Debt distress concerns have mounted in the recent past as countries such as Ghana, Zambia and Ethiopia have engaged their creditors for a restructuring in a bid to ease the burden on their economies.
At its just-concluded 2023 Spring Meetings, the International Monetary Fund (IMF) stated that Kenya is not a candidate for debt restructuring despite the relatively elevated debt pressures it is currently facing
The IMF Deputy Director for Strategy and Review Department, Mark Flanagan, discussed debt restructuring and what it means for economies that opt to go that route.
What are the different classes of creditors and how are they handled in a restructuring process?
For low-income countries, there are multilateral development banks which offer credit on highly concessional terms.
These are typically considered preferred creditors and what this means is that in a restructuring scenario debt owed to them is not restructured.
The second class is official bilateral creditors and these could be Paris Club such as the United Kingdom or non-Paris Club such as China, India and Saudi Arabia.
In restructuring, there’s obviously an efficiency gain if all these bilateral creditors can do it together. The other class is commercial creditors and their debt is restructured through contractual processes.
Could you walk us through the restructuring?
When we think about reducing the burden of debt, we think about reducing the interest rate and making the amortisation profile lighter. We talk about two types of restructuring one being a face value reduction.
Imagine a debt that’s $100 million. A face value reduction might reduce it to $70 million and if it entails a bullet maturity it may require redeeming only $70 million as opposed to $100 million even though it may retain the same original interest rate.
Another way is through maturity extension. So, we could now say that if the debt was maturing in five years, we extend that to 20 years.
How do we handle domestic debt in restructuring?
Generally, external debt held by non-residents has far less costs for the domestic economy when restructured because it affects someone else’s balance sheet.
When it comes to domestic debt under domestic law held by domestic residents restructuring implies those residents will bear the cost. So, it can be far more costly for the economy.
Think of big holders of domestic debt being banks and non-bank financial institutions like pension funds, restructuring them could mean de-capitalising them and you may damage their balance sheets.
That can be very costly and it is something that most countries want to avoid. When restructuring domestic debt you can generate this sort of financial stability issues.
So, what happens when one has non-residents holding domestic debt?
Often, it is referred to as a carry trade and could change the calculus as well because if you have non-residents holding domestic debt that cost is going to be borne by a balance sheet outside the economy.
It’s a complicated matter that governments and their advisers have to make when they decide to restructure debt.
What does ‘too little too late’ mean in debt restructuring?
It means that countries can be reluctant to enter into restructuring and wait too long to get into it and when they negotiate a restructuring, they may not negotiate enough to correct their problem.
A few years later, they may have to come back and do it again.
This may happen because creditors are not particularly happy to write down their debt and they will fight as much as possible and if a government yields too easily to that, you end up with too little.
There are some who argue that perhaps economies facing debt distress should always consider pre-emptive restructuring. What does this mean and would you recommend it?
Pre-emptive restructuring is defined as restructuring before arrears. Arrears happen when a country gets to a point where it literally cannot pay its debt and it tells bondholders that it cannot pay the interest that is due or is unable to service the principal and then arrears start accruing.
So pre-emptive restructuring essentially tries to avoid that and studies have shown that this can be beneficial.
However, it requires identifying the debt distress probability sufficiently way in advance to allow the economy to sit down with creditors and talk through solutions that they can agree to.
For creditors, a situation involving arrears makes their debt illiquid, difficult to trade and has regulatory implications for banks because they have to book provisions and so it is very costly.
So we generally recommend that if you have to restructure, try to do it pre-emptively.
Debt restructuring should ideally be a last-resort measure. What should have preceded it in the efforts to steer economies off this path?
The first thing is to identify the risk of distress earlier on through the use of debt sustainability frameworks which help assess the risk that a sovereign will start experiencing stress.
That could be financing stress where the markets may start to shut and the sovereign has some difficulty accessing new financing.
Sometimes stress can come from things that can be easily addressed like countries may have a bulge of debt maturities coming due and one way you can address that is just ahead of time to try to pre-issue and pre-amortise some of the debt coming due. So sometimes there are easy solutions.
In other instances it reflects deeper problems like a government may have been running large deficits requiring high financing every year and constantly adding to the debt stock.
That calls for a different solution because adjusting budgets where you reduce spending and increase revenues can be a difficult process and there are limits to it.
A sovereign could also look at other sources of finance it can access which are relatively inexpensive.