II. Commercial Bank Debt Restructuring

International Monetary Fund
Published Date:
January 1992
  • ShareShare
Show Summary Details

A number of countries, notably Argentina and Brazil, have made substantial progress toward restructuring commercial bank debt during the past year. In contrast, the use of debt conversions has continued to decline, reflecting a rise in secondary market prices of claims on most middle-income debtors and a slowdown in privatization-related conversions. Interest in debt-for-development conversions has increased, however, particularly in smaller and low-income countries where secondary market prices remain low.

Recent Bank Agreements

Five countries signed agreements with their commercial bank creditors in the past year (Algeria on a refinancing operation; Gabon on a rescheduling operation; and Mozambique, Nigeria, and the Philippines on comprehensive restructuring operations) (Table A1). Argentina, Bolivia, Brazil, and Guyana reached agreement on term sheets for bank restructuring packages. In addition, Mexico and Paraguay reduced their external debt through informal buy-backs in the secondary market, and the states of the former Soviet Union obtained a series of deferrals of principal amounts falling due.

Algeria reached an agreement in principle with commercial banks in October 1991 on the terms for a voluntary floating-rate loan facility. Syndication of the operation (involving some two hundred banks) was completed in early March 1992. The agreement refinances principal maturities falling due in the period October 1, 1991–March 31, 1993. The financing facility amounts to about $1.45 billion and consists of two tranches.

Gabon signed a rescheduling agreement with its commercial bank creditors on May 12, 1992, covering debt contracted or guaranteed by the Government (Table A2). Under the agreement, banks will reschedule principal payments coming due through the end of December 1992 over ten years with a four-year grace period at a reduced interest rate of ⅞ of 1 percent over LIBOR. The agreement, which will provide waivers for debt-for-debt and debt-for-equity conversions, will become effective once all interest arrears have been cleared (targeted for January 1993). The operation reschedules approximately $157 million, which accounts for the majority of outstanding commercial bank debt (about 5 percent of the total stock of external debt).

Mozambique bought back $124 million of principal outstanding on the country’s public and publicly guaranteed commercial debt in December 1991 (Table A3). This operation was transacted at a discount of 90 percent, and it eliminated about 64 percent of Mozambique’s commercial bank debt. All past-due interest associated with the debt repurchased was canceled. The buy-back was financed by grants from the IDA debt reduction facility and by France, the Netherlands, Switzerland, and Sweden.

Nigeria finalized an agreement with its commercial bank creditors to restructure virtually all of its commercial bank debt (about $5.8 billion) on December 20, 1991. Prior to the closing of the operation, all interest arrears ($373 million) were cleared through cash payments. The exchange of instruments took place in January 1992. The package provided for a menu of options including a buy-back, a par bond exchange, and new money commitments. In the event, banks chose only the “exit” options offered under the package; 62 percent of eligible debt was canceled through the buy-back option (involving a discount of 60 percent), while the remaining 38 percent was exchanged for collateralized par bonds. The total cost of the operation was approximately $2.1 billion and was financed from Nigeria’s own resources.

The Philippines signed a restructuring agreement with its commercial bank creditors on July 24,1992, and the operation is expected to be completed by year-end. In accordance with the term sheet, banks have allocated eligible debt between (1) a new money facility, in which new money would be provided in the ratio of 1:4 to debt assigned to this option (both new money and original debt would be securitized); (2) a cash buy-back; (3) a temporary interest rate reduction bond, offering a one-year rolling interest guarantee for the first six years; and (4) a front-loaded interest rate reduction bond, with a 14-month rolling interest guarantee for the term of the bonds and collateralization of principal. The buy-back operation was completed on May 14, when $1.3 billion was purchased at an average price of 52 percent of face value.4 Regarding the restructuring options, as of August 31, banks have submitted tenders to exchange $1.9 billion of eligible debt for principal-collateralized interest reduction bonds, $0.9 billion for the temporary interest rate reduction bonds, and $0.5 billion for the debt conversion bonds associated with the new money facility. The total cost of the operation, including the cash buy-back, is estimated at $1.1 billion.

Argentina and its commercial bank creditors reached preliminary agreement on a bank financing package on April 7, 1992, with the term sheet finalized on June 23, 1992. This package would restructure $23 billion of principal and $8 billion of interest arrears and cover virtually all outstanding commercial bank debt. Eligible principal is to be exchanged for discount bonds (at 65 percent of face value) and reduced-interest par bonds. The discount bonds will carry a market interest rate, and the par bonds will pay fixed rates that rise from 4 percent in the first year to 6 percent in the seventh year and on. Both types of bonds will have a 30-year maturity, a full principal guarantee, and a 12-month rolling interest guarantee for the life of the bonds. The new bonds will be eligible for debt-equity conversions in the context of privatizations.

