Abstract

This chapter reviews selected Caribbean debt restructuring cases. In particular, it deals with three interrelated policy questions. First, it delineates the history of resolving debt overhangs in emerging market and low-income economies generally. Second, it reviews selected Caribbean experiences with debt restructuring and associated challenges in the region. And third, it examines the needs for additional traditional debt restructuring in Caribbean economies, along with some alternative options and the role that the IMF can play in helping to restore the region’s fiscal and debt sustainability.

This chapter reviews selected Caribbean debt restructuring cases. In particular, it deals with three interrelated policy questions. First, it delineates the history of resolving debt overhangs in emerging market and low-income economies generally. Second, it reviews selected Caribbean experiences with debt restructuring and associated challenges in the region. And third, it examines the needs for additional traditional debt restructuring in Caribbean economies, along with some alternative options and the role that the IMF can play in helping to restore the region’s fiscal and debt sustainability.

Past attempts at tackling high debt in Caribbean economies through debt restructuring have not yielded lasting gains for all countries. Among the cases where restructuring succeeded in helping to lower public debt were the efforts in Guyana, Suriname, and Trinidad and Tobago. Certain factors contributed to their success, including favorable commodity prices in the years following the restructuring. These countries also adopted, to some extent, broader macroeconomic policy reforms that changed the way things were done.

In a number of other cases, particularly in the tourism-dependent countries, debt restructurings were not sufficient to yield sustainable debt reduction. At the same time, their small size and geographic location make them highly vulnerable to a host of frequent shocks, against which it is costly to insure. These shocks have contributed to the pile-up of their debt. As a result, these economies have had a silent debt crisis for the past two decades, contributing to a high-debt–low-growth trap. More particularly, the high public debt has constrained fiscal policy flexibility, which in an environment of growing debt intolerance can easily trigger a fiscal crisis.

Financial innovation and international cooperation have been key factors in resolving past international debt overhang cases. An important example of this was the use of Brady bonds, which reduced the debt overhang of some emerging market countries in the late 1980s while facilitating renewed international capital market access. Over time, this solution popularized the use of public bond markets among emerging market economies, particularly in Latin America, as a mechanism for raising money. For low income developing economies, the Heavily Indebted Poor Countries (HIPC) Initiative helped reduce their debt overhang and poverty.

However, some have argued that the public debt overhang for middle-income small island developing states represents a new challenge for the existing debt resolution mechanisms, one that has not been sufficiently studied. Notwithstanding the fact that these economies are highly indebted, most of them—many of which are small island nations in the Caribbean—have not benefited from past international programs for comprehensive debt relief. Also, many have been graduated from concessional borrowing at the World Bank given their relatively high per capita income.

That said, a number of Caribbean countries have pursued debt restructuring over the past 25 years, although the relief secured has not been sufficient by itself to restore long-term fiscal and debt sustainability. Looking ahead, the changing structure of Caribbean public debt (high levels of domestic debt held by domestic banks) necessitates more innovative debt restructuring strategies to secure sufficient debt relief without instigating a financial crisis. In addition, a credible macroeconomic framework is required to lock in the fiscal space achieved through debt restructuring.

The remainder of this chapter is organized as follows. First the international experience with debt restructuring is reviewed. Then the chapter reviews recent selected Caribbean debt restructuring cases, followed by a discussion of the challenges of debt restructuring in the region. Lastly, it discusses the case for additional traditional debt restructuring in the region along with alternative options for debt reduction and the role that the IMF can play both in debt reduction and more broadly in helping restore sustainable public finances.

International Debt Restructuring and Debt Relief Mechanisms1

The international framework for addressing debt restructuring is a collection of mechanisms—both market-based and official—that continue to evolve over time in response to different debt crises. Indeed, since the 1950s there have been more than 600 sovereign debt restructurings in 95 countries. About two-thirds of these have been Paris Club agreements for official bilateral debt. These include debt restructuring operations under the HIPC and Multilateral Debt Relief Initiative (MDRI) initiatives, which have provided extensive debt relief for highly indebted low-income countries. The remaining third have been debt exchanges with private creditors.

Commercial Bank Debt

Commercial bank debt has been restructured through a Bank Advisory Committee—better known as the London Club. These restructurings were particularly prevalent during the late 1970s and early 1980s. Notwithstanding legal, coordination, and logistical issues as well as holdouts and intercreditor disputes, there were more than 100 restructurings between 1980 and 1990. The majority of them required the recipient country to have an IMF program in place. This was done to assure creditors that the adjustment effort, together with the debt restructuring and new funding, would be adequate to close any residual financing needs and achieve debt sustainability. In this context, it is important to note that the IMF introduced some innovations as the debt crisis unfolded. In particular, “it assumed a much more active role than heretofore in arranging the total financing packages for adjustment programs. . . the standard practice for the staff before the crisis was to estimate the financing that would be provided by other private and official creditors under normal conditions and with good policies in place. The Fund would then negotiate a program that would make such financing possible, and it would provide financing (within the established access limits) to close any remaining gap” (Boughton, 2001, p. 545). However, as the debt crisis evolved in the early 1980s it became clear that in some cases private creditors wanted to reduce their exposure and in such cases IMF funding would be insufficient to close the financing gap. According to Boughton, “The solution was to require concerted lending by the banks so as to stabilize their aggregate financing” (p.545). In this regard, the IMF programs played a critical role in mobilizing resources from foreign and multilateral creditors and donors and in ensuring a viable medium-term macroeconomic strategy.

