Issues in Restructuring of Sovereign Domestic Debt

Policy Papers, December 1, 2021

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Emerging and developing economies are accumulating more domestic sovereign debt, increasing the likelihood that domestic debt will play a larger role in future sovereign debt crises.
The paper analyzes when and how to restructure sovereign domestic debt in unsustainable debt cases while minimizing economic and financial disruptions.
Key decision criterion: weigh the benefits of a lower debt burden against the fiscal and broader economic costs of achieving that debt relief.

Fiscal and broader economic costs can be incurred as part of restructuring because of the need to:
- maintain financial stability;
- ensure the functioning of the central bank;
- replenish pension savings.
A sovereign domestic debt restructuring should be designed to anticipate, minimize, and manage its impact on the domestic economy and financial system.
Casting the net wide across claims can help boost participation in the restructuring by lowering the relief sought from each creditor group.
Strategies that tend to work best:
- engage creditors constructively and as transparently as possible;
- rely on market-based incentives;
- present the exchange as part of a consistent macroeconomic plan.

When considering domestic debt restructuring, explicitly weigh:
- the benefits of reduced debt burden against fiscal and wider economic costs;
- the need to preserve financial system functioning and central bank operations;
- the implications for pension systems and other contingent fiscal obligations.
Design restructurings to:
- anticipate, minimize, and manage domestic economic and financial spillovers;
- broaden the participation base ("cast the net wide") to reduce per-creditor relief and increase overall participation;
- use market-based incentives to encourage voluntary participation;
- maintain transparency and constructive creditor engagement;
- situate the debt exchange within a coherent macroeconomic policy framework.

International Monetary Fund. "Issues in Restructuring of Sovereign Domestic Debt", Policy Papers 2021, 071 (2021).