Interest arrears are treated separately.5 At closing, following a downpayment of $0.7 billion, remaining past-due interest claims (including interest on past-due interest) will be refinanced through the issuance of uncollateralized new bonds carrying a market interest rate and a backloaded amortization schedule.6 In addition, from January 1, 1992, interest on the eligible debt (including past-due interest) will accrue at below-market rates.7 Interest on past-due interest will be capitalized at the annual average one-month LIBOR through the end of 1991 and the above-mentioned below-market interest rates thereafter. Argentina is expected to meet the cost of the package from its own reserves and from official bilateral and multilateral sources.

Bolivia reached agreement in principle with the four leading bank creditors on a debt reduction package on April 9, 1992, with the term sheet finalized on July 10, 1992. The agreement involves three options for outstanding principal and includes cancellation of all interest arrears. The options consist of (1) a cash buy-back of existing principal claims at 16 percent of face value; (2) an exchange of existing principal claims at par for fully collateralized, noninterest bearing bonds with a bullet maturity after 30 years; and (3) a discount exchange of existing principal claims for noninterest bearing bonds (at 16 percent of face value) with a nine-month maturity, which would be eligible for investments by nongovernmental organizations in projects in the environment, health, education, and cultural sectors.8 The par bonds include a value recovery clause linked to developments in the world price of tin. The discount bonds would be convertible into domestic-currency assets at a 50 percent premium. Bolivia has requested support under the IDA debt reduction facility to help meet the cost of the operation.9 Eligible debt amounting to $200 million (excluding past-due interest)—accounting for all of Bolivia’s outstanding commercial bank debt—is expected to be restructured under this agreement.

Brazil reached a preliminary agreement with its bank creditors on a restructuring of its medium- and long-term debt and a parallel arrangement on 1991 and 1992 interest payments on July 9, 1992; the term sheet was finalized on September 22, 1992. The package would cover debt amounting to an estimated $40 billion, excluding past-due interest.10 The agreement contains a menu of six options. Three of the six involve debt and debt-service reduction: a discount exchange, a reduced-interest par exchange, and a front-loaded interest reduction par exchange. Two other options offer a front-loaded capitalization of interest through either a loan restructuring or a bond exchange. The sixth option requires the provision of new money in conjunction with the exchange of existing claims into bonds.

Agreement was also reached on interest payments during 1992 and interest arrears accumulated during 1991 and 1992. In May 1991, an agreement was reached on the treatment of interest arrears outstanding at the end of 1990.11 The agreement contains provisions under which Brazil would make payments equivalent to 50 percent of contractual interest due from January 1, 1992. Brazil would continue to make payments equivalent to 30 percent of contractual interest due until the Senate approves the term sheet; at that time, it would increase the payments to 50 percent, retroactive to July 9, 1992. Payment of the additional 20 percent of contractual interest falling due from January 1 to July 9, 1992, would be made no later than the date on which at least 95 percent of the banks have signed the financing package.12 The package provides for some additional debt reduction, as interest on eligible debt (including past-due interest) would be reduced to below-market rates from January 1, 1992.13 The remaining interest arrears (including interest on past-due interest), calculated at contractual rates for 1991 and 4 percent for 1992, would be converted into bonds.

In view of the large upfront cost of the package, the delivery of principal and interest enhancements would be phased over two years. At the date of closing, Brazil would provide $1.0 billion of its own resources, or an amount equivalent to the resources provided by international financial institutions, whichever is greater. If there are insufficient resources at the time of closing to finance the enhancements for the discount and par exchanges, eligible debt will be exchanged for “phase-in” bonds; these would subsequently be exchanged for par and discount bonds as the requisite collateral is provided. The phase-in bonds carry an interest rate of LIBOR plus of 1 percent and have a tenor of 10 years with a grace period of 2 ½ years.14 In this regard, banks can choose between two options (Option A and B), which provide different distributions of principal and interest guarantees.

Guyana reached agreement on a term sheet with its commercial bank creditors to buy back $103 million of bank debt, including past-due interest and export credit debt, at the end of August 1992. The operation would be at a discount of about 89 percent. The total cost of the operation is estimated at $11 million and would be financed by a grant provided under the IDA debt reduction facility.

Paraguay bought back an estimated $191 million of its commercial bank debt on the secondary market between February 1990 and March 1992. This amounted to about 80 percent of total liabilities to commercial banks and consisted mostly of principal and interest arrears. The operation cost $85 million, implying an average buy-back price of 44 cents on the dollar. In addition, in March 1992 the authorities concluded an agreement with a commercial bank creditor to reschedule $18 million (including arrears and penalties) and are currently negotiating another rescheduling with a consortium of banks holding $5 million in claims.