The IMF also developed procedures for monitoring adjustment programs that were not supported by IMF financing—such as enhanced surveillance. Under these procedures the IMF provided information and analysis (staff reports that evaluated non-IMF-financed programs) to private creditors.2 Nevertheless, despite a chain of rescheduling agreements, countries generally only received short-term liquidity relief and their debt paths remained unsustainable.

The Brady Plan was launched in 1989 to address debtor insolvency and commercial bank exposure. The plan signaled a shift in the official policy stance on debt restructurings from short-term relief to face-value reductions in debt to restore debtor solvency. It had three key elements. First, banks exchanged their loans for sovereign bonds. Second, creditors were offered a menu of options with respect to instruments with different terms and implications for NPV and face-value reductions. And third, the plan provided for the capitalization of the interest arrears that were not written off by commercial banks. There were 17 deals between 1989 and 1997 under this plan, which is widely regarded as a success since it lowered the debt levels of emerging-market countries (particularly in Latin America), normalized their relations with creditors, and allowed them to regain access to capital markets. According to Boughton (2001), under the Brady Plan, the IMF provided the resources used for repurchasing bank loans at secondary market prices.

Sovereign Bond Debt

Sovereign bonds are typically restructured through an exchange offer. This involves identifying bond holders, verifying their claims, preparing an exchange offer (most likely after consultation with the bondholders), launching the exchange offer that sets conditions and deadlines for bondholder participation, and exchanging the debt. Sovereign bond restructurings have not always been smooth, and in some cases negotiations have been protracted. The IMF’s role in these restructurings has been to provide information and assess the debt sustainability of the proposed offer.

Since 1998, there have been more than 18 bond exchanges with foreign bondholders, involving bonds with a cumulative value of about US$81.1 billion. Some countries have pursued domestic and external debt exchanges at the same time, while in other cases, such as in Jamaica (in 2010 and 2013) the focus has been only on domestic creditors. Although delays due to holdouts and litigation are possible, these have been rare in recent times (IMF, 2012b). Indeed, only Dominica (2004) and Argentina (2005) have had difficulties with creditor holdouts and with regaining access to international capital markets after the bond exchange.

Official Bilateral Debt

Official bilateral debt has generally been restructured under the auspices of the Paris Club. A country must demonstrate payment difficulties and reach an understanding with the IMF on an adjustment program in order to be considered for a Paris Club restructuring. The level of debt relief granted by the Paris Club has been aligned with the debtor financing gap identified in the IMF program, and has been related to a country’s income level. Before the 1990s, most Paris Club restructurings delivered only short-term refinancing and maturity lengthening, but they did not address underlying fiscal solvency issues.3 Overall, between 1950 and 2010, a total of 447 Paris Club agreements in 88 countries were implemented for official debt amounting to US$545 billion.

Debt Relief for Highly Indebted Poor Countries

Highly indebted poor countries have been eligible for the joint IMF- and World Bank-sponsored HIPC and MDRI initiatives. Under the HIPC initiative, launched in 1996, highly indebted poor countries could obtain relief in the context of an IMF and Bank program by following a two-step process. First, countries had to meet a set of conditions, including having a poverty reduction strategy, a track record of reform and sound policies, and a debt burden that could not be addressed through traditional mechanisms. Meeting these conditions qualified a country to reach the HIPC decision point, where preliminary commitments for debt reduction were made. Second, the country had to meet additional conditions, including establishing a further track record of good performance under an IMF-supported program; satisfactory implementation of key reforms agreed upon at the decision point; and satisfactory implementation of its poverty reduction strategy, to reach the “completion point,” when the debt relief committed at the decision point was delivered.

In 2005, as a contribution toward achieving the Millennium Development Goals (MDGs), the Group of Eight agreed that the IMF, World Bank, and African Development Bank would provide relief under the MDRI for 100 percent of their debt claims on countries that reached the completion point under the HIPC initiative.4 Thus far, 33 countries have reached the completion point and have received or are receiving full debt relief under the HIPC and MDRI initiatives. Participation in both these initiatives was closed in 2006, with a further ring-fencing in 2011. Of the countries that reached the HIPC completion point, two are in the Caribbean: Guyana and Haiti, which also benefited from the MDRI as noted above.

The majority of Caribbean economies have relied increasingly on the evolving market-based arrangements for countries in debt distress to help reduce their debt levels and restore debt sustainability. These efforts have not been successful in all cases.

Features of Selected Recent Public Debt Restructurings in the Caribbean

Caribbean economies have received many rounds of debt relief since the 1970s (see Table 9.1). Some countries, such as Jamaica, have had repeated restructurings and are still very highly indebted. Other countries, such as Suriname and Trinidad and Tobago, have been able to lock in the gains of debt relief; supported by high commodity prices, they have reduced their public debt ratios over time. Although most countries pursued debt restructurings in the context of IMF programs, in some cases, such as Belize in 2007 and 2013, debt relief operations occurred despite the absence of an IMF-supported program.

Table 9.1

Debt Restructuring in the Caribbean, 1978–2013

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Sources: Das and others (2012); and IMF staff reports.Note: HIPC = Heavily Indebted Poor Countries.

The Government of Grenada announced its intention to restructure in March 2013.

