A. Proposed Reforms to the LIOA Policy

14. More explicit guidance on the application of the LIOA policy is essential for the Fund to provide financial support to member countries. The policy already allows for additional safeguards. Being more explicit about when such safeguards are warranted would be important for treating creditors in the same way, for providing greater certainty to both creditors and debtors about the process and judgments that the Fund will need to make (allowing these to be internalized in their decision-making and overcoming creditor inter-dependencies), and thus ultimately for speeding up restructuring processes and arrears resolution. Introducing further transparency is also critical to help the Fund explain to the broader public why it is taking certain approaches.

The 2015 Pathways Under LIOA

15. The use of strand 1—where the Fund works with a representative forum—should remain the Fund’s central focus. A representative forum is more efficient at coordinating creditors and can support a restructuring in ways that the Fund cannot, including by shepherding actual negotiations and ensuring CoT among official bilateral creditors. While cases under the CF have involved significant delays, there has been a trend improvement in time required, and staff is confident that this can be sustained. Thus, staff does not propose any change to strand 1.

16. The Fund must remain willing to utilize consent and/or application of the three criteria to some creditors without seeking additional safeguards.

• Consent. Where creditors work well together and first mover problems do not exist, consent is the fastest route forward and will provide adequate safeguards. In particular, ensuring that a majority of creditors consent to Fund financing despite arrears strengthens the pressure on the debtor to work in line with program parameters and ultimately can help secure compliance with CoT provisions. In turn, this justifies that safeguards are in place for Fund lending.

• Application of the three criteria. It remains important for the Fund not to allow a holdout creditor to subvert the will of the international community to assist a Fund member. At the same time, preserving prospects for cooperation on future financing is critical for the Fund to discharge its mandate to help its members restore medium-term external viability and solve balance of payments challenges. The staff in particular value the carefully built and maintained relationships with the Paris Club and major non-PC creditors. Still, it could be possible to apply the three criteria to a creditor who could have an important role for future financing. For example, it is possible in the future that such a creditor could shift to a non-cooperative stance with the Fund, signaling no chance for cooperation on future financing regardless of how the Fund proceeds. Staff does not presently see any creditors that raise such a risk, but this will be kept under review. Also, there may be cases in future that involve specific considerations that mitigate future financing or even majority concerns. These would perhaps involve unique noneconomic disputes between the relevant debtor and creditor. In all cases, the Board would need to have the final call, advised by staff.

Utilizing Additional Safeguards—Proposed LIOA Strand 4

17. As noted above, the Fund has been using additional safeguards when the LIOA pathways alone cannot provide a way forward, and this requirement needs better definition. There are three issues to deal with. First, how to determine that the existing LIOA pathways alone cannot provide a way forward (and that there is thus a need to secure additional safeguards). Second, what these additional safeguards could be. Third, how to apply them in a straightforward and even-handed way linked to the circumstance.

18. The threshold issue is how to determine that the existing pathways under LIOA cannot provide a way forward.

• A first case to consider is whether the requirements under strand 1, or a combination of strands 2 and 3, can be met. It is generally straightforward to make such a determination, starting always with the Fund's preferred route, working with a representative standing forum (see Box 3).

• A second case may arise where it is possible to apply the second and/or third strands, but the Fund requires additional safeguards. This would include situations where exceptional access is proposed (and thus a high probability of debt sustainability must be assessed, per the second exceptional access criterion).¹¹ It would also include situations under normal access where: (i) a creditor's authorities have conveyed that though they consent, they have no intention of restructuring in line with program parameters; and (ii) creditors communicate to Fund staff a desire for strong support to creditor coordination. Leaving such situations unaddressed would portend future program problems which accordingly should be addressed upfront.

19. There are three types of safeguards that can be applied, when needed. These are: (i) program design elements (i.e., phasing and conditionality); (ii) commitments from the debtor to creditors on good faith efforts (which embeds an intention to deliver comparability of treatment); and (iii) direct commitments from a "sufficient set” of creditors to the Fund about their restructuring intentions. These safeguards can together help assure that a sufficient stock of the arrears will be resolved, that other official bilateral creditors will be brought in to resolve arrears on similar terms, and that the restructuring will be agreed in a timely manner by a sufficient set of creditors within the program period.¹² Conversely, without program design to better pin down a timeline, a restructuring would likely become elongated, with the negative impacts seen in present cases, and safeguard issues for the Fund . Without the right approach by the debtor, creditors would likely wait each other out and resist proceeding with a debt restructuring. And without a sufficient set of bilateral official creditors committed, other creditors would be more likely to hold out.