The Mexican authorities announced, on July 3, 1992, that $7.2 billion of external debt had been purchased in the secondary market over the past two years and would now be retired. The bulk of this debt is accounted for by par and discount bonds arising from the 1989 restructuring agreement with commercial bank creditors.

Creditor banks of the states of the former U.S.S.R. agreed at the end of September 1992 to a fourth 90-day deferment of principal payments, through December 31, 1992. The deferral applies to debt contracted prior to January 1, 1991, excluding public issues, bonds, and short-term debts and facilities.

A number of other developing countries are currently discussing debt restructuring packages with their commercial bank creditors. These include, but are not limited to Bulgaria, Congo, Côte d’Ivoire, Dominican Republic, Ecuador, Jordan, Nicaragua, Panama, and Poland.

Experience with Market-Based Debt Reduction

Through September 1992, concerted debt and debt-service packages have reduced gross claims payable by developing countries to banks by some $41 billion (Table 2). Approximately 25 percent of the reduction was achieved through buy-backs, with the remainder through debt exchanges. Of the latter part, over $11 billion represents reduction in the present value of the future stream of interest obligations achieved through reduction in interest rates in exchanges involving debt-service reduction. About $9 billion represented reduction in principal in discount exchanges. The remainder is accounted for by effective prepayments of principal and interest through the establishment of collateral accounts ($10.4 billion).15 These operations have cost $15 billion, including the costs of buy-backs, collateral, and downpayments on past-due interest. Thus, these debt packages have implied a net reduction of $26 billion in developing countries’ external debt.

The distribution of bank menu choices has varied among packages (Table 4). In the aggregate, about half of total exposures has been allocated to debt exchanges involving debt-service reduction. Banks have selected menu options that best suit their particular tax, regulatory, and accounting situations, as well as their views on the future path of interest rates and prospects for the countries involved.

Table 4.Bank Menu Choices in Debt Restructuring Packages(In percent of total eligible bank debt)
Debt ReductionDebt-Service Reduction



Par Exchange
Other Par

New Money
Costa Rica6337
Sources: National authorities, and IMF staff estimates.

In the various packages agreed to date, the relationship between enhancement resources and the overall amount of debt reduction achieved has been broadly consistent with secondary market prices prevailing during the negotiations. In general, however, options providing greater debt reduction have required more upfront resources.16 In Nigeria, Uruguay, and Venezuela, for example, the prices for buy-back options were close to their respective secondary market prices in the period immediately preceding the agreements (Table 5). In contrast, the buy-back equivalent prices of the par and discount exchanges agreed to date have tended to be below secondary market prices prevailing at the time of the announcement of agreements or during the period of negotiation.17 This may have reflected creditors’ views that with bond exchanges, the remaining unguaranteed obligations were somewhat more likely to be serviced than the exchanged syndicated loans. Between the two, discount bonds have usually entailed less collateral while providing somewhat less debt reduction than par exchanges. This reflects the convention that has emerged of fully collateralizing the principal on both types of bonds (which is less expensive with discount bonds), and banks’ willingness to accept similar interest collaterals. From the debtor’s perspective, par exchanges have been attractive because of the reduced interest risk, despite their higher relative costs. Because of default risk, as well as general market thinness for long-term hedges, it is relatively more difficult for countries with recent debt-servicing difficulties to use market-based hedges to insure against long-term interest rate shifts.

Table 5.Buy-Back Equivalent Prices in Debt and Debt-Service Reduction Operations1(In percent of face value)
Debt-Service ReductionSecondary

Market Price

at Time of


in Principle
Debt ReductionPrincipal


Par Exchange

Other Par


Costa Rica3163241919
Philippines (1989)505050
Philippines (1992)5243274752
Sources: IMF staff estimates.

As noted above, in a number of cases secondary market prices rose while restructuring negotiations were under way (Chart 2). It is difficult to distinguish the extent to which this reflected improving external influences (such as oil price increases, in the cases of Nigeria and Venezuela); greater confidence in a country’s adjustment efforts, which the debt package was intended to support; or demand pressures in the secondary market caused by the restructuring packages themselves. In no case, however, has a significant price fall occurred following a successful agreement. On the contrary, in several cases prices have risen following completion of an exchange, indicating improved perceptions of conditions regarding repayment of the smaller amount of debt remaining after restructuring. In fact, anticipation of the positive impact of debt operations, as well as of sustained policy implementation, has tended to put upward pressure on the prices of claims on countries that have not yet implemented packages.

