Reform of the International Debt Architecture is Urgently Needed
IMF Blog, October 1, 2020
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- Authors: Kristalina Georgieva, Ceyla Pazarbasioglu, Rhoda Weeks-Brown
- Published: October 1, 2020
Debt dynamics and immediate risks
- Compared to end-2019, average 2021 debt ratios are projected to rise by 20 percent of GDP in advanced economies, 10 percent of GDP in emerging market economies, and about 7 percent in low-income-countries.
- These increases come on top of debt levels that were already historically high.
- About half of low-income countries and several emerging market economies were already in or at high risk of a debt crisis before the pandemic.
- If left unaddressed, further rises in debt could trigger defaults, capital flight, and fiscal austerity, producing a potential second wave of economic distress and turning recoveries into protracted setbacks.
- IMF research cited: waiting to restructure debt until after a default occurs is associated with larger declines in GDP, investment, private sector credit, and capital inflows than preemptive debt restructurings.
Policy actions to date and their limits
- No debt crisis has happened yet thanks to decisive policy actions by central banks, fiscal authorities, official bilateral creditors, and international financial institutions early in the pandemic.
- Key measures taken:
- The G20 Debt Service Suspension Initiative (DSSI) — described as "highly welcome" — expires at the end of this year.
- The IMF has provided about US$31 billion in emergency financing to 76 countries, including 47 low-income countries, and provided debt-service relief to the poorest countries under the Catastrophe Containment and Relief Trust.
- Limitations of current measures:
- They are temporary by design and may prove insufficient as needs remain high in 2021 and beyond.
- Most measures have focused on liquidity; solvency problems (the inability to repay debts) are increasingly coming to the forefront.
Urgent steps recommended to prevent a developing country debt crisis
- Extend the Debt Service Suspension Initiative into 2021; without extension, current recipients would likely be forced into austerity to resume debt service.
- The extension should provide incentives to tackle unsustainable debt problems early (for example, linking length of extension to IMF and World Bank programs designed to reduce debt vulnerabilities).
- Countries with debt vulnerabilities should address them urgently through:
- A combination of debt management and measures to restore growth.
- Restructuring unsustainable debt as soon as possible; private sector claims should be included, where applicable.
- Reform the international debt "architecture" to enable speedy and sufficiently deep debt relief, including:
- Sovereign debt contracts.
- Institutions such as the IMF and the Paris Club.
- Policy frameworks that support orderly debt restructuring.
Specific aspects of the debt architecture that require fixing
- Strengthen contractual provisions:
- Continue promoting enhanced Collective Action Clauses in international bonds.
- Develop similar provisions for non-bonded debt to facilitate orderly restructurings.
- Consider clauses that lower debt payments or automatically suspend debt service in events such as natural catastrophes and other large economic shocks.
- Increase debt transparency:
- Creditors need to know what countries owe and on what terms to make informed lending decisions and to participate in restructurings.
- Achieve a common approach among official bilateral creditors:
- Most official debt is now held by creditor countries that are not Paris Club members and do not follow Paris Club procedures, complicating restructurings.
- A common approach could include a common term sheet requiring the debtor to transparently lay out its debts and seek restructuring agreements from all creditors—official and private—on comparable terms to ensure information sharing and fair burden sharing.
- Such an approach could raise participation and avoid costly delays.
- Address limits of current contractual framework:
- While effective for sovereign bonds in many cases, the framework has been less effective for restructuring non-bonded debt, collateralized debt, and debt with collateral-like features.
- The recent restructurings of Ecuador and Argentina demonstrate remaining issues, including significant expansion in the diversity of commercial creditors and lack of debt transparency.
- Non-bonded and collateralized loans, often undisclosed, appear particularly prevalent in low-income countries exporting natural resources.
Role of the IMF
- The IMF is supporting members with policy advice, financing, and capacity development to prevent a debt crisis.
- Ongoing IMF actions include:
- Providing debt service relief to the poorest countries under the Catastrophe Containment and Relief Trust.
- Fostering debt transparency, including through a stronger debt limits policy.
- Providing technical assistance on debt management.
- Working with the G20 to extend the Debt Service Suspension Initiative.
- Supporting debtor-creditor coordination and debt restructuring through analysis of actions to restore debt sustainability and by conditioning financial support on high creditor participation.
Key takeaways and call to action
- The world is at a critical juncture and should not wait for a crisis to act.
- The key steps called for are:
- Extending the Debt Service Suspension Initiative.
- Addressing countries’ debt vulnerabilities promptly.
- Building a more robust debt architecture encompassing better contracts, greater transparency, and a common approach among official bilateral creditors.
- The authors call on all stakeholders to do their part to reduce the risk of a catastrophe and pave the way for a safer financial system; low-income countries and their populations are especially at risk if a debt crisis occurs.
Kristalina Georgieva, Ceyla Pazarbasioglu, Rhoda Weeks-Brown — October 1, 2020