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Recent Innovations in Debt Restructuring

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1992
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Debt and debt service reduction, together with sound policies, has strengthened the economic prospects of a number of countries

The recent agreements with commercial banks on debt reduction packages for Argentina and Brazil and the implementation by Paris Club creditors of a menu of enhanced concessions in reschedulings for low-income countries have made headlines. These are, however, only the latest steps in a series of debt restructuring innovations aimed at facilitating the resolution of debt servicing problems for countries carrying out strong adjustment and reform programs. This article reviews the experience with these innovations and looks at prospects for the many developing countries that still face heavy debt burdens.

The shift in approach toward debt reduction since the late 1980s reflected widespread appreciation that the existing strategy needed to be reinforced. Expectations in the early years of the debt crisis that debtor countries would be able to resume normal debt servicing within a short period of time were not borne out. Meanwhile, with repeated reschedulings of principal and consolidations of interest, the stock of debt continued to grow, impairing domestic confidence and undermining countries’ adjustment efforts. Moreover, the refinancing of interest on bank claims through new money packages became increasingly difficult to negotiate as the financial position of commercial bank creditors strengthened.

Bank debt restructurings

Against this background, in March 1989, US Treasury Secretary Brady proposed that official support be provided to countries to finance the restructuring of commercial bank debt through comprehensive packages involving a “menu” of market-based debt and debt service reduction options. The main condition for this support was that the debtor be implementing a strong set of adjustment and reform policies that, combined with debt operations, would provide for substantial progress toward external viability. Under this approach, banks can choose among a range of options previously agreed between the borrower and a committee of the country’s leading bank creditors. Among the options, buybacks have allowed banks to exit by selling their claims back to the borrower at a discount. Under more complex bond exchanges, existing loans have been swapped for bonds with a reduced principal amount (discount exchanges), or predetermined sub-market interest rates (par exchanges). In addition, the repayment period on the remaining obligations has been extended, reaching up to 30 years.

To encourage creditors to participate in debt exchanges, they were given the opportunity to convert their loans into less easily rescheduled securities and to attach collateral accounts—often funded with the assistance of official creditors—to guarantee the payment of the principal and/or a portion of the interest on the new bonds. Because the collateral is refundable (or can be drawn to cancel liabilities), such guarantees provide an additional effective reduction in claims payable to banks by effectively prepaying a portion of the remaining obligations through the collateral accounts.

The menu approach has facilitated nearly universal participation by banks in debt packages and has lowered costs by allowing banks to select options that best suit their particular tax, regulatory, and accounting situations, as well as their views on the future path of interest rates and the country’s prospects. Experience has shown that despite the variety of instruments and menus, in general, the amount of debt reduction achieved through each of the packages has been broadly consistent with—and generally somewhat greater than—what might have been achieved through buybacks at the secondary market prices prevailing when agreement was reached.

Implementation of these debt restructurings has been time-consuming, but progress has been fairly steady. Agreements have now been reached covering about three-fourths of bank claims on countries that had experienced recent debt servicing difficulties. Packages have been completed for six countries—Costa Rica, Mexico, Nigeria, the Philippines, Uruguay, and Venezuela. A second package is in the process of being completed for the Philippines, while agreements in principle have been reached for Argentina and Brazil, and negotiations are in progress in number of other cases.

Taking the packages already completed, claims to be paid to commercial banks by debtor countries have been reduced in present value terms by about $38 billion since 1989, cutting these countries’ medium and long-term bank debt by roughly two-fifths (see Table 1). Associated interest relief in relation to GDP has varied, depending, among other things, on the size of the bank debt involved, but has generally been around ½ of 1 percent of GDP for the major debtors. Required funding for these operations has totaled around $14 billion, of which the IMF and the World Bank, in connection with borrowers’ economic adjustment programs, have each lent around $2 ¼-$2½ billion. The remainder has come from bilateral loans and grants and the countries’ own reserves. Officially supported debt reduction has been complemented by a continued role for debt-equity conversions, with over $24 billion of debt converted under official schemes during 1989-91, bringing the total to about $40 billion since 1984.