Chart 2.Secondary Market Prices for Bank Claims During Negotiations of Bank Restructuring Packages

Sources: Solomon Brothers; ANZ Bank Secondary Market Price Report, and IMF staff estimates.

1Prior to completion of the package, Costa Rica’s debt price included past-due interest. The series has been adjusted to show price per unit of principal. After closing, the price shown is the collateralized series-A par bonds.

Debt-Conversion Programs

The pace of commercial bank debt-equity conversions slowed sharply over the past year. The face value of debt eliminated under the main official conversion schemes amounted to $292 million in the first quarter of 1992, compared with $4.5 billion in 1991 and an annual average of $9.5 billion during 1988–90 (Table 6). The decline in activity mainly reflects the continued rise in the secondary market price for the commercial-bank-related debt of several Latin American countries with prominent debt-conversion programs (Chile, Mexico, and Venezuela), and a curtailment of conversions linked to privatization programs (Argentina and Brazil). In contrast, activity has increased—albeit on a modest scale—in debt-for-development conversions, particularly in Mexico and in countries where commercial bank debt continues to trade at substantial discounts on the secondary market. Such conversions have been financed mainly through official bilateral resources, inflows from nongovernmental organizations, and debt donations by commercial banks.

Table 6.Debt Conversions, 1986–First Quarter 19921(In millions of U.S. dollars)
1984–8619871988198919901991First Quarter

Costa Rica789441241723
Ecuador1272613245202 3
Honduras9144732756 3
Mexico4131,6801,056 45324351,86829
Sources: Central Bank of Argentina; Central Bank of Brazil; Central Bank of Chile; Mexico, Ministry of Finance; Central Bank of Philippines; Bank of Jamaica; Central Bank of Venezuela; and IMF staff estimates.

Country Experience

Activity under Chile’s debt-conversion program slowed sharply in 1990–91 and fell to close to zero in the first quarter of 1992. The increase in the price of commercial bank debt in the secondary market (to about 90 cents on the dollar since early 1991) has virtually eliminated demand for formal debt-conversion mechanisms. Only one fourth of the 1991 conversions occurred under the two existing formal debt-conversion mechanisms for residents and nonresidents, with the remainder arising from conversions outside formal central bank channels.

A large increase in conversions in Mexico in 1991 was associated partly with the conversion of $1.2 billion of interbank credit lines into privatization notes subsequently redeemed at par for investment into newly privatized Mexican banks.18 In addition, foreign investors exercised $565 million out of the total $3.5 billion of “conversion rights” awarded in the two 1990 auctions (as agreed under the 1989 agreement with commercial banks); the proceeds were used mostly for investment in infrastructure projects (communications and transportation). Use of these “conversion rights” dropped sharply in early 1992 as the secondary market price of par bonds rose above the auction-determined conversion price, thus eliminating the incentive to exercise such rights.

A similar situation has developed in Venezuela. The continued rise in the secondary market price of commercial bank-related debt reduced investor interest in debt-equity conversions linked to large projects.19 These projects are the only investments still eligible for debt conversion after the suspension of the auction system in August 1991. Lack of investor interest has also reflected the narrowness of investment choices, which have been limited to export-oriented industries. During 1991 and the first quarter of 1992, conversions were primarily in the petrochemical and tourism sectors.20 Interest in activity related to the aluminum sector has waned with the decline in the world price of aluminum. (Venezuela does not allow debt-equity conversions in its privatization program.)

With the bulk of the first phase of the Argentine privatization program completed in 1990, only $12 million of commercial bank debt was retired in 1991 through privatization of a hotel.21 The trend has been reversed in 1992 with the commencement of the second phase of the privatization program, under which over sixty companies are to be sold.

Debt conversions in Brazil have slowed sharply since debt-conversion auctions were halted in late 1988 because of concerns about their inflationary impact. More recently, conversions linked to privatization have been modest, as commencement of the program was delayed and foreign participation limited. Although seven privatizations were undertaken by the summer of 1992, foreign investor participation has been small, and less than 2 percent of the total generated sales revenue (about $1.7 billion) arose from debt conversions.22 The main deterrents to the use of debt conversions in these operations were (1) regulations that set the discount applied to the bank debt eligible for privatization auctions at a fixed 25 percent of face value, while domestic debt could be used at no discount; (2) restrictions on dividend remittances extending for 12 years; and (3) requirement of a minimum two-year ownership period. In an effort to attract foreign participation, the minimum holding period has since been abolished, the repatriation restrictions have been halved to six years, and the eligibility at par of another class of foreign bank debt has been authorized. Following this liberalization, and in anticipation of the possible introduction of an auction scheme, several groups of foreign banks have established privatization funds.23

Conversion activity in the Philippines increased in 1991 following the reintroduction of an official debt-conversion program in February.24 To date under the revived program, debt-equity conversion rights amounting to $357 million have been allocated. The average price increased from 54 cents on the dollar at the first auction in February 1991 to 58 cents on the dollar at the March 1992 auction. The resulting investment would be evenly divided between domestic and foreign investors and concentrated in export-oriented and financial sectors. Approximately 15 percent of the conversion rights were targeted for the privatization and recapitalization of commercial banks.

