Questions and Answers on Sovereign Debt Issues
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Scope and current debt challenges
- Debt levels were elevated before the COVID-19 crisis: an IMF paper (February 2020) found that half of low-income countries (LICs) (36 of 70 countries) were at high risk of debt distress or already in debt distress.
- The COVID-19 pandemic is pushing debt levels to new heights by increasing spending needs and reducing revenues, adversely affecting both solvency and liquidity indicators of most if not all emerging market- and developing economies.
- The ultimate extent of debt distress depends on:
- how deep and prolonged the pandemic’s impact is, which varies by country (access to medical interventions; importance of commodity and oil exports, tourism, remittances);
- the extent of international support through debt service relief, concessional financing, and debt restructuring where needed.
- Countries with higher debt burdens face trade-offs between scaling up health, social safety net spending and public investment, and containing debt vulnerabilities.
Debt Service Suspension Initiative (DSSI) — purpose, scope, and numbers
- Definition: The DSSI means that bilateral official creditors are, during a limited period, suspending debt service payments from the poorest countries (73 low- and lower middle-income countries) that request the suspension to free up resources to address the COVID-19 crisis.
- Role and limits:
- The DSSI addresses immediate liquidity needs but does not in itself resolve underlying debt sustainability problems.
- More than 50 percent of IDA countries were classified as either in or at high risk of debt distress before COVID-19.
- Participation and relief amounts:
- As of March 8, 2021, more than 60 percent of the eligible countries have made requests for the debt service suspension.
- In 2020, 43 countries are estimated to have benefited from US$5.7 billion in debt service suspension.
- The first six-month DSSI extension through June 2021 could provide an additional US$7.3 billion of debt service suspension for the participating countries as of March 8, 2021.
- On April 7, 2021, G20 bilateral official creditors agreed to a final extension of the DSSI by 6 months through end-December 2021.
- Interaction with IMF financing:
- To apply for the DSSI, a country either needs to be in an IMF financing arrangement, or it needs to have requested financing (including emergency financing) from the IMF; a request is sufficient.
- A country already participating in the DSSI that wants an extension into 2021 did not need to make another request for IMF financing.
Private sector participation
- The International Institute of Finance (IIF) released Terms of Reference (ToR) on May 28, 2020 to facilitate voluntary private sector involvement in the DSSI.
- Private sector participation has been limited to date.
- The IMF and the G20 would like to see private creditors participating on equal terms when requested by eligible countries, noting that such participation supports recovery and is in long-term commercial interest of private creditors.
IMF role, concessional support, and debt relief mechanisms
- Technical support: IMF and World Bank staffs provide technical support to the DSSI and monitor use of resources released by the DSSI to address the pandemic shock.
- IMF additional lending and emergency financing:
- As of early April, 2021, the IMF Executive Board had approved emergency financing to 51 LICs, totaling about $12bn, with support for more possible.
- The IMF is substantially increasing its overall outstanding lending on favorable terms compared to the market.
- Catastrophe Containment and Relief Trust (CCRT):
- The CCRT has provided debt service relief to 29 of the poorest and most vulnerable member countries, covering eligible debt falling due to the IMF for the period between April 2020 and mid-October 2021.
- The IMF is working with donors to increase funds for further debt relief through the CCRT to extend grant-based debt relief to up to a two year period, ending April 2022.
- A new feature in the current CCRT initiative is tranche-based grant disbursements so relief can be immediately available without waiting for full fundraising.
- Rapid Credit Facility (RCF) and concessional lending:
- The IMF temporarily increased access limits under the RCF (PRGT) to respond to LICs’ urgent needs and is seeking additional donor support to expand PRGT concessional lending.
G20 Common Framework for Debt Treatments beyond the DSSI
- Scope and membership:
- The Common Framework is an agreement of the G20 and Paris Club countries to coordinate debt treatments for up to 73 DSSI-eligible low income countries.
- It includes Paris Club members and G20 official bilateral creditors (e.g., China, India, Turkey, Saudi Arabia) that are not Paris Club members.
- Types of treatment:
- For unsustainable public debt: deep debt restructuring with reduction in net present value sufficient to restore sustainability.
- For sustainable debt but liquidity pressure: deferral/rescheduling/reprofiling of debt service payments for a number of years.
- Conditions to access:
- A country must have an IMF‑supported program (e.g., Extended Credit Facility) to benefit from a debt treatment under the Common Framework; if it does not, it must request one in conjunction with a Common Framework request.
- The IMF defines the financing envelope (debt relief envelope) consistent with the IMF-supported program and the accompanying debt sustainability analysis (DSA).