Since 2004 there have been eight episodes of sovereign debt restructuring in six Caribbean countries—Antigua and Barbuda, Belize, Dominica, Grenada, Jamaica, and St. Kitts and Nevis. Table 9.2 provides an overview of the eight debt restructurings for these six countries. There are both similarities and differences in the characteristics of these recent episodes. Six episodes were supported by IMF programs, in some cases with financing of over 300 percent of quota. These restructurings were completed within a relatively short period: less than a year and a half. In the case of Jamaica (2010), the domestic debt exchange took about two months, and in the cases of Dominica, Grenada, and St. Kitts and Nevis, it took 10 to 15 months to complete. The restructurings in Belize (2007 and 2013) and another in Jamaica (2013) did not involve an IMF program5 (Table 9.2).

Table 9.2

Characteristics of Recent Sovereign Debt Restructuring in the Caribbean, Selected Countries, 2005–12

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Sources: Alleyne (2011); Government of Antigua and Barbuda, Review of Antigua and Barbuda Debt Portfolio from 2006 to 2010 (http://www.ab.gov.ag/article_details.Php?id=2729&category=114); Antigua and Barbuda Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding, May 21, 2010; Jahan (2012); IMF (2006, 2012a, and 2012b); and www.clubdeparis.org/en.

Based on IMF staff reports and staff estimates.

The Paris Club agreement reduced by over 90 percent the debt service due to Paris Club creditors during the IMF-supported program under the Poverty Reduction and Growth Facility. The debt was rescheduled under classic terms. Repayment of non-Official Development Assistance (ODA) credits over 12 years, with 5 years of grace. Repayment of the ODA credits over 12 years, with 5 years of grace. The agreement also deferred a large part of moratorium in interest due under the rescheduling and then deferred until 2009 through 2013 the repayment of arrears accumulated on short-term debt. In May 2009, Grenada obtained an extension of the Paris Club agreement through end-2009. (http://www.clubdeparis.org/sections/communica…rchives-2006/grenade/switchLanguage/en).

On debt to two large statutory bodies, the Medical Benefits Scheme and the Social Security Scheme. See Review of Antigua and Barbuda Debt Portfolio from 2006 to 2010 (http://www.ab.gov.ag/article_details.Php?id=2729&category=114).

The Paris Club Agreement reduced by over 86 percent the debt service due to the Paris Club creditors during the IMF-supported program under the Stand By Agreement. It rescheduled US$117 million consisting of arrears due as of August 31, 2010, as well as maturities falling due from September 1, 2010 up to April 30, 2013 to be repaid over 12 years, including 5 years of grace. The ODA loans were rescheduled at a commercial rate (http://www.clubdeparis.org/sections/communica…2010/Antigua-barbuda/switchLanguage/en).

Review of Antigua and Barbuda Debt Portfolio from 2006 to 2010 (http://www.ab.gov.ag/article_details.Php?id=2729&category=114).

The Paris Club agreement reduced by over 90 percent the debt service due to the Paris Club creditors during the IMF-supported program under the Stand By Arrangement. This included rescheduling the stock of debt over 20 years, including a 7-year grace period (http://www.clubdeparis.org/sections/communica…nt-christophe-nieves/switchLanguage/en).

Most Caribbean debt restructuring operations are delayed until the countries face the possibility of economic collapse. In particular, the median delay in debt restructuring events from the time of establishing that their debt is unsustainable is about three years (Table 9.2). However, there are important differences among Caribbean countries. For example, while Jamaica (2010) conducted its debt exchange about two years after losing market access, it took Antigua and Barbuda about 20 years to deal with a clearly unsustainable public debt path. The other cases fall within these extremes. It is likely that the delays in effectively dealing with their public debt overhang have aggravated it, causing much uncertainty in the macroeconomic environment.

The range of debt relief varied widely, ranging from about a 10 percent reduction in NPV terms in the case of Jamaica (2013) to about 73 percent for St. Kitts and Nevis. Also, the cut in face value varied across countries, ranging from zero in the case of Jamaica to about 32 percent of the eligible debt for St. Kitts and Nevis. In addition, with the exception of Antigua and Barbuda and Dominica, all recent Caribbean debt restructurings were pre-emptive. Finally, Jamaica restructured only domestic debt (in both 2010 and 2013), while Belize (in 2013 and 2007) and Dominica (in 2004) restructured only foreign instruments. The remaining countries—Antigua and Barbuda, Grenada, and St. Kitts and Nevis—restructured both their domestic and external debt portfolios (see Table 9.2).

Except in the case of St. Kitts and Nevis, the recent debt restructuring operations for most countries appear to have provided mainly cash flow relief, and debt sustainability remains at risk. While gross financing needs and debt service ratios declined after the debt restructuring operations, all these countries remained highly vulnerable to debt distress, given their still high debt ratios (see Figures 9.1 and 9.2 and Table 9.3). For St. Kitts and Nevis, however, the debt stock declined to about 87 percent of GDP the year after debt restructuring from 154 percent of GDP the year before debt restructuring. Clear evidence of debt restructuring operations that have provided insufficient debt relief includes the cases of Jamaica (2010) and Belize (2007), both of which recently repeated their debt restructuring exercises within five years. Another example is Grenada, which restructured its debts in 2005 but announced in March 2013 its intention to once again restructure its external debts. It remains to be seen whether the recent debt restructuring cases in Jamaica (2013), Belize (2013), and St. Kitts and Nevis (2012) have provided sufficient debt relief to ensure medium- to long-run public debt sustainability.