As required under the 1991 restructuring agreements with commercial banks, Uruguay launched a debt-conversion program in February 1991. The regulations limit conversions to $40 million annually and involve administrative procedures, rather than a pure auction, in the setting of the domestic conversion price. In view of the high price on the secondary market for Uruguay’s commercial bank debt, however, investors have shown little interest in the debt-conversion scheme, which is not linked to the country’s privatization program.

Activity under the debt-conversion program in Honduras amounted to $75 million in 1991, almost double that in 1990. The debt, converted at par but at an appreciated—relative to the official—exchange rate, was used to fund both foreign and domestic investments in export-oriented enterprises, particularly the banana and shrimp sectors.25

Debt for Development

Since a pioneering debt-for-nature conversion undertaken in Bolivia in 1987, such conversions have proven to be popular in the lower-income countries with high secondary market discounts for their commercial bank debt. Through mid-1992, such conversions have extinguished debt with a face value of about $160 million (Table 7).26 This debt had been obtained at an average price of approximately 20 cents on the dollar and generated local currency resources corresponding to about 65 cents on the dollar (Table A4). The bulk of the conversions have been concentrated in relatively few countries, with Costa Rica accounting for about three quarters of the total and Ecuador, about one tenth. Funding for the largest operations has come from industrial-country governments. Conservation agencies have also played an important role, especially International Conservation, the Nature Conservancy, and the World Wildlife Fund.

Table 7.Debt for-Development Conversions1 (Completed through end-June 1992)(In thousands of U.S. dollars)
Country Name19871988198919901991Jan–June

Costa Rica38,40030,10010,754600
Dominican Republic2,582
Of which:Debt for nature34,93339,12747,37112,2288,88920,150
Debt for education22,76428,600180,30066,800
Debt for health5,13516,300117,60038,200
Sources: National authorities, Nature Conservancy, UNICEF, and World Bank.

More recently, conversions have been applied to other developmental projects, especially in education. In July 1990, Mexico approved a special debt-conversion program aimed at increasing expenditures on development projects in the areas of education, environment, and social assistance. The projects are to be administrated by nongovernmental organizations. Through April 9, 1992, 61 projects, worth $466 million, had been approved with 31 nongovernmental organizations. Completed transactions through the end of July 1992 generated the equivalent of $322 million in domestic-currency-denominated assets. Most of the spending is expected to benefit education and social assistance, with 61 percent and 35 percent, respectively, of the projects approved in these two sectors.

Related initiatives have recently been announced by international organizations, creditor governments, and commercial banks. The Inter-American Development Bank created a lending program to purchase commercial bank debt in the secondary market. The debt would subsequently be converted into domestic currency at mutually agreed conversion rates and invested in an inflation-indexed fund to be disbursed for IDB-approved environmental projects. Projects will be approved on a case-by-case basis, up to a maximum limit of $400 million. The first project, valued at $100 million, was approved in June 1992 to support tree planting in heavily polluted Mexico City. Similarly, under its Enterprise for the Americas Initiative, the United States pledged $8 million to help finance a $38 million conversion, at par, of Panamanian commercial bank debt into environmental bonds. These bonds are envisaged to disburse the equivalent of $2.5 million a year, to be administered by the conservation group, Nature Conservancy, and to be used mainly to protect the rain forest.

The increase in activity has been assisted by environmental initiatives in several debtor countries. Specifically, in August 1991, Brazil for the first time permitted debt-conversion programs targeted at environmental projects, up to a total of $100 million. The first official debt-for-nature conversion under this program will involve a $2.2 million conversion of commercial bank debt into dollar-denominated long-term bonds carrying a 6 percent coupon; the bonds will endow a fund for Grande Sertao Verdas National Park in northern Brazil. Mexico approved its first debt-for-nature swap in February 1991. Conservation International is expected to extinguish $4 million of commercial bank debt in exchange for the government spending $2.6 million on specified environmental projects, including preserving and documenting fauna in the Selva Lacandona forest.

The largest donation to date by a commercial bank to support environmental projects was announced during the Rio Earth Summit in June 1992. A bank from the United States donated $11.5 million of Bolivian debt at face value to support debt-for-nature conversions. The donation is expected to generate the equivalent of $2.8 million for environmental and conservation projects and will be jointly managed by the World Wildlife Fund, the Nature Conservancy, and the Bolivian National Environmental Fund. In September 1991, the World Wildlife Fund completed a $9.7 million debt-for-nature conversion in the Philippines, which included a $1 million donation from a Japanese bank.