20. To operationalize a straightforward approach to additional safeguards linked to (evolving) circumstances, staff proposes the following (Figure 2):

• To seek additional safeguards in two cases. First, when strand 1 (and 3) are not available, and consent is not forthcoming by 4 weeks after a staff request for such (though staff may choose to wait longer if deemed useful). Based on consultations with creditors, staff believes that allowing 4 weeks would appropriately balance the need to move forward with the Fund-supported program, and the need to give creditors time to assess their desired modalities for cooperating with each other and with the Fund. Second, when the program would involve exceptional access, staff would need to explain to the Board the basis for a determination that additional safeguards would be needed.

• To set a standard approach for normal access cases (i.e., the "standard safeguards approach”). This would be based on a combination of program design elements and debtor commitments to creditors to establish safeguards for Fund lending. Essentially this would involve an arrangement with capped initial access, with program conditionality to support the restructuring process (where warranted under the GoC), and a commitment from the debtor to good faith efforts. Box 4 discusses this in more detail. This approach would be expected to catalyze progress from creditors concerned about coordination (i.e., because they are reassured by the debtor's commitments and/or by the clarification of the timeline and steps in the restructuring provided by program design elements). This builds on what was done at program inception for Suriname.

• To set a standard approach for exceptional access cases (i.e., the "enhanced safeguards approach”).¹³ This would involve the "standard safeguards approach” described above, and in addition, a direct commitment to the Fund by a "sufficient set” of creditors about their restructuring intentions (i.e., a "financing assurance”, as discussed in the next section). Note that if a sufficient set commits, then creditor coordination has de facto been achieved. Other creditors' arrears would be deemed away for the purposes of Fund arrears policy.¹⁴

This is similar to the approach taken at arrangement approval in the case of Sri Lanka.

• To expect the standard safeguards approach to be used in regular access cases but allow a shift to the enhanced safeguards approach informed by explicit signals from significant creditors. The latter would be defined as a creditor or creditor group regarding whom the three criteria could not be satisfied. Staff would need an explicit signal from such a creditor (or creditor group) that it was unwilling to restructure in line with program parameters, or that it saw an essential need for the Fund to support greater creditor coordination. As noted, where such a creditor or creditor group makes such signals, problems lie ahead, and it is best to resolve them upfront to derive the safeguards required for Fund lending so as to help the member address BoP problems and restore medium term external viability. The Staff Report would explain why the enhanced approach was invoked, which creditor(s) requested it, why the use of direct creditor coordination mechanisms was not feasible in the situation, and any efforts made by creditors to directly coordinate.

• To immediately shift to strand 1 if it becomes available. It is possible that in some circumstances, efforts to achieve the enhanced safeguards approach could lead creditors to decide to coordinate more formally through a recognized forum. In such a situation, the Fund's approach would revert to LIOA strand 1 (with any realized safeguards preserved).

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Proposed LIOA Policy with Strand 4 Safeguards

Citation: Policy Papers 2024, 017; 10.5089/9798400273704.007.A001

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21. A key underpinning to this approach concerns the debtor’s commitment to good faith efforts including CoT, and it is important to consider how the Fund can support this consistent with its policies. Note that CoT considerations are currently given weight under Fund policies, and staff proposes to further strengthen the incentive Fund policies provide. There are three distinct time periods to consider:

• The period between when there is an agreement-in-principle on the restructuring and the conclusion of the debt restructuring agreement. If during this period creditors raised concerns about CoT, this would almost certainly prevent a conclusion of the agreement. Creditors would indeed likely want to revisit the agreement-in-principle to better secure CoT. Any pending financing assurances review under the Fund supported program would then have to take into account this important development in debt-creditor relations. The program would likely not be able to move forward until this could be resolved. In this way Fund policy can already give weight to CoT considerations.

• The period between the completion of the debt restructuring agreement (when arrears are resolved) and the end of the program. If a restructuring agreement was in place and arrears resolved, financing assurances reviews would no longer apply. However, a decision by creditors to trigger CoT claw backs would create financing and possibly sustainability gaps in the program, which would need to be closed for any program review to proceed. In this way, Fund policy again already gives weight to CoT considerations.

