Several examples of EMs currently undergoing debt restructuring or at risk of debt distress highlight the main challenges faced during restructuring negotiations as well as the difficulties in ensuring the fulfilment of EMs’ financing needs.
Ukraine
The stability of the macroeconomic framework has been severely affected by the war. The current economic equilibrium is dependent on international support and domestic borrowing while the financial resources raised are entirely devoted to war expenses and the provision of essential public services, with grave consequences for debt sustainability.
Ukraine’s successful reconstruction and economic stabilisation after the war – a strategic priority for NATO, the EU and other allies – will require significant financial resources. Official and private sector support should play an essential role. In order to raise private sector finance, the issue of debt sustainability will have to be addressed, first through a restructuring of the existing debt stock. In this context, some private sector participants stressed that it would be desirable to promptly establish a broad based process of engagement with all stakeholders to ensure that information and expertise are shared effectively. The potential advantages of swift negotiations with commercial creditors are demonstrated by the standstill on payments in relation to bonded debt agreed by bondholders in 2022, thus before the start of Ukraine’s current IMF programme. Incentivising private sector creditors to provide debt relief and avoiding holdout issues will require thinking about innovative solutions to raise cash flows.
For example, some suggested that the seizure of the proceeds generated by frozen Russian assets could be considered as an interim measure before a definitive legal solution for the stock of such assets is reached. Furthermore, as the need for a future debt restructuring following the end of the war can already be anticipated, Ukraine’s restructuring might provide an opportunity to discuss and experiment with the employment of innovative financial instruments to help mobilise new financing flows. Some have suggested this could include debt for reconstruction swaps or future financing rights.
Zambia
Zambia’s debt crisis has been long in the making. Well before the COVID shock, a public investment drive in infrastructure projects mainly financed by non-Paris Club bilateral creditors increased the vulnerability of the country’s finances while market funding had dried up already in 2015. In the wake of the pandemic, Zambia obtained interim cashflow relief under the DSSI. However, the launch of a subsidy programme for the agricultural sector led to a further increase in domestic debt and arrears and partial usage of the July 2020 increase to the IMF’s special drawing rights (SDRs). In September 2020, negotiations with bondholders, who had formed a committee some months earlier, for a voluntary debt standstill failed. With debt levels exceeding 140% of GDP, the government defaulted on a Eurobond coupon in November 2020 and subsequently announced a moratorium on all other debt except for debt owed to multilateral creditors.
In February 2021 Zambia applied for a comprehensive debt restructuring under the Common Framework, but the process initially stalled due to the government’s unwillingness to realistically engage with creditors pending elections in the summer of 2021. Negotiations resumed after the elections, leading to a staff level agreement on an IMF programme in December 2021. The approval of the 3 year $1.3 bn IMF programme, though, was held up due to the need to obtain financing assurances from bilateral creditors; indeed, the official creditors committee was only formed in July 2022, while financing assurances were provided shortly after.
The approval of the IMF financial assistance programme was accompanied by the publication of the DSA, determining the restructuring envelope. However, several aspects of the DSA proved controversial for some private creditors, causing further delays in the restructuring negotiations. Most significantly according to some private creditors, the DSA assumed the exclusion of non-resident holdings of domestic debt from the restructuring perimeter despite their significance (non-resident holdings amounted to $3.2 bn out of a total external debt stock of $20bn. Another sticking point for some private creditors concerned the assumption that Zambia’s classification as having ‘weak debt carrying capacity’ extended to the post programme period, while alternative economic models predicted that the country’s debt carrying capacity could rise to medium by the end of the programme.