Since its inception in early 1991, the United Nations Children’s Fund’s (UNICEF) conversion program—Debt Relief for Children—has undertaken seven operations. The objective of the program is to generate additional resources for the implementation of UNICEF-supported development programs. Six operations in Sudan eliminated about $21 million of debt—for the most part donated by commercial banks—in exchange for about $2 million in local currency funds. The domestic counterpart was used for water supply and sanitation projects. In May 1992, with the assistance of the Dutch Government through UNICEF-Netherlands, $4 million of Jamaican bank debt was purchased, at a cost of $2.9 million; the debt was converted into an equivalent amount of dollar-denominated (interest earning) funds to be disbursed over three years on education, women’s programs, and assistance to needy children.

Secondary Market for Claims on Developing Countries

Price Trends

During 1991 and the first nine months of 1992, secondary market prices for bank claims on developing countries increased significantly. The weighted-average price for claims on 15 heavily indebted countries increased by 28 percent in 1991. The price rose by another 3 percent in the first nine months of 1992, reaching 53 cents on the dollar at the end of September 1992, compared with 40 cents on the dollar at the end of 1990 (Chart 3).27 Prices have, however, also been subject to heightened volatility, especially since the fourth quarter of 1991.

Chart 3.Secondary Market Prices of Bank Claims on Selected Indebted Countries

(In percent of face value)

Sources: Solomon Brothers, and ANZ Bank Secondary Market Price Report.

1Argentina, Bolivia, Brazil, Chile, Colombia, Côte d’lvoire, Ecuador, Mexico, Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, and Yugoslavia.

2Bulgaria, Former U.S.S.R., Hungary, and Poland.

The price increase since the end of 1990 has been driven mainly by improved perceptions for Latin American debt, especially that of early market reentrants—Chile, Mexico, and Venezuela. The price of bank claims on Chile rose to nearly 90 cents on the dollar in early 1991, up from 74 cents on the dollar at the end of 1990. The stripped prices of restructured bank claims on Mexico increased from 53 cents on the dollar at the end of 1990 to about 76 cents on the dollar by the end of September 1992.28 The stripped value of Venezuelan claims followed a similar path until interrupted by an attempted coup d’état in February 1992. Prices subsequently declined by about 20 percent, from a peak of about 82 cents on the dollar to 63 cents at the end of September 1992.

Movements in the prices of claims on Argentina and Brazil contributed to much of the overall price movement and volatility during the 21-month period under review. Prices of Brazilian claims have been highly volatile, reflecting the uncertain status of the economic reform program and news about the progress of debt negotiations with commercial bank creditors. The secondary market price on Brazil’s debt increased from 21 cents on the dollar at the beginning of 1991 to 33 cents at the end of September 1992. During this period, however, prices slid over 40 percent in the fourth quarter of 1991, and by 25 percent in June 1992. The price of Argentine debt rose from 20 cents at the end of 1990 to 52 cents on the U.S. dollar at the end of September 1992. This increase reflected, among other things, improved economic performance, the successes and future prospects of the privatization-linked debt-conversion program, and progress in debt negotiations with commercial banks.

Several other highly indebted countries have experienced significant increases in secondary market prices, owing largely to improved market perceptions about economic and financial prospects. The higher prices of claims on the Philippines and Uruguay, for example, reflected the impact of recent debt restructuring agreements with commercial bank creditors, and in the case of Uruguay, the successful issuance of a Eurobond. For the Dominican Republic, Panama, and Peru, the market reacted positively to the normalization of relations with official creditors and the improved prospects for debt restructuring with commercial creditors.

The experience of Eastern European countries was mixed. For Bulgaria and Poland, secondary market prices increased by 27 percent and 58 percent, respectively, during the past 21 months, to 19 cents and 26 cents on the dollar at the end of September 1992. In contrast, the price of claims on the former U.S.S.R. fell precipitously, with most of the decline occurring at the end of 1991, when the extent of debt-servicing difficulties became apparent. Offer prices declined from 58 cents in January 1991 to 20 cents at the end of September 1992. Similarly, political disruption and diminished debt-servicing prospects in Yugoslavia have led to steep declines in the secondary market price for its debt. The price of claims on Yugoslavia fell from 52 cents at the beginning of 1991 to a bid price of 17 cents at the end of September 1992.

