By Dr. Dushni Weerakoon:
Sovereign debt restructuring can be pre-emptive or
post-default. A default is inherently costly as it can result in a sustained
loss of access to capital markets. That leaves pre-emptive restructuring when a
country deems itself unable to service outstanding debt.
The complex creditor landscape of today though
makes governments reluctant to entertain sovereign debt restructuring. The landscape of sovereign borrowing has
evolved from a small group made up of multilateral organisations, a few
commercial banks, and the ‘Paris Club’ of rich countries to something much more
complicated. In recent decades, emerging markets and developing economies have borrowed proportionately more from
international bond markets with their dispersed private investors, and tapped
new non-Paris Club lenders like China. From the sovereign’s perspective, this makes
a potential debt restructuring operation particularly complicated.
first step in any restructuring is calculating how much a country owes and to
whom. This involves sharing detailed information on all categories of sovereign
debt denominated in foreign currency, including collateralised liabilities and
the debts of state-owned enterprises. The adoption of an IMF programme may be
conditioned as a part of a restructuring to underwrite the data, economic plan
and the promise of macroeconomic and fiscal supervision.
will weigh the upfront losses of a debt standstill and restructuring against
the total magnitude of
in the event of a default. In entering restructuring talks, though, they will
also demand to do so on the principle of comparable treatment of
creditors in any proposed debt reprofilings and restructurings. Lenders will be mindful that any relief
offered does not give preferential treatment to other creditors, especially in
the face of new geopolitical power rivalries. This would typically mean
that a country in distress asks for debt
relief from friendly governments to whom it owes money and then seeks a
comparable deal from private lenders.
past decades, there has been progress in governance frameworks to deal with
sovereign debt crises, but considerable gaps persist. In the COVID-19 era, the
G-20 Common Framework for Debt Treatments apply only to low-income countries
(LICs), and even then, do not compel the participation of private creditors.
Emerging markets that have undergone debt restructuring most recently (e.g.
Argentina and Ecuador) are categorised in academic research as countries with a
track record of serial default – i.e. more than two default spells or
episodes. Given research evidence that
countries that have defaulted on their debt obligations in the past are more
likely to default again in the future, creditors have an added incentive to
enter into negotiations in such cases.
told, with the creditor landscape transformed, debt restructuring is still very
much a matter of ad hoc negotiations between a sovereign and its creditors.
The creditors are aware of their special legal
protection that comes down to a question of money due but not paid. At the same
time, creditors too have virtually no choice but to negotiate as there will be
inadequate assets to satisfy every creditor’s claims even with a successful
legal remedy. In the extreme, ‘vulture funds’ have used
litigation as an investment strategy to buy the debt at a hefty discount and pursue
full payment through the courts. Confronted with this
reality, a negotiated resolution should appeal to both creditors and debtor
centre of such a coordinated effort will be creditor (especially bondholder)
committees. The composition of such committees – inclusive of large
institutional investors, hedge funds, etc. – is critical to obtain a relatively
quick resolution. However, there are no guarantees of fast and efficient
mechanisms, and countries still risk fighting creditor lawsuits from those who
may hold out.
holdout creditors may not necessarily take the view that what
is good for the many is always good for the few. A disgruntled holdout creditor
has the leverage to cause disturbing headlines, especially when countries
resume bond market access once again at some point. Holdout creditors can be
reined in through exit consents – where a majority of holders can amend terms,
or as more commonly used now, employ collective action clauses (CACs) in bond
agreements to bind minority holders. In the latter case, a specified
supermajority of holders (usually 75%) can bind a minority to the
terms of a debt restructuring. But much depends on whether a debtor country’s outstanding
stock of international sovereign bonds contains these clauses. Some countries
have also adopted anti-vulture fund legislation that limits holdout
creditor recovery as a deterrent.
Net Benefit Calculation
High uncertainty during a restructuring, and the risk of prolonged negotiations means debt restructuring is still the last resort, to be done only if you must. A restructuring is a costly exercise with reputational downsides, loss of market access and more expensive debt issuances, weighed down further by concerns about adverse legal implications. For policymakers, a decisive step can be taken after a careful net benefit calculation of whether a country’s economic conditions are likely to deteriorate further without a restructuring, or whether a timely restructure may reduce the total magnitude of upfront losses and return debt to a sustainable level at the lowest cost to both the country and its creditors.
Dr. Dushni Weerakoon is the Executive Director of the Institute of Policy Studies of Sri Lanka (IPS) and Head of its Macroeconomic Policy research. She joined IPS in 1994 after obtaining her PhD, and has written and published widely on macroeconomic policy, regional trade integration and international economics. She has extensive experience working in policy development committees and official delegations of the Government of Sri Lanka. Dushni Weerakoon holds a BSc in Economics with First Class Honours from the Queen’s University of Belfast, U.K., and an MA and PhD in Economics from the University of Manchester, U.K. (Talk with Dr Dushni – [email protected])