• The post-program period. Once a program is concluded the Fund does not presently have a mechanism to support continued CoT. The Fund could, however, create a deterrent. This could be done by modifying the arrears policy to re-classify any new arrears that arise due to the exercise of a CoT clause. These arrears would in this proposal be seen, in the context of a new arrangement, as "not OSI-related” for arrears policy purposes, even if further OSI would be required. This treatment would subject such arrears to the Fund's non-toleration of arrears policy (as opposed to OSI-related arrears which fall under the LIOA policy). While this would not rule out the restructuring of such arrears, it would require the non-objection or acquiescence of that creditor to the Fund approving any new financing and/or completing any subsequent reviews, providing the aggrieved creditor extra leverage. This proposal would thus be a deterrent by raising the ex-post cost for all involved (but its effectiveness does rely on the debtor authorities recognizing and internalizing this).¹⁵

22. A second key underpinning concerns how to define a “sufficient” set of creditors from whom to seek a commitment under the enhanced safeguards approach. The issue of how to make an assessment about commitments of individual creditors in the "sufficient set” is left to section C. A simple definition of the sufficient set—analogous to the approach under LIOA strand 1—would be to look for an "adequately representative” set; that is, a creditor or a group of creditors that accounts for a majority of the total financing contributions required from official bilateral creditors over the program period (covering both the restructuring and new financing). A more appropriate definition (in view of the aim to more clearly establish Fund safeguards and/or resolve a deeper creditor problem through collaboration with creditors) would require involvement of any representative forum (whose members are creditors), and any creditors with influence over the debtor. Such creditors also need to be "at the table” with a voice. In this context:

• A creditor could be considered as having potential influence over the debtor if it has the ability to extract repayment on more favorable terms inconsistent with program parameters. Indicators of this include enforceable and economically meaningful collateral or collateral-like features in its debt contract; a share in the total debt stock or debt service flows that is high (e.g., among the top three creditors); or if its total BoP relationship with a country (trade and capital flows) is high (e.g., in the top three countries over the previous 5 years).¹⁶

• However, case-specific mitigating factors would also need to be assessed by staff, for instance the inherent flexibility in the debtor countries' trade (e.g., because the country has alternative sources of supply in theory); or whether the collateral is playing a positive role (i.e., "related” collateral which would directly give rise to repayment capacity).¹⁷

23. Staff proposes embedding the standard and enhanced safeguard approaches in the LIOA policy under a new fourth strand. This strand would be applied when the existing three strands cannot alone provide a way forward; or when the Fund determines that additional safeguards are needed (per the considerations in paragraph 20, bullet 1). Under this new strand, the Fund would consider lending into official arrears only if the safeguard requirements described in paragraph 20 are met, according to the type of case. The assessment required in any one case would be a judgement by the Board, informed by advice and assessment from staff (based on the factors listed above).

B. Proposed Reforms to Financing Assurances Reviews

24. The Fund presently has a procedural tool under the LIA and LIOA policy, the financing assurances review, but the lack of a systematic approach limits its effectiveness in practice. Under the policy, the financing assurances review is required to take place alongside normal program reviews so long as there are unresolved arrears. It is supposed to assess whether adequate safeguards remain in place for the further use of the Fund's resources and that the debtor's adjustment efforts have not been undermined by developments in debtor-creditor relations. While originally envisaged as a substantive safeguard, financing assurances reviews are often not reported in any meaningful depth at present. And while in many cases there are substantive discussions among departments about whether assurances have been obtained, the extent of engagement with the authorities, creditors, and their advisors may not always be as structured and deep as desirable and often the Board may not have deep enough insight into this engagement and the overall process.

25. Staff proposes to make Fund financing assurances reviews more effective, consistent with the original intent of the LIA policy and the Guidelines on Conditionality (GoC). This would involve further guidance on both the arrangement approval and review stages (for programs where a financing assurances review under either the LIA and/or the LIOA policy is required):

• The Staff Report for the arrangement request would be expected to present a clear depiction of the expected steps and the schedule for a restructuring process. This would be based on an understanding of the schedule developed with the debtor and its advisors, and would cover key steps (e.g., information sharing, offers, etc.). The timeline would be understood to be indicative, and the Staff Report would need to be clear that the timeline would be subject to change in the event of material developments. Consistent with current Fund policy, there should be clarity about the creditors involved, and the process being utilized (e.g., common framework, PC and others in parallel, etc.).

• The subsequent financing assurances review would then be expected to draw on the indicative steps and schedule to give a clear assessment of the progress with the debt restructuring and whether it remains on track to ensure that overall program objectives are met (i.e., restoring debt sustainability and medium-term external viability).