Table 1Bringing the debt down Commercial bank debt restructuring, 1987—June 1992(In billions of US dollars)
Debt reductionDebt-

service

reduction 3/
Total

reduction

in claims

payable to

banks 4/
Debt

restructured 1/
Buy-

back
Discount

exchange 2/3/
Pre

payments
Bolivia (1987)0.50.30.200.5
Chile (1988 and 1989)0.40.40.4
Costa Rica (1990)1.61.00.21.2
Mexico (1988 and 1990)46.77.97.07.722.6
Mozambique (1991)0.20.20.1
Niger (1991)0.10.10.1
Nigeria(1991)5.43.40.60.44.3
Philippines (1990 and 1992) 5/5.22.60.70.53.9
Uruguay (1991)1.20.60.20.10.9
Venezuela (1990)13.51.40.52.71.76.3
Total74.710.08.611.310.340.2
Of which:
Since March 198970.39.47.311.39.837.8
Source: IMF staff estimates.

In addition to the middle-income countries cited above, a number of low-income countries—in particular Bolivia, Mozambique, and Niger—have completed buybacks at deep discounts that have greatly reduced the commercial bank debt of these countries. Given the countries’ generally weak external positions and low income levels, these operations have been financed with concessional resources. These countries have also benefited from various types of debt for development conversions (e.g., debt-for-environment, debt-for-health, and debt-for-education). However, for most low-income countries facing debt servicing difficulties, debt to commercial banks accounts for a relatively small proportion of the total, and the treatment of bilateral official debt, which often accounts for the preponderant share, is an important aspect of their efforts to regain external viability.

Bilateral official creditors

Over the past decade, bilateral official creditors have assisted developing countries encountering debt servicing difficulties through a wide range of instruments, including new financing through officially supported export credits and direct bilateral loans and grants, debt service restructuring, and bilateral ODA (official development assistance) debt forgiveness initiatives. A key feature of the approach taken by bilateral official creditors has been to exclude short-term debts and new (post-cutoff date) claims from reschedulings. This strategy—which has effectively given seniority to these claims—has been crucial to the continuation of new official support. As a result, net resource flows to developing countries from official creditors remained positive and even increased in many cases over the past decade. Moreover, resources were provided on increasingly concessional terms.

Notwithstanding these efforts, low-income countries in particular found increasing difficulties in meeting the terms of previous reschedulings. In addition, the growing need for cash-flow relief required increasingly comprehensive consolidations, which in turn contributed to a growth in the stock of debt. The Paris Club initially responded by lengthening the repayment periods for these countries from ten years to up to twenty years (and the grace periods from five years to up to ten years), beginning in 1987. A second and more decisive step was taken in late 1988, when Paris Club creditors adopted a menu approach with concessional options (“Toronto terms”). Through 1991, 20 debtor countries had obtained 28 reschedulings on Toronto terms, consolidating debt obligations of some $6 billion with an average grant element of over 20 percent on nonconcessional debt (see Table 2).

Table 2Official financing through Paris Club reschedulings
1986198719681989199019911992
Jan.-June
(Amount consolidated in billions of US dollars)
Low-income countries 1/9.21.51.23.02.80.90.9
Of which under:
Toronto terms0.52.02.80.2
Enhanced concessions0.80.9
Middle-income countries3.923.98.215.613.772.613.8
Of which:
Poland and Egypt15.410.457.8 2/
Cumulative total
amount consolidated 3/50.776.285.6104.2120.7194.2208.9
(Number of reschedulings)
Low-income countries 1/1279131045
Middle-income countries4106118125
Cumulative total number
of reschedulings 3/83100115139157173183
Cumulative total number of
rescheduling countries 3/40424350525555
Source: Paris Club Agreed Minutes; and IMF staff estimates.

While reschedulings under Toronto terms brought some low-income countries closer to a graduation from the rescheduling process, creditors recognized that more far-reaching concessions would be required for most other low-income rescheduling countries to achieve a sustained improvement in their debt situation. Creditors agreed in December 1991 to implement a new menu incorporating enhanced concessions in reschedulings for low-income countries. This new menu provides for a 50 percent reduction (in net present value terms) of debt service payments consolidated on non-ODA debts and a graduated repayment schedule over 23 years, through either an outright cancellation of 50 percent of the consolidated claims or a rescheduling at concessional interest rates. The menu also includes the nonconcessional option available under Toronto terms. With respect to concessional loans, creditors agreed to graduate payments and to maintain concessional interest rates to achieve the same proportion of effective debt reduction.

