The COVID-19 pandemic has pushed debt levels to new heights. Compared to the end of 2019, average debt ratios in 2021 are expected to increase by 20% of GDP in advanced economies, 10% of GDP in emerging market economies, and around 7% in low income countries. returned. These increases come on top of already historically high debt levels. While many advanced economies still have the capacity to borrow, emerging markets and low-income countries face much stricter limits on their ability to take on additional debt.
Indeed, around half of low-income countries and several emerging market economies were already facing or at high risk of a debt crisis, and the continued rise in debt is alarming. As they begin to recover from the pandemic, many of these countries could experience a second wave of economic distress, triggered by defaults, capital flight and fiscal austerity. Preventing such a crisis can mean the difference between a lost decade and a rapid recovery that puts countries on a sustainable growth path. As IMF research recently showed, waiting to restructure debt until default occurs is associated with larger declines in GDP, investment, private sector credit, and capital inflows than preemptive debt restructurings.
The world is at a critical juncture and should not sit idly by while waiting for a crisis.
No debt crisis has occurred again thanks to the decisive political actions of central banks, tax authorities, official bilateral creditors and international financial institutions at the very beginning of the pandemic. These actions, although essential, quickly become insufficient.
First, the initiatives taken so far are temporary in nature. The G20 Debt Service Suspension Initiative, which was a very welcome response to an appeal from the IMF and the World Bank, expires at the end of this year. The IMF also provided about US $ 31 billion in emergency financing to 76 countries, including 47 low-income countries, as well as debt service relief to the poorest countries under the Containment and Disaster Relief Trust. As needs are expected to remain high, developing countries will need additional low-cost financing in 2021 and beyond.
Second, most measures so far have focused on liquidity – maintaining countries’ access to finance, both from official sources and from the market. But as the crisis continues, solvency issues – the inability to repay debts – have come increasingly to the fore.
Preventing a developing country debt crisis requires urgent additional measures.
What areas require action?
The Debt Service Suspension Initiative is to be extended until 2021. Otherwise, its current beneficiaries will be forced to resort to austerity measures in order to resume debt service, exacerbating the human suffering already caused by the crisis. The expansion of the initiative is expected to provide incentives to quickly tackle unsustainable debt problems. For example, the length of the extension could be linked to IMF and World Bank programs designed to reduce debt vulnerabilities.
Countries vulnerable to indebtedness urgently need to address it through a combination of debt management and growth stimulus measures. Where debt is unsustainable, it must be restructured, the sooner the better. Claims from the private sector should be included, where applicable. Ignoring credit problems only makes them worse.
Perhaps more importantly, it is necessary to reform the “architecture” of international debt comprising sovereign debt contracts, institutions such as the IMF and the Paris Club, and policy frameworks that support orderly debt restructuring. The goal is to provide rapid and deep enough debt relief to countries in need, to the benefit not only of those countries but of the system as a whole.
Today we released a new report assessing the current private debt restructuring architecture and suggesting possible improvements. The existing contractual framework has been to a large extent effective in restructuring sovereign bonds, but recent cases of restructuring in Ecuador and Argentina show issues that still need to be addressed, including the significant expansion in the diversity of commercial creditors and the lack of debt transparency. For example, the framework has been found to be less effective in restructuring the growing volume of non-bond debt, as well as secured debt and debt with collateral-like characteristics. While the terms of these loans remain in many cases undisclosed, they appear to be particularly prevalent in low-income countries exporting natural resources.
Beyond credit claims, most official debts are now held by creditor countries that are not members of the Paris Club and do not follow Paris Club procedures. It is therefore more difficult than in earlier times to restructure the debt of official bilateral creditors and to ensure a strong participation of public and private creditors.
What aspects of the current debt architecture need to be corrected?
First, debtors and creditors should continue to strengthen contractual arrangements to help minimize economic disruption when debtors encounter difficulties. The IMF and others have been successful in promoting the adoption of improved collective action clauses in international obligations. But there is still a lot to do. Similar provisions are needed to facilitate the orderly restructuring of non-bond debt. Clauses that reduce debt repayments or automatically suspend debt service, such as in natural disasters and other significant economic shocks, can also be helpful.
Second, debt transparency should be increased. Without knowing what countries already owe and on what terms, creditors cannot make informed lending decisions. They will also be reluctant to participate in restructurings unless they know the terms granted to other creditors.
The third, official bilateral creditors should agree on a common approach to restructure official bilateral debts. It should be acceptable to both Paris Club members and others. Restructuring could include a common list of conditions that oblige the debtor to transparently establish its debts and seek restructuring agreements from all its creditors – public and private – on comparable terms. Such an approach would aim to ensure information sharing and equitable burden sharing among all creditors. Doing so would likely increase attendance and avoid costly delays.
Not all of these reforms would have an immediate impact. While it will take time for contractual improvements to affect outstanding debt, a common restructuring approach encompassing all official bilateral creditors – currently being debated by the G20 – could make a crucial difference almost immediately.
The role of the IMF
The IMF is working hard to avert a debt crisis, supporting its members with policy advice, financing and capacity building. We will continue to reduce the debt service of the poorest countries as part of the Containment and Disaster Relief Trust. We also promote debt transparency, in particular through a debt limit policy, providing technical assistance on debt management, and working with the G20 to expand the Debt Service Suspension Initiative. We support debtor-creditor coordination and debt restructuring by analyzing measures to restore debt sustainability and by making our financial support conditional on high creditors’ participation.
All stakeholders must do their part
The world is at a critical juncture and should not sit idly by while waiting for a crisis. It needs to review its arsenal of weapons – a task we have done at the IMF. It must also do all it can to prevent, and if necessary prevent, another sovereign debt quagmire. The alternative could be large-scale defaults that would seriously damage economies and delay their recovery for years. Low-income countries are particularly at risk and their populations are likely to suffer the most in the event of a debt crisis.
The main steps are to expand the Debt Service Suspension Initiative, address countries’ debt vulnerabilities and build a more robust debt architecture. We call on all stakeholders to do their part to reduce disaster risk and pave the way for a more secure financial system.