Over the period since the end of 1992, steady progress has been achieved toward resolving the commercial bank debt problems of middle-income countries.1 By the end of 1994, most of the major debtor countries in this group will have completed restructurings of their bank debt. At the same time, a number of developing countries—including some of the former major debtors—have expanded their access to spontaneous private financing, as investor interest in developing country bonds and equities broadened significantly. The markets for these securities ran into substantial turbulence at times during the first half of 1994, however, reflecting higher interest rates in international markets prompted by the tightening of monetary conditions in the United States and by adverse developments in some developing countries.
Progress with Commercial Bank Debt Restructuring
Recent Experience
Over the past year, Brazil, Bulgaria, the Dominican Republic, Jordan, Poland, Sao Tome and Principe, and Zambia completed bank-debt-restructuring packages with support from the Fund, the World Bank, and bilateral official agencies. Ecuador also is expected to complete an arrangement with its bank creditors before the end of 1994. By that time, a total of 21 countries will have concluded bank debt- and debt-service-reduction operations. Debt worth approximately $170 billion will have been restructured, representing roughly 75 percent of bank debt outstanding at the end of 1989 for the group of heavily indebted developing countries (Table A1). Panama and Peru are the most heavily indebted middle-income countries that have not yet regularized relations with their commercial bank creditors; both are engaged in negotiating restructuring agreements.
South Africa continued to address its external debt problems through a rescheduling of obligations to commercial banks. Agreement on a fourth and final arrangement following the 1985 payment “standstill” was reached in September 1993. In the case of Russia, talks have focused on rescheduling its stock of bank debt and capitalizing a declining share of interest arrears. A preliminary agreement was reached in July 1993, but its implementation was delayed pending resolution of issues regarding Russia’s waiving sovereign immunity and designation of the official agency that would be the signatory to the agreement. These issues were resolved in September 1994, and the agreement is to come into effect by the end of the year, after Russia makes a previously agreed payment of $500 million with respect to past due 1993 interest obligations.
A growing number of low-income countries also are making efforts to resolve their debt problems, often aided by the resources of the debt reduction facility for countries of the International Development Association (IDA). Progress for most, however, remains slow. With the backing of IDA resources and assistance from official bilateral sources, debt buy-backs have been concluded by Bolivia, Guyana, Mozambique, Niger, Sao Tome and Principe, Uganda, and Zambia. Preliminary discussions on similar operations are under way with several other countries.
Further innovations in debt operations have occurred over the past year. Bulgaria’s discount bond, for example, involves a much steeper discount than has been the case in previous debt packages. In addition, Poland’s agreement provided for some debt reduction for interest arrears and did not include interest collateral. Packages now generally include limits on the use of certain options or explicit rebalancing clauses to provide countries with more certainty as to the up-front costs of an operation and the profile of debt-service relief ultimately provided. The Fund and the World Bank have also shown increased flexibility in the use of their own resources by eliminating the segmentation provisions in their guidelines governing support for bank debt operations.
Over the past year, bank debt operations for Brazil and Jordan were financed entirely by the debtor countries themselves. While not directly involved in these deals, the international financial institutions have provided some indirect support. The bank deal with Jordan was predicated on the existence of a Fund arrangement with the country. In the case of Brazil, the country’s stabilization program, which was expected to be monitored by the Fund, and continuing discussions on a Fund arrangement were considered sufficient assurance to enable completion of negotiations with creditors.
Prospects
Notwithstanding recent progress, certain developments appear likely to make future negotiations between indebted developing countries and the holders of their commercial bank obligations more complex. Nonbank investors now have purchased significant amounts of bank debt in the secondary market. Difficulties in persuading them to accept certain aspects of the debt packages negotiated by bank advisory committees have contributed to delays in completing some recent restructuring operations. Negotiating committees in the future will have to take better account of the diverse interests of these investors.