Figure 9.1
Figure 9.1

Total Public Sector Debt, Selected Caribbean Countries, 2004–13

(Percent of GDP)

Source: Author’s calculations using data from the IMF, World Economic Outlook database and individual country Debt Sustainability tables.Note: DS = debt restructuring. Debt ratios for Antigua, Jamaica (2013), Belize (2013) and St. Kitts and Nevis include projections. These projections are based on debt restructuring agreements that have already been completed or are already in progress. For Dominica and Grenada, since the debt restructuring exercises their GDP has been rebased resulting in a higher GDP level and lower debt ratios, including before and after debt restructuring.
Figure 9.2
Figure 9.2

Debt Service, Selected Caribbean Countries, 2004–13

(Percent of GDP)

Source: Author’s calculations using data from the IMF, World Economic Outlook database and individual country Debt Sustainability tables.Note: DS = debt restructuring. For Antigua and Barbuda, Jamaica (2010), St. Kitts and Nevis, Jamaica (2013), and Belize (2013) debt service includes projections. These projections are based on debt restructuring agreements that have already been completed or are already in progress.
Table 9.3

Outcomes Before and After Debt Restructuring (DS), Selected Caribbean Countries, 2004–13

(In percent of GDP)

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Sources: IMF staff reports; and author’s calculations.Note: Debt ratios for Antigua and Barbuda, Jamaica (2013), Belize (2013), and St. Kitts and Nevis include projections. These projections are based on debt restructuring agreements that have already been completed or are already in progress. For Dominica and Grenada, since the debt restructuring exercise GDP has been rebased, resulting in a higher GDP level and lower debt ratios, including before and after debt restructuring.

Debt ratios have been lowered since the rebasing of the GDP (which made the level of GDP higher for countries in the Eastern Caribbean Currency Union).

The averages for three years after DS for these countries include projections.

The commercial and Paris Club debt restructuring occurred during the same year.

The averages for three years after DS for Jamaica include projections.

The averages for three years after DS for Belize include projections. It also includes additional liabilities from 2015.

Key features of some of these debt exchanges contained elements that threatened medium-term sustainability and contributed to renewed restructuring. Of particular note is the interest rate step-up feature that characterized Belize’s and Grenada’s debt exchanges. These interest rate step-ups assumed improved medium-term prospects relative to the time of the debt restructuring. However, in both cases, the interest rate step-up occurred in the middle of the global financial crisis and when growth was sub-par for both countries. This timing, combined with a deterioration in the fiscal balances, caused serious financing difficulties, forcing both governments to seek additional relief from creditors.

On the question of market access, the story is mixed. On the domestic front, all countries were able to maintain private market access.6 In some countries, this was secured by explicit protection of certain maturities from eligibility for restructuring, such as in St. Kitts and Nevis and Grenada, where treasury bills were declared ineligible. Even in the case of Antigua and Barbuda, which had a prolonged period of debt distress before the explicit announcement of restructuring, regional debt market access was gained and maintained within the context of the regional government securities market. On the external front, while Antigua and Barbuda, Belize, Grenada, and St. Kitts and Nevis lost market access, Jamaica maintained external credit market access after the domestic debt restructuring.

Looking at broader macroeconomic outcomes, median growth rate and inflation were higher for the region as a whole three years after debt restructuring than they had been three years before (Table 9.3).7 Two groups of countries can be identified. The first group (Dominica, Jamaica, and St. Kitts and Nevis) are countries where growth and inflation (only for Jamaica) appear to have been better three years after the debt restructuring than three years before.8 The second group (Antigua and Barbuda, Belize, and Grenada) are countries where GDP growth was lower and inflation higher (except for Belize) three years after the debt restructuring than three years before.9

On financial sector outcomes, available indicators appear to suggest that the effects of debt restructuring operations overall has been manageable. In the cases examined, capital ratios were most affected, followed by profitability. In particular, capital ratios declined in Dominica and Antigua and Barbuda after the debt restructuring operations compared with the median ratios three years before the event (see Table 9.4).10 Although for Jamaica and St. Kitts and Nevis it may be too early to assess the impact of the recent debt restructuring on the financial sector, analysis done by IMF staff suggests that in the case of Jamaica most institutions were able to remain above the 10 percent minimum capital adequacy ratio (CAR) as excess capital helped financial institutions to absorb the initial reduction in capital (IMF, 2013c). In the case of St. Kitts and Nevis, IMF staff did a post–debt restructuring stress test of the indigenous banking sector to illustrate the impact of the debt restructuring (including the debt/land swap). They noted that the CAR following the debt/land swap would decline from 45 percent to 20.7 percent, but still remain above the regional benchmark. They also noted that interest income would decline, but the nonperforming loans-to-total loans ratio would increase (from 6.1 percent to 15.4 percent) given the high weight of government loans with indigenous banks (IMF, 2013d).

Table 9.4

Financial Sector Outcomes Before and After Debt Restructuring (DS), Selected Caribbean Countries, 2004–13

(In percent)

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Sources: IMF staff reports; and author’s calculations.Note: Recent data are not available to measure the impact, if any, on the financial system of the recent debt restructuring operations in Belize (2013), Jamaica (2013), and St. Kitts and Nevis (2012).

The commercial and Paris Club debt restructuring occurred during the same year.

