Debt distress among low and lower-middle income countries has long been an endemic global economic feature. The International Monetary Fund recently observed, based on its LIC debt sustainability framework, that 14% of countries face debt distress, 36% moderate distress and 39% low distress. Meanwhile, bilateral aid is down and net external financing flows are often negative.
Over past decades, the Heavily Indebted Poor Countries initiative, enhanced HIPC initiative and Multilateral Debt Relief Initiative eliminated much debt and, along with collective action clauses for market borrowers, became staples of the financial community’s work.
Yet, the problem of deep stress remains acute. One-size-fits-all approaches do not work because LICs and LMICs are differentiated. Some have low stress, others are illiquid or insolvent. There is no substitute for countries undertaking the hard work of reform – the real key to sustainability and avoiding distress.
Following MDRI, non-traditional official creditors gobbled up freed fiscal space. Many LICs and LMICs – including Zambia, Sri Lanka, Pakistan, Egypt and Bangladesh – have interest bills exceeding one-quarter of their revenues, squeezing resources for social protection. These assessments were made before the latest Middle East shock. At the IMF-World Bank spring meetings in April, IMF Managing Director Kristalina Georgieva stressed that LICs could be hardest hit.
Illiquidity versus insolvency
One prism often framing sustainability judgements and debt action is illiquidity versus insolvency. The distinction is somewhat artificial – illiquidity and insolvency exist on a continuum. The two are blurred and differ country-by-country according to many considerations.
Nonetheless, illiquidity raises notions of lighter-touch debt refinancings, while insolvency conjures up deeper debt relief such as restructurings, defaults and haircuts. Net present value reduction can be achieved through refinancings at below-market interest rates, without resorting to face-value haircuts.
The incentive structure among actors is skewed towards viewing distress as cases of illiquidity, even when stress runs deep. Bilateral official and private creditors do not like to lose money and would generally prefer to refinance obligations coming due. For private creditors, recognising losses up front can hit balance sheets more immediately and are probably bad for bonuses. Country policy-makers also downplay distress as it raises questions about their economic stewardship and concerns over access to capital.
Role of the IMF
The IMF seeks to build a consensual financial plan among parties within its debt sustainability frameworks. It too has emphasised ‘illiquidity’.
The Common Framework, an effort to build a Paris Club-type approach for LICs needing restructurings by non-traditional official creditors such as China, is seen as a flop – few countries signed up and securing action was a lengthy affair. That is unfair insofar as its ineffectiveness was not because of design flaws per se – the principles guiding the approach are applicable for other countries – but because China and others weren’t keen to play along. You can lead a horse to water but you can’t make him drink.
Instead, the IMF emphasises its Global Sovereign Debt Roundtable – a forum bringing private and public creditors together. The IMF also advances its ‘three pillar’ approach – mobilising domestic resources, providing international support and reducing debt service burdens ‘for countries that do not have solvency problems but need to manage the high debt servicing levels’.
Sources of funding
An IMF programme’s financing gap can be filled by country economic adjustment, new money or debt action. Allocating the distribution is an art, not science, involving tough choices.
Countries cannot be sustainable going forward unless they adhere to reforms – that requires tackling macroeconomic stabilisation, mobilising domestic resources and fighting corruption. But imposing heavy new adjustment measures on impoverished people and social safety nets can be overly burdensome.
New money can come from international financial institutions and official creditors. The IMF is a source of new financing under its programmes and facilities, especially when private and official credit has pulled back. That is why it’s a preferred creditor. Again, official bilateral support is down and the IMF has access limits consistent with its mandate.
If country adjustment and new money are constrained, debt relief becomes the residual. Bilateral official and private creditors would rather see the IFIs stump up more money or perhaps support greater country adjustment and lessen the burden on their pockets.
Increasing the quantum of relief
The IMF’s role is central in the allocation. Its programme determines the quantum of relief. For example, it entails far less austerity for a country to run a primary surplus of 1% of gross domestic product than 3%, but a lower primary surplus entails a far smaller resource flow to creditors. A country growing by 1% versus 3% over time has fewer resources for creditors. In Ukraine in 2015 and Greece between 2015-17, the IMF showed how energetically weighing in on allocation could affect the quantum of debt relief.
The Fund needs to be more forceful in using its bully pulpit. Consensus is preferable but finding a more harmonious consensus should not necessarily be the Fund’s objective. Removing debt overhangs and creating fiscal space for countries to adopt more sustainable reforms should govern its assessments.
In the current environment, returning to wholesale elimination of debt akin to the period of the MDRI is infeasible for better or worse. That might necessitate IMF gold sales and a significant step-up in bilateral official assistance. Critics would undoubtedly fear such relief would help finance some of China’s past excessive lending.
Still, tougher IMF positions should increase the quantum of relief afforded countries facing significant distress, especially in the light of the Middle East crisis.
Mark Sobel is Chief Economist and Vice Chair of OMFIF.