Another possible complication arises from the market impact of speculation that a country will conclude a debt- and debt-service-reduction operation. For example, so-called pre-Brady speculation has contributed to the run-up in the secondary market prices for the bank debt of Panama and Peru. In recent years, such price run-ups have tended to be earlier and larger than was the case for countries that concluded debt packages in 1989 and 1990 (Chart 1). As a consequence, secondary market prices may not always fully reflect a country’s medium-term capacity to service its debt and the up-front costs of completing a debt-restructuring agreement may be bid up significantly. The potential effects of such speculation will need to be taken into consideration in negotiating the terms of bank packages in the remaining cases.
Selected Developments in Secondary Market Prices During Negotiations of Bank Restructuring Packages
Sources: Salomon Brothers; ANZ Grindlays Bank; and IMF staff estimates.1Per unit of claim.Selected Developments in Secondary Market Prices During Negotiations of Bank Restructuring Packages
Sources: Salomon Brothers; ANZ Grindlays Bank; and IMF staff estimates.1Per unit of claim.Selected Developments in Secondary Market Prices During Negotiations of Bank Restructuring Packages
Sources: Salomon Brothers; ANZ Grindlays Bank; and IMF staff estimates.1Per unit of claim.While most of the major bank debt cases have been resolved, attention still needs to be focused on the problems of low-income countries. In many of these countries, the process of debt restructuring has been delayed owing to economic and political difficulties. Although the amounts owed by these countries are small compared with the debt of the large middle-income debtor countries, individual debt burdens for many are severe. In some cases in the past, commercial banks have accepted steep discounts on these debts, particularly when they had no significant longer-term business interests and had already made provisions for losses. Additional flexibility will be needed in the future. There will also be a continuing substantial need for concessional assistance to finance debt operations. For some low-income countries, the total amount of assistance required to buy back bank debt, even at very steep discounts, is likely to be relatively large. Resources from the debt reduction facility for IDA countries and from other official agencies may not be sufficient. In such cases, it may not be enough to organize simple buy-backs of commercial bank debt. Instead, more complex operations may have to be considered that reduce up-front costs but still provide debt and debt-service reduction in line with a country’s payments capacity over the medium term. Such deals might involve options that include larger discounts on discount bonds, par bonds bearing lower interest rates, more favorable treatment of past due interest, and less than full collateralization of principal.
Private Financial Flows
Recent Experience
The resurgence in private market financing to developing countries that began in the late 1980s continued during 1993 as both portfolio flows and net foreign direct investment rose sharply.2 The strong expansion in international bond and stock placements was fueled in large part by a broadening of the investor base to include a wider group of institutional investors.3 Medium- and long-term commercial bank lending, however, remained limited. Moreover, while total private market financing for developing countries as a group increased strongly in 1993, much of these flows continued to go to a small number of countries, primarily in Asia and Latin America.
Toward the end of 1993 and in early 1994, spreads on bonds narrowed appreciably, and demand for developing country bonds, as well as equities, began to fall dramatically. This coincided with increases in U.S. interest rates and adverse developments in several borrowing countries. In addition, highly leveraged investors were reported to have liquidated their positions in developing country securities in an effort to meet margin requirements or to take profits. The slide in demand for these bonds and equities continued through April 1994, before recovering moderately in May and June.
While countries with weaker economic performance experienced cutbacks in market access somewhat earlier than others, financing flows to all developing countries, including those in Asia and stronger performers in Latin America, fell to very low levels by April 1994. Both issuers and purchasers pulled back sharply in the wake of overall market uncertainties. Bonds placed after February 1994 tended to be from only the better credit risks and to carry floating interest rates and shorter maturities. While highly leveraged investors unwound most of their positions, it appears that institutional investors generally maintained their holdings, even if they curtailed their demand for new bond and equity issues.
Durability of Market Re-Entry and Pricing of Risk
The increase in private financing to developing countries over the past few years and the market’s ability to rebound from a moderate correction in 1992 engendered optimism about the sustainability of the process of market re-entry.4 While the sharp correction in early 1994 raised fresh doubts, the emergence of a recovery later in the year reinforced that optimism. As noted in previous reports in this series, three conditions appear basic to sustaining private flows to developing countries: an expanded investor base, appropriate pricing and assessment of risk, and continued implementation of sound policies that help match future debt-servicing requirements to payments capacity. Progress continues to be made along these lines.