Institutional Developments

Market participants have reported a marked increase in turnover in the secondary market for developing country claims. Turnover in such claims—including new bond issues, bonds arising from bank restructuring agreements, and unrestructured bank debt—is estimated to have increased from about $100 billion in 1990 to approximately $200 billion in 1991; turnover rose further in the first half of 1992.29 The turnover for bank loans accounts for about ⅔ to ⅖ of the market, with the focus on the larger restructuring countries, in particular

Argentina and Brazil. Part of the increase in demand was reportedly due to the entry into the market of such institutional investors as fund managers, insurance companies, and pension funds. These investors have been attracted to restructured bank debt as listed and rated securities offering relatively high yields; they also were drawn by the potential for capital gains, a reduction in risks associated with collateralization, and an increase in market liquidity.30

The increased volume and volatility in the cash market since the last quarter of 1991 has boosted demand for derivative instruments, although the sector remains relatively small. Market participants estimate the volume of options written in 1991 at $15-$20 billion, or about 10 percent of cash transactions, and the volumes of forward contracts at about $60 billion. So far, reflecting the yet undeveloped nature of the market, most trading is over-the-counter (OTC) with short maturities. However, there is increased interest in exchange-traded instruments, and warrants have been issued on Argentine, Brazilian, Mexican, and Venezuelan bank debt instruments. Moreover, most of the demand is linked to loan instruments in the more liquid and volatile segment of the market. Indeed, the increased use of derivative products may have served to generate more market volatility, as investors have been able to leverage speculative positions. Such an effect was observed in the last quarter of 1991, when price declines were worsened by the exercise of put options being used as hedges and by the sale of claims by speculators who could not meet margin calls on forward contracts.

The increased activity and volatility observed in the secondary market during 1991 and 1992 has had the indirect effect of providing an impetus to the preparation of guidelines on the trading of the instruments of developing countries. The Emerging Markets Debt Traders Association (formerly known as the LDC Traders Association) has prepared a draft code of conduct that will include recommendations to enhance the efficiency and integrity of the secondary market. The code consists of nonbinding guidelines that spell out the responsibilities of traders regarding disclosure terms, fair dealing, and use of nonpublic (insider) information. The code is expected to be issued before the end of 1992.

The Philippines purchased $1.3 billion at 52 percent of face value and $6 million of nuclear power plant debt at 43 percent of face value. Previously, $100 million had been bought back using the $50 million second tranche of a World Bank $200 million Debt Management Program Loan.

Argentina has accumulated arrears since April 1988. Beginning in January 1991, it raised monthly payments to banks to $60 million a month from $40 million a month.

The payment will consist of a cash payment of $0.4 billion and a debt exchange of $0.3 billion in interest arrears for fully collateralized dollar-denominated zero coupon notes with a market value of $0.3 billion.

The interest rate varies according to currency but was calculated by subtracting 43.75 basis points from the respective currencies’ six-month LIBOR effective on April 7, 1992; for example, for U.S.-dollar-denominated debt, the interest rate will be 4 percent.

The face value of the discount bonds would also include an amount equal to interest on the discounted amount for a period of nine months at an annual rate equal to the yield on nine-month U.S. Treasuries.

Mozambique and Niger have previously received support under this facility, which provides low-income countries with a grant to finance debt reduction operations.

Interest arrears at the end of 1991 are estimated at $9.3 billion, with about $7 billion covered in the agreement of May 1991.

This agreement resulted in cash payments amounting to $2.0 billion in 1991. The remaining pre-1991 interest arrears of about $7 billion are to be converted—at the conclusion of the term sheet for the medium- and long-term debt—into 10-year bonds (including a 3-year grace period) carrying market interest rates. This latter agreement was signed with the bank committee on September 10, 1992.

If at least 95 percent of the banks had committed to the financing package within 10 weeks after the date the term sheet is issued, Brazil will pay, at that time, 10 percent of the interest due between January 1 and July 9, 1992.

The interest rate on the U.S.-dollar-denominated claims was set at 4 percent, a reduction of 43.75 basis points relative to six-month LIBOR.

The difference between the interest rate on the phase-in bonds and the interest rate on the par and discount bonds will be deposited in an escrow account. If the enhancements are provided as scheduled, these funds will be returned to Brazil.

Calculations of the relief implied by par exchanges are sensitive to assumptions regarding alternative interest rates. Par exchanges can be viewed as a combination of two operations, a conversion of floating-rate debt into fixed-rate debt, and a reduction in the rate. Thus, a notional floating interest rate was constructed by adding the 30-year U.S. Treasury yield to the 10-year interest rate swap premium and a spread of of 1 percent. The debt reduction is calculated at the date of the preliminary agreement.

This relationship was reversed, however, in the case of Costa Rica where, in order to induce creditors voluntarily to provide a minimum level of debt reduction, creditors were offered a more attractive option if they tendered at least 60 percent of their claims to the buy-back.