The macroeconomic vulnerabilities associated with public debt over the medium term after debt restructuring, gauged by a debt sustainability analysis, have been somewhat mixed (Table 9.5). In particular, using the central debt projection and the results of stress tests in IMF staff reports, we find that except for Belize (2013) and Jamaica (2013), in all cases the medium-term baseline projections were below the pre–debt-restructuring debt levels. Also, except for Belize (2013) and Dominica (2004), the means of the projected debt levels of both the historical and no-policy-change scenarios for most countries at the end of the projection horizon were lower than before debt restructuring. Nevertheless, for most countries both baseline and mean debt level after debt restructuring remained high—in most cases over 100 percent of GDP. At the same time, the dispersion of the projected debt levels was higher than the pre–debt-restructuring levels for some countries, including Antigua and Barbuda, but broadly the same for Dominica (2004) and St. Kitts and Nevis (2013).

Table 9.5

Caribbean Economies: Medium-Term Vulnerabilities

(In percent of GDP)

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Sources: IMF staff reports; and author’s calculations.Note: This analysis is based on debt sustainability projections in IMF staff reports both at the time of the debt restructuring, and post-debt restructuring. The medium-term years before debt restructuring were as follows: Dominica end-2007; Belize (2007), end-2011; Belize (2013), end-2016; Antigua and Barbuda, end-2015; St. Kitts and Nevis, end-2016; Jamaica (2010), end-2013/14; Jamaica (2013), end-2016/17. The medium-term years after debt restructuring were as follows: Dominica end-2007; Belize (2007), end-2011; Belize (2013), end-2018; Antigua and Barbuda, end-2017; St. Kitts and Nevis, end-2017; Jamaica (2010), end-2014/15; Jamaica (2013), end-2016/17.

Mean and standard deviation (STD) of scenarios and bound tests.

Grenada is excluded as the debt sustainability analysis framework used before (market access) and after debt restructuring (low income) are not comparable.

Challenges with Debt Restructuring in the Region

Challenges to debt restructuring in the Caribbean include the required size of debt reduction, high levels of domestically held public debt, lack of fiscal discipline, potential for spillovers and contagion, implausible optimistic growth forecasts, slow resumption of market access, and the political economy of debt restructuring.

The Required Size of the Debt Reduction

The required debt reduction to achieve lasting debt sustainability can be large in some countries (see Table 9.6). This can be shown using assumed debt sustainability target levels. For example, if Caribbean countries aspire to achieve a 60 percent debt-to-GDP ratio, the median haircut, without fiscal adjustment, amounts to about 25 percent of GDP. With this debt target, Jamaica and St. Kitts and Nevis (using their pre–debt-restructuring debt ratios) would require the largest haircuts—of 58 percent and 61 percent, respectively. On the other hand, using the natural debt limit concept of debt sustainability (see Chapter 6), and using the Caribbean average natural debt limit of about 30 percent of GDP, the median haircut, without fiscal adjustment, for public debt to achieve sustainability would be about 88 percent of GDP. With this debt target, six countries would require a haircut of over 60 percent of GDP on their public debt ratios.11

Table 9.6

Illustrative Required Haircuts to Achieve Debt Sustainability by Country

(In percent of GDP)

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Source: Author’s calculations.

The Share of Public Sector Debt Held Domestically and By Multilateral Agencies

At the same time, eligible debt is largely held by domestic agents or multilateral financial institutions. As noted in Chapter 3, the structure of the public debt for the highly indebted countries in the Caribbean is skewed toward domestic debt, with the domestic financial sector being the key holder of domestic debt. Therefore, the scope for traditional approaches is limited as large debt writeoffs raise the risks to financial stability. Further, in some countries a large proportion of foreign debt is held by multilateral institutions, which have only provided debt relief to the very poorest countries. Even so, except for Guyana and St. Vincent and the Grenadines, where multilateral debt represents about one-third of total public debt, the relief from reducing multilateral debt may be limited.

Access to External Private International Debt Market

Even after undergoing debt restructuring operations, a number of countries have failed to regain market access. Does this reflect the private sector’s perception that the public debt remains high and the economy highly vulnerable?

The Tendency for Short-Lived Fiscal Consolidation Efforts and Weak Macroeconomic Policy Frameworks

Debt restructuring is often necessary, but it is rarely sufficient to deliver sustained debt reduction. To be successful, debt restructuring operations must be supported by credible policy reform programs to restore fiscal sustainability, maintain creditor confidence, and lock in the gains of any debt relief. The general observation in the Caribbean has been that fiscal consolidation efforts are short lived and mostly insufficient to deliver sustained reductions in the public debt ratio. In addition, macroeconomic policy has not always responded appropriately to exogenous shocks, leading to a continuous buildup of public debt.

The Potential for Spillovers and Contagion Effects

The Caribbean has a relatively high level of financial integration. As a result, a cluster of debt restructurings in one Caribbean country can impact other countries through the financial sector, including banks, social security schemes, and some insurance companies, which hold a portfolio of regional government securities. In addition, for the countries of the ECCU which have a closely connected banking system, spillovers from a debt restructuring in one country (potentially) can create a systemic banking crisis for the entire currency union if mitigation measures are not adopted.

Optimistic Projections

Debt restructuring scenarios and instrument design have not sufficiently taken into consideration the reduced long-term growth prospects and macroeconomic vulnerability of Caribbean economies. As a result, some of the new offers, post-restructuring, have been based on overly optimistic assumptions about future growth. A good example of this is the use of step-up interest rate instruments that have not worked well where they have been tried in the Caribbean. These instruments appear to have sown the seeds of additional debt restructurings/defaults in the countries where they have been used.