The IMF ultimately revised the DSA macro framework in April 2023, which enabled overcoming the issues surrounding the exclusion of non-resident holdings of domestic securities. Moreover, additional MDB grants were included as programme financing, ameliorating China’s concerns on the marginal contribution of multilaterals to the resolution of the crisis. Against this background, an agreement on official debt treatment was finally reached, allowing the implementation of the IMF programme and paving the way for the signature of an MoU. The agreement is rather innovative, as it foresees the possibility of a subsequent adjustment of the debt treatment if economic conditions justify an upgrade of Zambia’s debt carrying capacity as evaluated under the IMF/WB LIC DSA. An agreement on the treatment of commercial debt is outstanding, and negotiations in this regard are ongoing. The bondholder committee comprises 15 global organisations, directly holding 45% of Zambia’s Eurobonds. Several challenges will need to be resolved in order to reach an agreement. First, the commercial debt treatment will have to fit within the parameters of the DSA and will have to be broadly comparable to the treatment provided by bilateral creditors. Notably, the latter focused largely on duration extension and a downward adjustment of interest payments, while commercial creditors are willing to also provide principal reductions. Moreover, the agreement with commercial creditors will have to replicate the conditional treatment envisaged by bilateral creditors, allowing adjustment to the parameters of the relief provided depending on the evolution of Zambia’s debt carrying capacity. To this end, objective and reliable indicators of economic performance, such as export revenues, will have to be identified.
Sri Lanka[1]
Sri Lanka’s ongoing debt restructuring has been prompted by a severe social, political and economic crisis. The authorities, however, have responded positively to the unfolding crisis by promptly engaging with the IMF and official creditors. This allowed them to negotiate an IMF Extended Facility programme to underpin debt restructuring and to ultimately obtain bilateral financing assurances from official creditors within a reasonable timeframe.
Nonetheless, given that Sri Lanka was not eligible for debt treatment under the Common Framework, conducting separate bilateral negotiations with official creditors has proved challenging due to creditor fragmentation and geopolitical tensions. At the end of 2022 the country’s outstanding debt stock was $41 bn, the largest share of which consisted of private sector bonded debt (32%) and the rest divided among different official creditors: 28% held by multilateral creditors, 12% by Paris Club members, 18% by China, and 4.5% by India. China, in particular, has been voicing concerns as to the preferred treatment of multilateral creditors vis-à-vis Chinese development banks. Moreover, while signalling willingness to consider debt reprofiling and coupon reduction, it has opposed principal haircuts. Although financing assurances have been obtained, separate negotiations as to the precise terms of the treatment of bilateral obligations are still ongoing.
One element of Sri Lanka’s IMF programme that has been particularly challenging is the focus on total debt as opposed to external debt, and the consequent requirement to restructure domestic debt alongside external obligations. Moreover, the engineering of the domestic debt restructuring raises significant inter-creditor equity issues, as domestic banks (which held approximately 30% of the bonds) have been excluded from the restructuring due to the need to preserve financial stability.
As concerns private sector debt, which represents the biggest component of Sri Lanka’s debt stock, bondholders organised swiftly and took the initiative to independently offer financing assurances to support the IMF’s programme approval. A conclusive agreement on the treatment of private sector debt remains outstanding. The main challenge in this regard concerns the gap between the market’s expectations about future economic prospects and those entailed in the IMF DSA, based on the Market Access Countries Debt Sustainability Framework (MAC DSF). Some have suggested that this gap could potentially be bridged through the employment of innovative financial instruments, such as fixed income instruments meeting the DSA scenario accompanied by other financial instruments mobilising additional cash flows depending on the improvement in economic parameters.
Ghana
Clear indicators of debt distress in Ghana had already emerged in 2019, but crisis response was delayed due to impending elections. Following the change of government, the authorities negotiated a staff-level agreement with the IMF for an upper credit tranche programme in December 2022 and applied for debt treatment under the Common Framework. The official creditor committee was formed in May 2023 and negotiations for the restructuring of $5.4 bn in bilateral debt are ongoing. Ghana’s external debt stock also comprises $14.6 bn of Eurobonds, which need to be restructured. Indeed, the implementation of the IMF programme depends on the restructuring of external debt totalling $11bn.
In the meantime, in order to demonstrate their commitment to tackle debt sustainability issues, the authorities chose to restructure domestic debt, which accounted for over 20% of debt servicing costs. The domestic debt restructuring has been facilitated by the employment of regulatory coercion over the banking sector, with the central bank weighting the risk of non-restructured bonds at 100% and the risk of exchange bonds at 0%. However, the implications for financial stability could be severe; 75% of the investment of the banking sector was in government securities and the restructuring determined a loss in NPV terms of around 30% to 35%. Moreover, the central bank’s exposure to domestic debt has significantly increased throughout the restructuring.
[1] This discussion of Sri Lanka is based on the context that existed up to the conference dates of 13-15 September, and therefore does not take account of more recent developments.