As explained more fully in Annex I, the buy-back equivalent price for a debt exchange is the total value of enhancements as a proportion of the total reduction in claims payable to banks, including effective prepayments through collateralization, evaluated at prevailing interest rates. This is the price at which the debt reduction achieved through a debt exchange is equivalent to the debt reduction under a buy-back at this price. The calculations include estimates of the value of value recovery clauses but not equity-conversion rights; they are also sensitive to assumptions regarding the path of future interest rates.

The privatization notes were issued under a Dutch auction held on July 3, 1991, at an average discount of 1.6 percent to face value. The notes, which were negotiable, had a 10-year tenor with a 5½-year grace period and yields equivalent to 3-month LIBOR plus of 1 percent.

To qualify as a large project, a new investment must be in one of the following five areas: petrochemicals, aluminum, pulp and paper, tourism, or infrastructure; and the total investment must be for at least $150 million, with the exception of tourism ($50 million) and infrastructure (discretionary limit). Debt conversions can finance up to 30 percent of the total investment of a given project; exceptions are tourism and infrastructure, where the respective ratios are 50 percent and 100 percent.

The two largest debt operations in 1991 involved the conversion by two groups of U.S. and European banks of debt with a face value of $295 million into $243 million of equity; $128.4 million in Olefinas del Zulia (a producer of propylene and ethylene); and $115 million in Cloro Vinilios del Zulia (a producer of vinyl, caustic soda, and chlorine). In April 1992, a third group of European and U.S. banks were reportedly investing in the $142 million capital of a joint-venture project to produce methanol (Supermetanol CA).

In 1990, $6.7 billion of commercial debt was retired through the sales of the telephone company, the national airline, and four petrochemical companies.

The following companies were privatized: Usiminas (steel), Celma (airplane engine maintenance), Mafersa (railroad transport), Cosinor (steel manufacturer), SNBP (river transport), Indag (fertilizer), and Piratini (steel).

The Brazil Plan for Privatization and Development Fund envisages subscriptions of $1.25 billion of Deposit Facility Accounts, while two other groups expect to raise $400 million and $100 million, respectively.

A debt-conversion program was in place from 1986 to 1988. However, it was suspended on the grounds that the debt conversions were inflationary.

The debt is converted at the fixed exchange rate of 2 lempiras to the U.S. dollar, while the official exchange rate was 5.4 lempiras to the U.S. dollar at the end of May 1992.

Official and multilateral debt, as well as commercial bank debt, has also been used in debt-for-development conversions. The United States is involved in several operations under the Paris Club’s new initiative for lower middle-income debtors whereby up to 10 percent of these countries’ official bilateral debt could be converted to fund local-currency conservation projects. Under the Enterprise for the Americas Initiative, debt-reduction agreements have been signed with Bolivia, Jamaica, and Chile. Under these agreements a portion of PL-480 debt is forgiven, with the option for the interest on the remaining principal to be deposited in equivalent local currency for environmental trust funds. For these three countries, such trust funds are envisaged to amount to $1.8 million, $1.4 million, and $9.2 million, respectively. Legislation has been proposed that would convert a portion of a $400 million Commodity Credit Corporation loan to Mexico into a peso fund to be used on environmental projects along the U.S.-Mexican border. In another initiative, $0.6 million of Costa Rican debt owed by a multilateral development institution—Central American Bank for Economic Integration (CABEI)—was purchased by a conservation group (Rainforest Alliance) and converted into domestic currency to be used to buy land at the International Children’s Rainforest in Costa Rica.

Prices reported for collateralized securities exchanged for bank claims have been adjusted to exclude the estimated value of the secured portion of the payments to provide continuity with price developments for (uncollateralized) bank debt instruments. See Annex II for further details.

This price is the average price of par and discount bonds, adjusted to exclude the estimated value of the collateral.

These estimates of market volume are highly uncertain. The unregulated nature of the market only permits the estimation of market volumes from—understandably inexact—surveys of trading houses. One problem has been divergent definitions of the market. For further information on this point, see “Double Cream,” Risk, Vol. 5, No. 3 (March 1992).

Liquidity was facilitated by the listing of bonds in Luxembourg and their trading through the clearing houses, Euroclear and Cedel. The market in restructured Mexican bank debt is reported to be one of the most liquid bond markets in the world, after the U.S. Treasury and Japanese Government bond markets. Reflecting this, bid-ask spreads during the past 21 months narrowed significantly (by about 70 percent in the cases of Argentine and Brazilian loans, and by about 50 percent for Mexican and Venezuelan bonds).

    Other Resources Citing This Publication