The Political Economy of Domestic Debt Restructuring

Domestic debt restructuring can result in income and wealth redistribution among constituents. The government can determine the distribution of these losses based on income or the capacity of the economic agents to absorb the losses on their balance sheets. Domestic debt restructuring can therefore have a high ‘political cost’ if not managed effectively. This can be especially so if financial stability is threatened in the restructuring process or if an important domestic constituency is adversely impacted.

Is There a Case for Further Public Debt Restructurings?

High debt levels represent a significant burden on many economies in the region, and strong policy frameworks are necessary to put debt on a steady downward trend.12 Notwithstanding debt relief and rapid growth in some Caribbean countries in the years preceding the global economic crisis, by 2011 the average debt-to-GDP ratio had risen above its 2001 level to about 82 percent of GDP, with significant differences across countries.

As discussed in Chapter 6, Caribbean countries can be classified into three groups with respect to their public debt situation (see Figures 9.3, 9.4, and 9.5):

  • Countries that have stabilized their public debt ratios at below 60 percent of GDP (including Suriname and Trinidad and Tobago). They have low debt-service payments of about 12 percent of total revenues, including interest payments of 8 percent of revenues. These countries are at low risk of debt distress.

  • Countries whose debt-to-GDP ratios range from 60 to 90 percent of GDP (including Belize and St. Vincent and the Grenadines). Some of these countries have debt ratios that are stabilizing, but others, in the absence of further adjustment or debt relief, face rising debt ratios and are at risk of debt distress. A further factor that would affect the risk of debt distress is the debt structure and the amortization profile (see Chapter 3). On average, these countries have debt service payments of about 22 percent of total revenues (with interest payments of 9 percent of revenues).

  • Countries that have debt-to-GDP ratios above 90 percent of GDP (including Barbados, Grenada, and Jamaica). Their total debt service averages about 34 percent of total revenues (with interest payments of 19 percent of revenues), and their primary balances are insufficient to reduce or stabilize their debt ratios. These countries are generally at a high risk of debt distress.

Figure 9.3
Figure 9.3

Changing Size of Public Debt, Caribbean Region, 2001–11

(Unweighted average; percent of GDP)

Source: Author’s calculations.
Figure 9.4
Figure 9.4

Public Debt by Country, 2011

(Percent of GDP)

Sources: IMF staff reports; and author’s calculations.
Figure 9.5
Figure 9.5

Debt Service by Country, 2011

(Percent of revenues)

Sources: IMF staff reports; and author’s calculations.

Sustained large fiscal adjustments may not be sufficient in a number of countries. While there is no consensus on a specific debt-to-GDP ratio that could serve as a reference point for concern about debt sustainability, recent IMF staff studies suggest that a threshold of 60 percent should trigger a careful assessment of a country’s debt sustainability to determine the risk of debt distress.13,14 Indeed, a debt-to-GDP ratio of 60 percent has been commonly used as a ceiling in fiscal responsibility laws and in the context of regional integration agreements, including the ECCU, as discussed in Chapter 6. In a number of countries, reducing the debt ratios to 60 percent of GDP would require maintaining sizeable primary surpluses over a sustained period (averaging 7 percent of GDP over a 10-year period). Some of the required adjustments are so large over a sustained period that they may not be economically, socially, or politically feasible (see Figures 9.4 and 9.5 and Appendix Table 9.1). In addition, most countries have large negative international investment position, low average growth rates, and high debt and debt-service-to-revenue ratios (see Appendix Table 9.1).

At the same time, since the onset of the global financial and economic crisis, GDP growth has decelerated sharply and the recovery is now being held back by high debt and a weak external environment. The median medium-term growth projection (for tourism-dependent economies15) has fallen since the global crisis from about 3.6 percent before the crisis to about 1.7 percent. In light of this, some of the assumptions upon which debt was contracted have substantially changed, and it may not be feasible to adjust the fiscal policy to correct for growth short falls.

Without reforms to boost competitiveness, sustained fiscal retrenchment will further depress economic activity. While fiscal consolidation is generally believed to lead to a real depreciation of the exchange rate, this adjustment usually takes an extended period of contraction/depression, which may not be feasible in an already depressed economy. Long-lasting improvements in competitiveness would require a number of structural reforms to improve the non-price competitiveness and business environment of the region. In this context, easing the debt overhang could both provide fiscal space and permit a lowering of distortionary taxes so that private enterprise could once more thrive.

What Additional Options are Available?

Caribbean economies will need to develop new and innovative approaches to reduce their debt burdens and also seek to address their fiscal difficulties much sooner than they have done in the past. In particular, the countries should seek the assistance of the IMF much earlier than they have done in the past, especially when their challenge involves fiscal reform and adjustment.

Innovative Solutions to Debt Restructuring

Among the possible options are debt or equity swaps, such as those that are being pursued in St. Kitts and Nevis, and domestic debt exchange operations, such as was undertaken by Jamaica.16 Debt conversions offer opportunities for both domestic and external debt reduction. On the domestic front, a number of public enterprises can be privatized through this mechanism. This will facilitate a reduction in public debt, an increase in private sector activity, and improved productive efficiency. On the external front, the PetroCaribe arrangement17 already provides an option for debt repayment using goods and services; it can be used by Caribbean countries that are in a position to do so (an example is Guyana, which exports rice in exchange for a reduction of its PetroCaribe debt). It is important to emphasize that each country would have to examine its circumstances to determine a debt reduction strategy that best meets its needs given the constraints it faces.