- Differences versus DSSI:
- DSSI provided temporary, uniform liquidity relief with specific grace periods and repayment spreads (suspended May–December 2020 repayments due after a one-year grace period and spread over the following three years; for the first six months of 2021 suspension, repayments spread over five years).
- Common Framework rescheduling is tailored to country-specific needs, potentially covering debt service due over a number of years and adjusting terms (including grace periods) accordingly.
- DSSI encouraged comparable treatment from private creditors but did not require it; the Common Framework requires the debtor to seek treatment from other creditors, including private creditors, at least as favorable as official bilateral creditors’ treatment, with comparability assessed at the level of private creditors as a whole.
Country cases, restructuring needs, and IMF conditionality
- Recent requests under the Common Framework:
- Requests from Chad, Ethiopia, and Zambia are noted as welcome, with the Common Framework able to tailor treatments to differing country needs.
- IMF approach to restructuring:
- The IMF takes a case-by-case approach, using DSAs to determine whether restructuring is needed and the financing envelope necessary to restore debt sustainability.
- For countries with unsustainable debt, IMF lending is precluded unless members take steps to restore debt sustainability, including debt restructuring; in some cases, IMF financing may proceed before restructuring is completed if official bilateral creditors provide adequate assurances and credible steps toward private creditor restructuring have been taken.
- Coverage beyond LICs:
- Many emerging market economies are also at significant risk of debt distress; some (e.g., Argentina, Ecuador) have concluded restructurings, while others (e.g., Lebanon, Zambia) remain works in progress.
- The IMF stands ready to provide financing and support for debt restructuring beyond LICs when needed.
Comparability, creditor roles, and legal limits
- The IMF cannot force creditors to forgive loans or interfere in bilateral debt contracts; restructuring decisions and terms are made by sovereign authorities in consultation with legal and financial advisors.
- The IMF’s role in sovereign debt restructurings is to:
- determine the financing envelope based on a realistic DSA;
- aim for high creditor participation and restoration of debt sustainability consistent with the DSA;
- support creditor and debtor discussions but not manage the restructuring process.
- Private creditor comparability under the Common Framework will be implemented based on circumstances as evaluated by official bilateral creditors signing the agreement with the debtor.
Gold, IMF balance sheet, and resource constraints
- Gold holdings:
- Gold provides fundamental strength to the Fund’s balance sheet and enables the IMF’s role as crisis lender.
- Reaching agreement on gold sales requires approval by an 85 percent majority of total voting power.
- The IMF has lending capacity to support middle income countries with debt vulnerabilities and is focused on rapid measures to help poorest members, including raising additional donor resources to expand concessional lending.
Past debt relief initiatives and comparison with current efforts
- CCRT versus past initiatives:
- CCRT provides grant-based debt service relief for a limited time; in April 2020 this was expanded to cover exceptional balance of payments needs from COVID-19.
- The CCRT mobilized debt relief faster than previous initiatives and uses tranche-based grants to make relief immediately available.
- HIPC and MDRI history:
- The HIPC Initiative and the MDRI provided grants to cancel debt but took longer to mobilize and implement.
- The IMF Executive Board adopted the MDRI in November 2005; it became effective on January 5, 2006.
- The IMF delivered MDRI debt relief of SDR 2.3 billion to 30 qualifying countries.
- There is no longer any outstanding IMF debt eligible for MDRI debt relief, and the MDRI trust accounts have been unwound.
Outlook: restructuring prospects and system reform
- A wave of restructurings is possible:
- The IMF observes a significant increase in debt vulnerabilities; some countries have undertaken fiscal consolidation post-pandemic, while others may need deeper restructurings to restore sustainability.
- The number of restructurings may rise if the global slump is deeper and more prolonged; the IMF’s main goal is to help the international community avoid such a scenario.
- Targeting and sequencing:
- Debt reduction should be targeted to LICs that truly need it to return to sustainable growth; many LICs have manageable debt vulnerabilities and may benefit from rescheduling rather than reduction.
- Sovereign Debt Restructuring Mechanism (SDRM) and architecture:
- The IMF supports contractual approaches (e.g., enhanced collective action clauses) and recognizes a need to strengthen the international debt “architecture” to provide speedy, sufficiently deep debt relief.
- The SDRM did not command requisite IMF membership support in the early 2000s; recent IMF staff work has taken stock of private debt restructuring architecture and possible improvements.
- The G20 Common Framework is an important step toward timely debt resolution and burden sharing among creditors.
Content in this bundle
- G20’s Common Framework for Debt Treatments beyond the DSSI
References