Shaping tomorrow's debt restructuring system

As the debt crisis has unfolded in many of the world’s poorest countries, much attention has focused on seeking individual debt restructurings through the G20 Common Framework. This remains a priority, but the implementation remains slow and lacks the predictability needed to provide debtors and creditors with confidence. The Global Sovereign Debt Roundtable and the April 26 World Bank debt conference, Breaking the Impasse in Global Debt Restructuring, discussed effective debt restructurings and debt sustainability.  The conference also addressed how to avoid excessive debt build-up; and pressing questions regarding the debt sustainability implications of a decline of net international reserves into negative territory as countries draw on debt-like instruments such as swap lines. Following this week’s G7 Finance Ministers and Central Bank Governors meeting in Japan, we will publish the initial findings from a recent debt reconciliation initiative, which points to many technical challenges in agreeing on the amounts of debt to be treated in a restructuring.

Developing countries’ budgets are being hit hard against the backdrop of narrowing market access and limited foreign aid.  There is no doubt that financing for development must increase -- and that countries need to better manage resources. This brings to the fore the pressing need for prudent fiscal policies to avoid excessive and unmanageable debt build-up. Large fiscal problems stem from procyclical and inefficient spending and taxation decisions often combined with monetization of the fiscal deficit. The result undermines macroeconomic stability, local currencies, and investment, leaving unsustainable debt.

Developing countries are faced with an extraordinary set of challenges. Debt is more expensive, which underscores the importance of prudent fiscal policies.

Meanwhile, spending pressures have become immense to meet today’s pressing needs for health, education, infrastructure, climate costs and private sector development. In my March 30 speech in Niger ahead of the World Bank Group-IMF Spring Meetings, I advocated debt relief and a resumption of external resources, and also urged policy reforms including increased spending efficiency and restraint, removing wasteful and regressive subsidies and tax exemptions, and broadening the tax base. There is a strong case for improving fiscal discipline by adopting fiscal rules that boost confidence to provide an anchor for policymakers and investors and help avoid boom and bust cycles. There also needs to be more fiscal commitment to investments in preparedness for natural disasters and health emergencies – this will help countries lower the cost of catastrophes and unsustainable debt accumulation when disasters hit.

Strengthening private sectors in developing countries and attracting private capital from abroad will be key steps in meeting the financing challenge. The World Bank Group’s private capital facilitation agenda includes a focus on business enabling reforms and strengthened mobilization of private domestic and foreign resources. As advanced economies absorb an increasing portion of global capital, this is more urgent than ever. The forthcoming Business-READY report, and a renewed Bank-wide emphasis on our existing Country Private Sector Diagnostics, can help countries identify key obstacles to private sector growth and describe useful reforms. To help meet preparedness needs, contingent financing through insurance instruments and CAT-DDOs can help protect public finances when emergencies do strike.

A key issue discussed at the April 26 conference was assessment of debt sustainability and the pressing need for greater debt transparency. It is hard to make progress on debt sustainability and debt restructuring when the amount of debt is unclear. Lack of transparency starts with individual debt contracts that use non-disclosure clauses to avoid public scrutiny or rely on escrow accounts and collateralization. The transparency problem is exacerbated by inadequate debt reporting by individual countries. These make it harder to assess debt sustainability and to restructure unsustainable obligations.  

The discussion at our April debt conference emphasized the need to adjust the Low-Income Country debt sustainability analyses to better incorporate complex debt-like instruments, climate costs, and the rapid expansion in domestic debt . Discussion at the conference also focused on important technical issues such as the treatment of swap lines; contingent liabilities; SOE debt when there is an identified stream of revenues; and debt-like collateralized instruments. One concern was the “black box” gap in some countries between their gross reserves, usable gross reserves, and net reserves and the lack of transparency around swap lines and their uses. The forthcoming review of the LIC DSF by the World Bank and the IMF offers a good opportunity to see how some of these issues can be addressed, while keeping the Debt Sustainability Analysis (DSA) as simple and clear as possible.

The World Bank has been very active in improving debt transparency, but more needs to be done.  We are working hard to make statistics more comprehensive and available to all stakeholders. The External Debt Reporting System remains the single most important source of verifiable information on the external debt of low- and middle-income countries. The coverage and accuracy of the DRS system has been expanded, and further efforts are being made to incorporate domestic debt modules.

Through the Sustainable Development Finance Policy, we are incentivizing IDA-eligible countries to implement concrete actions that enhance fiscal sustainability, debt transparency and management. We also advocate strongly for strengthened public transaction disclosure practices, and we are highlighting good practice approaches to transaction-level disclosure.

More progress needs to be made in debt reporting, which often falls short because systems are outdated and insufficient. Reconciliation of debt data is painfully long and ad hoc, as shown by the recent Common Framework cases of Chad and Zambia. There is also limited appetite among bilateral non-Paris Club creditors and private sector players to share disaggregated debt data. And while some progress was made recently under Japan’s G7 presidency in reconciling outstanding debt stocks for 2021 for IDA-eligible countries, it’s important to expand the reconciliation to middle-income countries and involve a broader group of creditors. Also, in the 21st century, it’s high time that debt reporting and reconciliation use modern technologies to provide accuracy and timeliness of this process. 

In the context of facilitating debt restructuring processes, the conference discussed the need to rebalance the creditor and debtor powers in debt restructuring, given the absence of a sovereign bankruptcy framework. If debt restructuring is the only solution, the process should offer more leverage to debtor countries to achieve a speedy resolution. Multiple tools can be considered. There is the possibility of including, for example, an aggregated collective action clause in all new official sector and private sector debt and debt equivalent instruments. Other measures that could facilitate restructurings include limiting creditor recoveries, immunizing sovereign assets from attachment, or incorporating a “most favored creditor” clause. The latter approach, currently contemplated by Sri Lanka, aims to ensure that if any creditor gets a better deal from the debtor country than the one agreed at restructuring, the better offer extends to all other creditors. This incentivizes creditors to accept comparable restructuring terms.

Developing countries are faced with an extraordinary set of challenges. Debt is more expensive, which underscores the importance of prudent fiscal policies.  The era of ultra-low interest rates is unlikely to return, so the ability of countries to borrow and roll over debt cannot be taken for granted. Significant reforms are needed in many countries to restore macroeconomic stability, but governments are instead drawing down reserves and tapping domestic savings.  This allows the debt problem to get worse month by month, harming prospects for new investment and growth.  

A sovereign debt resolution system that brings debtors and creditors together earlier in the process, reconciles outstanding debt quickly, and provides stronger incentives for creditors to participate in restructurings can help make the existing architecture work better for developing countries facing debt sustainability challenges.