More generally, Caribbean governments may want to consider issuing debt that is linked to GDP growth performance as a way of easing the pressure on public finances during recessions. In this way, a fall in GDP growth would mean lower debt payments and less strain on the public finances.

Leveraging the Catalytic Role of the IMF

Both in the context of IMF-supported programs and also more broadly, the IMF is playing a critical role to help mobilize the resources that countries need. This is particularly the case in two areas:

  • Resources from donors and multilateral institutions: IMF-supported programs are designed to ensure that the adjustment efforts undertaken by the country, together with the financing available, will be adequate to close any residual financing needs and achieve debt sustainability. In that respect, IMF programs play a critical role in mobilizing resources from foreign donors and multilateral creditors and ensuring a viable medium-term macroeconomic strategy.

  • Framework for debt restructuring: While strong policy frameworks are necessary to put debt on a steady downward trend, in some cases they need to be supplemented with market-friendly debt restructuring. The IMF has played a role by identifying the envelope of resources available for debt service payments. Other multilaterals have also made important contributions, such as providing guarantees and financing contingency funds.

The recent experience with debt restructurings in the Caribbean provides helpful guidance as to what can be done. It also confirms the importance of close coordination with creditors to design a menu of options carefully calibrated to deliver optimal results given policy constraints in each country. Finally, it underscores the importance of effective communication of the government’s economic policy and strategy. However, the structure of the Caribbean debt, in which a large share is held by the domestic financial system, imposes limitations to the scope of traditional debt restructuring.

Looking ahead, the IMF can help catalyze additional external resources to assist the region in its adjustment efforts. Greater reliance on external multilateral rather than domestic financing would reduce borrowing costs and free up resources from the domestic banking system that it can lend to the private sector, which would help finance growth.18 These strategies would have to be buttressed with carefully calibrated policies to raise production and productivity in key export sectors.

Conclusion

In this chapter we discussed some key issues related to public debt restructuring in the Caribbean. Given some of these countries’ high debt burdens and diminished growth prospects, a strong case may be made for debt restructuring to reduce debt and restore fiscal sustainability. This chapter has also shown that much of the past major international debt relief (such as the Brady Plan and HIPC) has not been available to the majority of the Caribbean nations, most of which are middle income. At the same time, many of these nations have had several rounds of debt restructuring, yet most are still highly indebted, and accordingly remain highly vulnerable to macroeconomic shocks. That said, there are several lessons to be learned from the successful debt restructuring cases in the Caribbean, including the need for a credible macroeconomic framework to lock in the gains of debt relief. Finally, the Caribbean should leverage the IMF’s catalytic role in its adjustment efforts while adopting broad base reforms to reduce macroeconomic vulnerabilities and boost export competitiveness.

Several policy implications can be drawn from these insights. First, there is a need for a holistic economic strategy over the medium term, anchored in debt sustainability. Second, nontraditional debt reduction and restructuring strategies are likely to have a key role in restoring fiscal sustainability given the structure of the region’s debt. Third, policy reforms that lock in the gains of debt relief for future generations would be essential to avoid a repeat of unsustainable fiscal outcomes.

Appendix 9.1. Key Elements of Successful Debt Restructuring: Lessons from Recent Episodes in the Caribbean

Credible economic program: A credible policy reform program is required to restore fiscal sustainability, maintain creditor confidence, and lock in the gains of any debt relief.

Effective communication: A credible and transparent communication strategy on the government’s economic policy and strategy targeted at creditors and other stakeholders is key to a successful debt restructuring. This was particularly critical in Dominica and in Jamaica, where the authorities explained to the bondholders the economic situation facing the government and the options available, along with the cost of each.

Ownership of economic policies: Country ownership of the broader economic reform strategy by the authorities is critical for successful outcomes. Antigua and Barbuda, Dominica, and St. Kitts and Nevis remained committed to fiscal adjustment, even in the face of severe contraction in GDP.

Contingency planning: A contingency fund to safeguard financial sector stability during debt restructuring operations is critical for domestic debt restructuring. These funds have been important in maintaining public confidence in the financial system and in providing liquidity in both Jamaica’s and St. Kitts and Nevis’ debt restructuring cases.

Case-by-case analysis: One size does not fit all countries. A menu of options, carefully calibrated to deliver optimal results given policy constraints, is required for successful debt restructuring. No single option will work for all countries; each restructuring has to be designed, case by case, based on an analysis of the objective conditions.

Multilateral support: The support of the multilateral organizations was key to the success of the recent successful debt restructurings. Of particular note is the recent innovation of providing a guarantee on restructured instruments, in the case of St. Kitts and Nevis, and more broadly the provision of funding, as in the case of Jamaica.1

IMF involvement: An IMF fiscal adjustment program has been a key component in the recent debt restructuring cases of Antigua and Barbuda, Dominica, Grenada, Jamaica (2010), and St. Kitts and Nevis. This has enhanced the IMF’s engagement with the countries and its role as a policy advisor with respect to assessing the sustainability of different policy options and in clarifying the financing gaps along with providing financing for three cases. The IMF also has an important review and monitoring role in the implementation of the agreed adjustment programs.

