Managing sovereign loans: Building up from the basics

Sovereign loans are an important source of financing for countries around the world. Borrowing can enable governments to support key areas for growth and development, such as healthcare, education, infrastructure and the green transition. Yet, managing public loans can be complex and challenging — with potential impact on countries’ finances and their people. Errors and inaccuracies in monitoring can have large financial and reputational implications. 

Loans follow a different dynamic from securities. Because they are not traded publicly, they tend to be less standardized. Debt managers need to fully understand the terms and conditions applicable to each debt instrument — down to the tranche level — to ensure that cash flows are broken down correctly into principal, stock, and interest payments. Debt recording and monitoring should be undertaken at the most granular level for each individual tranche. Having a clear understanding of the terms and conditions of each debt contract is critical for governments to manage risks and build to a more sustainable debt environment.

A recent World Bank guidance note, Managing Sovereign Loans: A Bottom-Up Approach, helps governments manage their sovereign debt more effectively — so debt can be an instrument to propel development, rather than a drag on it. The publication focuses on three things that countries must do to improve debt management:

• Understand and negotiate the terms and conditions with creditors,
• Use debt data to develop sound debt-management strategies,
• Monitor and report on the debt portfolio.

	Transportation and other infrastructure can be supported by sovereign loans. | © Pankaj Patel on Unsplash

Those steps may seem like common sense, but the reality is not that simple. Many middle- and low-income countries lack the technical capacity to effectively estimate and track the financial flows from loans in their portfolios. Training and other investments in human resources are necessary to enhance these countries’ ability, and here is where our guidance note can help.

The note describes the key components of a debt contract and recording and monitoring events that impact cash flows.  It covers aspects such the lifecycle of a loan (from disbursements to repayments), the parameters that change the cash flows patterns of debt repayments, and the type of interest rates (fixed, floating, simple, compounded).

To give just one example, when a creditor proposes a large debt repayment the debt manager will consider whether this is at a time when the country already has to pay other borrowings. To avoid bunching of payments, which may create a liquidity crunch, the debt manager can then counter-propose a different schedule for the repayments — reducing the bunching and the risks of debt stress.

The guidance, along with examples provided and technical assistance on the ground, was considered useful by Iraqi authorities as they recently drafted their first-ever public debt report. Despite the staff’s hard work and dedication, the country’s complex debt structure made it hard for debt officers to track all loans in detail. External debt accounts for about 28 percent of Iraq’s overall stock — the rest is domestic. The country’s Public Debt Department (PDD) manages around 110 external active loans from 13 different creditors.

The 18 real-life examples that illustrate the aspects presented in the guidance note can be especially helpful. Each is accompanied by a spreadsheet showing the detailed formulas and flows for different types of loans. The spreadsheet can be used for calculating the debt stock, for estimating the debt service for the budget, and for understanding the maturity profile, cost, and risks during the loan negotiation phase. The note is especially valuable for countries participating in the Debt Service Suspension Initiative, for transitioning out of Libor, and for those adopting SOFR for debt payments.