To date, seven countries have benefited from the new rescheduling terms—Benin, Bolivia, Equatorial Guinea, Nicaragua, Tanzania, Togo, and Uganda. The amount consolidated under these terms has totaled about $1 ¾ billion, with an average grant element of around 45 percent on nonconcessional debt, reflecting the use of the nonconcessional option by some creditors.

Under the new approach, Paris Club creditors have continued their practice of rescheduling only those obligations falling due during a concurrent arrangement with the IMF. However, the agreements also provide for the possibility that the remaining stock of debt might be similarly restructured and reduced after a period of three to four years, provided that previous reschedulings are fully implemented, other nonmultilateral creditors grant comparable relief, and appropriate arrangements with the IMF are continued. The terms of these operations have yet to be settled; nonetheless, creditors have in principle indicated readiness to provide a definitive resolution to the problem of bilateral official debt.

For middle-income countries, bilateral official debt usually accounts for a smaller share of total debt than for low-income countries and actions by bilateral official creditors on debt are less decisive in affecting these countries’ medium-term prospects for viability. In light of the difficulties faced by some of these countries, since 1990 Paris Club creditors have granted heavily indebted lower middle-income countries longer repayment terms, while selectively permitting voluntary swaps of debt for local currency obligations, such as debt-for-nature swaps. These new terms have been obtained by 15 heavily indebted lower middle-income countries, helping to reduce their number to a point where an exit from the rescheduling process is now in sight. Others, however, continue to face uncertain prospects. The July 1992 industrial country economic summit communique encouraged the Paris Club to recognize the special situation of some highly indebted, lower middle-income countries on a case-by-case basis.

In the meantime, bilateral official creditors have also dealt with the exceptional situations of Poland and Egypt. In each case, the Paris Club agreed to restructure the entire stock of debt (totaling a combined $58 billion) and to reduce the present value of the debt by 50 percent through a menu of options. An important feature of both agreements is that they provide for staged implementation, with some reduction taking place at the outset and the remainder taking place based on developments under the IMF arrangements supporting these countries’ adjustment efforts.

Future prospects

The combination of officially supported debt reduction, extended repayment schedules, and strengthened policy implementation has brought impressive and hopefully lasting results in a number of middle-income debtor countries. With a return to more normal creditor/debtor relations, costly and difficult concerted refinancing exercises are no longer needed, arrears have been eliminated, and investor confidence has been restored. As a result, discounts on the debt of these countries in the secondary market have declined, access to private financing (mainly through securities markets) has increased significantly, capital flight has been reversed, and growth prospects have improved. Mexico, Chile, and Venezuela have been in the forefront of this process of market re-entry; recently, Argentina and Brazil have also been able to gain access to sizable flows, even though they have yet to finalize debt restructurings.

For heavily indebted low-income countries, the new approach by Paris Club creditors provides the potential means for countries to exit from the rescheduling process. Some are already on the verge of achieving that goal, although they will continue to rely on appropriate concessional financing. For others, however, as well as for some lower middle-income countries, the current debt burden is such that their balance of payments situation will still remain difficult over the medium term.

Despite the benefits of debt reduction, the debt burdens of most restructuring countries remain significant. The authorities of these countries must continue to implement sound macroeconomic policies—complemented by further structural measures where necessary—to maintain confidence and ensure that new flows will be appropriately channeled into productive investment. A number of countries that have been experiencing continued debt-servicing difficulties have yet to gain access to the new restructuring terms potentially available to them on their commercial bank and bilateral official debt. For some of these countries, a renewed adjustment effort will be needed to address the internal and external imbalances that constrain their growth prospects. The favorable impact that the combination of strengthened policy implementation and the broadened menu of restructuring options have already had on the prospects of some countries demonstrates the benefits that potentially await them.

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