The expansion of the investor base in 1993 was part of a trend toward the globalization of portfolios. Relative stability of the investor base in 1994, despite the market correction, has been encouraging. As new investor groups come into the market, flows and prices of developing country securities could nevertheless be subject to considerable volatility, especially if new investors have poorer information and different liquidity preferences than existing investors. Although a number of developing countries have experienced increased volatility in security prices following the opening of local stock markets to foreign investors, a diversified and stable investor base can be expected over time to promote reduced fluctuations in asset prices, particularly as information becomes more widely disseminated.
The sharp run-up in the prices of developing country securities in late 1993 and early 1994 raises questions about the pricing of risk. It appears that the market ranks countries in a manner that is broadly consistent with their recent economic performance and immediate prospects. It is unclear, however, whether investors differentiate carefully among different borrowers. In general, and as would be expected, issuers from countries that previously rescheduled their debt tend to pay higher spreads, while those from countries with stronger growth and better inflation performance tend to pay lower ones. Beyond such broad differentiations, however, the market may be slow to make finer distinctions. For example, yield spreads on bonds of countries that ran into difficulties in late 1993 were slow to react to the deterioration in their economic performance until it was widely recognized; at that point, the response was quite significant. Investors also have been attracted to developing country securities because returns historically have not closely tracked price developments in industrial country financial markets. Under these circumstances, the diversification of portfolios by including developing country securities could raise the portfolios’ expected returns for a given level of risk. Experience during the market turbulence in 1994, however, suggests that asset returns of developing and industrial countries tend to become more closely related in turbulent periods.
To maintain market access on reasonable terms, countries need consistently to implement strong macroeconomic and structural policy programs. Maintenance of such programs is likely to be particularly important in the period ahead, given the high degree of uncertainty with regard to interest rate movements in the industrial countries. Developing countries are also now entering a period of rising debt amortization as the bullet repayments on bonds issued earlier this decade are beginning to fall due (Chart 2). The increasing integration of international financial markets also means that interest rates and equity prices in developing countries will become more sensitive to developments in asset prices in the major industrial countries. A more open international environment will have to be taken into consideration by developing countries in determining the appropriate stances of monetary, fiscal, and exchange rate policies. While at times it might appear tempting to supplement such policies with capital controls, such actions would ultimately tend to be counter productive. To provide a basis for sustained portfolio capital flows, continued efforts are also needed to strengthen financial markets in developing countries. Structural reforms to increase market transparency and reduce transaction costs and risks are important in fostering investor confidence. Intermediation of capital flows through the banking system points as well to the need for adequate banking regulation and supervision.
Maturing Bonds of Developing Countries
(In millions of U.S. dollars)
Sources: International Financing Review; EuroWeek; and IMF staff estimates.Maturing Bonds of Developing Countries
(In millions of U.S. dollars)
Sources: International Financing Review; EuroWeek; and IMF staff estimates.Maturing Bonds of Developing Countries
(In millions of U.S. dollars)
Sources: International Financing Review; EuroWeek; and IMF staff estimates.Developing countries can improve the mix of external financing by taking steps to remove obstacles to non-debt-creating capital flows. In recent years, international equity placements and direct purchases of equities by foreigners in domestic stock markets have risen sharply. At the same time, there has also been a surge in foreign direct investment inflows. These flows generally entail longer-term commitments on the part of foreign investors. Nevertheless, foreign direct investment flows, taking into account reinvested and repatriated earnings, also exhibit some of the same characteristics as other flows during periods of domestic macroeconomic instability. While investment positions are rarely liquidated rapidly, the totality of transactions associated with foreign direct investment may give rise to net outflows of funds.
For earlier periods, see Collyns and others (1993, 1992, and 1991). For information on official financial flows to developing countries, see Kuhn and others (1994).
International bond and equity flows amounted to $71 billion in 1993 ($33 billion in 1992); net foreign direct investment flows amounted to $58 billion in 1993 ($39 billion in 1992). Direct purchases of equity and bonds by nonresidents in local markets are not included because of the lack of sufficient data.
The expansion of the investor base is discussed further in Goldstein and others (1994).
The 1992 market correction is described in Goldstein and others (1993).