Even in cases where no formal IMF adjustment program has been agreed, the bond/loan holders look at the IMF’s assessment. The private sector relies on IMF assessments to clarify the consistency and credibility of a country’s economic program in restoring growth and promoting debt sustainability.

Technical team: Governments that are contemplating debt restructuring operations need to establish a strong technical team, including professionals with legal, economic, financial, negotiating, and public relations skills. Further, this technical team must have strong political support and be empowered to take decisions.

Appendix 9.2 Selected Indicators

Appendix Table 9.1

Caribbean Region: Selected Indicators, 2011

article image
Sources: IMF, World Economic Outlook (October 2012), and International Financial Statistics database; and author’s calculations.

Median ratings published by Moody’s, Standard and Poor’s, and Fitch.

The Bahamas: Staff Report for the 2012 Article IV Consultation (IMF, 2013e).

Caribbean Development Bank Country Poverty Assessments, accessed at http://www.Caribank.Org/publications-and-resources/poverty-assessment-reports-2.

Guyana: Staff Report for the 2010 Article IV Consultation (IMF 2010).

Jamaica: First Review Under the Extended Arrangement Under the Extended Fund Facility and Request for Modification of Performance Criteria (IMF, 2013c).

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1

This section is based on Das, Papaioannou, and Trebesch (2012), who examined cases that occurred between 1950 and 2010.

2

See Boughton (2001, p.547).

3

Over time the level of debt relief granted by the Paris Club has increased somewhat. Starting in 1988, the Toronto terms provided relief of 33 percent, which increased to 67 percent under the Naples terms in 1994 and further expanded with the HIPC initiative to 80 percent under the Lyons terms and then to 90 percent under the Cologne terms by the end of the 1990s. In 2003, the focus shifted to include debt sustainability with the launch of the Evian terms, which offered debt relief to non-HIPC countries.

4

The Inter-American Development Bank also delivered MDRI relief to some countries, including Guyana.

5

In the case of Jamaica, however, the 2013 debt exchange operation was a prior action for an IMF program.

6

In the countries, that make up the Eastern Caribbean Currency Union (ECCU), three markets can be identified, the narrow domestic market (the market within the country borders); the regional government securities market (the market for the currency union); and the external or extraregional market.

7

Two caveats need to be noted. First, in the assessment of macroeconomic outcomes, the impact of debt restructuring on expectations is not assessed. Expectations of agents can of course be an important factor in economic outcomes before and after debt restructuring. Second, care must be taken in the interpretation of these results as restructuring in some countries occurred during the 2008–09 global financial crisis, which severely affected tourist arrivals to many of these countries, causing GDP growth to contract sharply.

8

Inflation was slightly higher in Dominica and St. Kitts and Nevis three years after the debt restructuring than three years before.

9

Inflation was slightly lower in Belize three years after debt restructuring than three years before.

10

It must be noted that in Antigua and Barbuda, arising out of the effects of the global economic and financial crisis, two banks had to be rescued and these may affect the observed ratios.

11

It is important to note that this calculation is done for illustrative purposes only. It does not imply, for example, that a country must restructure once the debt level exceeds a certain level. Debt sustainability is a mix of judgmental exercises and is determined by a number of different factors, including, but not limited to, debt level, speed of debt reduction, creditor base, currency structures, interest rate structures, and liquidity conditions. Finally, it needs to be determined on a country-by-country basis.

12

See Appendix 9.1 for some lessons from recent debt restructurings in the Caribbean.

13

IMF (2011) indicates that based on recent empirical evidence, the reference point for public debt of 60 percent of GDP is to be used flexibly to trigger deeper analysis for market-access countries. The presence of other vulnerabilities would call for in-depth analysis even for countries where debt is below the reference point.

14

The debt target of 60 percent of GDP has been embedded in the IMF Stand-By Arrangements for Antigua and Barbuda and for St. Kitts and Nevis.

15

Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

16

In these efforts, special attention has to be given to the political economy implications of these strategies, as they may involve the shifting of the adjustment burden from one group of domestic agents to another.

17

The PetroCaribe Arrangement is an oil purchase agreement between the government of the Republic of Venezuela and many governments in the Caribbean. Under this arrangement member countries are permitted to defer payment for up to 90 percent of the oil shipments for up to 25 years. The repayment terms include a two-year grace period, and interest rates are concessional. More broadly the arrangement provides for the repayment of oil debt through goods and services by borrowing countries.

18

This, of course, would also need to be managed within a fully articulated debt management strategy that takes into account the cost-risk trade-off. An important risk from foreign borrowing that must be managed is the foreign exchange risk.

1

In 2008 the African Development Bank provided a guarantee of restructured debt instruments for Seychelles. This model was adopted by St. Kitts and Nevis in its 2012 debt restructuring operation.

Contributor Notes

For the purposes of this discussion, the Dominican Republic and Haiti have not been included. Some parts of this chapter draw on Gold and others (2012). The chapter has benefited from some very useful suggestions and comments from Takahiro Tsuka and Charles Kramer.
Tackling Fiscal and Debt Challenges
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    Total Public Sector Debt, Selected Caribbean Countries, 2004–13

    (Percent of GDP)

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    Debt Service, Selected Caribbean Countries, 2004–13

    (Percent of GDP)

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    Changing Size of Public Debt, Caribbean Region, 2001–11

    (Unweighted average; percent of GDP)

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    Public Debt by Country, 2011

    (Percent of GDP)

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    Debt Service by Country, 2011

    (Percent of revenues)