamaica (normal access SBA, 2010): - prior action required Jamaica to “launch and complete a debt exchange operation that ... achieves an estimated saving of over 3 percent of GDP in FY2010/11 and a reduction in the amount of debt maturing during 2010–12 by at least two thirds.” - the debt exchange was launched prior to circulation of the staff report and closed a day before Executive Board approval on February 4, 2010. - Jamaica (normal access EFF, 2013): - prior action required the government to “complete a debt exchange for domestic bonds consistent with a reduction in the public debt-to-GDP ratio by 2020 equivalent to at least 8.5 percent of GDP.” - the exchange was announced and launched before staff and authorities reached an ad-referendum understanding; closed with a nearly universal participation rate prior to issuance of the staff report in April 2013. - Greece (exceptional access EFF, 2012): - October 2011 EU summit targets included (i) a 50 percent face value cut in privately held Greek bonded debt; (ii) incentives, financed by the official sector, capped at € 30bn; (iii) a target to bring Greek debt-to-GDP under 120 percent of GDP by 2020, all targeting a € 100bn debt reduction. - a prior action in the EFF request required Greece to “close a debt exchange with private bondholders prior to the approval of an arrangement, while euro area member states are committed to providing financing on highly concessional terms.” - restructuring launched in February 2012; when the staff report was issued the debt exchange had already attracted almost universal participation, with the offer for foreign law governed bonds extended to March 24; the EFF request was approved on March 15, 2012. - Uruguay (exceptional access, 2003): - prior action required financing assurances to be met by time of the second review; the staff report stated financing needs were to be met to a large extent through a debt exchange. - authorities filed preliminary securities documentation with the U.S. Securities and Exchange Commission and intended to launch exchange offers in early April 2003 and complete by early May 2003; Executive Board completed the review a few days later. - Cyprus (EFF, May 2013): - structural benchmark established: restructuring of domestic debt by end-June 2013 and prior to the first review. - authorities given until the first review to roll over and restructure at least €1bn of domestic debt and roll over the €1.9bn recapitalization bond injected into a troubled bank. - Cypriot authorities also made program commitments (not in conditionality) to reschedule and lower the interest rate of a Russian bond falling due in 2016. - Lack of conditionality in Argentina 2001 and Greece 2011 reflected circumstances: - Argentina 2001: voluntary debt exchange for liquidity purposes; Argentina assessed to be solvent at the time. - Greece 2010 SBA: not foreseen at approval to include a debt restructuring; need for private sector involvement made explicit only at fourth review, with commitments in the MEFP to seek financing commitments from private and official sectors while design and extent of operation remained under discussion. ### Post-default cases: practice and timing - In post-default cases, programs allowed significantly more time for restructuring; conditionality focused on intermediate steps. - Large variation in time allowed from approval until completion of restructuring. - Dominican Republic: prior action to complete consultative phase as requirement for approval. - St. Kitts and Nevis and Seychelles: first and third program reviews respectively approved before finalizing debt exchange. - St. Kitts and Nevis prior action required only initial steps: public commitment to undertake a restructuring and appointment of legal advisors. - Argentina 2003: structural benchmark to announce a restructuring offer with intended content; second review later included a prior action to publish terms of engagement of banks and presidential decree to ratify appointment; debt exchange completed more than a year later. - Russia and Ukraine: - had ongoing arrangements to deal with liquidity problems when unexpected defaults occurred. - limited or no program commitments or conditionality related to debt restructuring. - reflected absence of conditionality, lesser importance of restructuring for program financing, and less committal MEFP language. - at the time, neither case was assessed to have a solvency problem. *Source: IMF staff report text excerpt (section 5 and annex on past practice, 1998–2014).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_040915.pdf_