• At the financing assurances review stage, a determination would also have to be made about whether the Fund still has appropriate safeguards to proceed with the financing. Where the restructuring is on track or even ahead of the indicative schedule, that conclusion would be normally within reach without further actions. However, lack of progress could raise concerns. The LIOA policy would need to be satisfied in any event, and the strand that applies could differ from the one originally applied, especially in the absence of progress. Thus, if strand 1 had been pursued at arrangement approval, it would be possible to apply (further) safeguards related to program design, if lack of progress raised concerns; and if strand 2 and/or strand 3 were utilized at arrangement approval, it would be possible to move to either the standard or enhanced safeguards approach under strand 4 if lack of progress raised concerns. If additional safeguards had already been applied at the arrangement approval stage, then it would be possible to further strengthen the safeguards utilized under the standard case or even apply the enhanced safeguards approach. Finally, in the same situation, where the exceptional access safeguards approach had been applied at arrangement approval, it could be possible to consider additional safeguards covering phasing and conditionality, but it would usually be appropriate to require agreement in principle on the official sector restructuring as a condition for completing the financing assurances review.

• Consistent with current requirements, inability to complete a financing assurances review would require holding the program pending progress in line with the initial indicative timeline or possibly with the application of additional safeguards.

• In completing a financing assurances review, where the restructuring remained outstanding, there would be a continued expectation of a clear depiction of steps and an adjusted indicative schedule, to facilitate a subsequent review.¹⁸ The Fund's Executive Board would have the opportunity, in the context of its Summing Up, to calibrate the message to the debtor and creditors/creditor forum about the urgency in moving through the next envisioned steps.

26. In line with the proposal to use financing assurances reviews to more effectively monitor progress in debt restructurings, going forward, the application of strand 1 under the LIOA to arrears arising after the date of adoption of this proposal would also require the completion of a financing assurances review until such arrears are resolved.

C. Proposed Reforms to the Fund's Financing Assurances Policy

27. The Fund's financing assurances policy for debt restructuring situations is optimized for the previous official bilateral creditor landscape.¹⁹ There are two dimensions to consider:

• Modalities for assessing that financing assurances are in place. The Fund has a very long history of close collaboration with the PC. The PC's well-developed processes, the underlying creditors' internal processes, and PC creditors' collective track record of timely treatments in line with Fund program parameters allow a simple and straightforward process for assessing that assurances are in place. These are derived from the PC's chair summing up at the end of a Club meeting, based on a working paper and in anticipation of an Agreed Minute. For non-PC creditors, the Fund has sought specific and credible assurances on debt relief/financing. This has come to entail written and/or verbal communication from the creditor, committing to negotiate a treatment to restore debt sustainability consistent with program parameters. However, as noted above, this has often resulted in lengthy processes and frictions with individual creditors due to their domestic legal requirements and constraints. The content of SCAs inevitably differs and could raise questions about comparable treatment across non-PC official creditors. Moreover, the approach falls somewhat short of what is received from Paris Club creditors when the creditor in question does not have the same history of successful and timely delivery of debt treatment standing behind it, again creating uniformity of treatment concerns among creditors.

• Approach to creditor coordination mechanisms. The PC plays a unique role in Fund policies as currently the only representative standing forum recognized by the Fund for purposes of the arrears policies. That unique role extends to situations where it cooperates with other creditors ("PC+" agreements, as well as CF agreements where the PC is involved, i.e., due to individual member involvement). Fund policy allows engagement with another such forum should it arise, and it would be useful to assess under what circumstances the CF can be considered a representative standing forum under the LIOA policy outside of the context of PC involvement. At the time of the 2022 LIOA policy review, most Directors agreed that more experience is needed in order to recognize the CF as a representative standing forum and welcomed staff's plan to closely monitor the CF's evolution and revert to the Board.²⁰ In the absence of CF work without PC involvement, staff is not in a position to revert at present.

28. The issues with the Fund’s approach to securing financing assurances are extremely difficult to resolve in the near term. Individual creditors' internal processes (including legal frameworks) can differ markedly and cannot be expected to change in short order, nor to completely mimic the PC procedures around which Fund policies revolve. Track records also vary considerably, and by definition will take time to change. A potential solution exists in the form of expanding the membership and reach of existing creditor coordination mechanisms (i.e., the PC or CF), and Fund staff will continue to support this, as it is the preferred approach. However, such a change is outside the control of the Fund, and in any event cannot be assumed to be feasible at a near-term horizon.

29. Against this backdrop, staff has focused on a reform proposal focused on creditor processes that could help mitigate these issues over time. Staff proposes that the existing requirement for a creditor to commit to deliver a restructuring in line with program parameters be operationalized through an assessment that a "credible official creditor process” (COCP) is in place. This would re-orient the Fund's approach towards a Fund assessment of processes as opposed to the delivery of specific statements by a creditor, eventually eliminating frictions and superfluous steps. Such a judgement about processes would need to be informed by an official creditor's track record of debt treatment delivery. Thus, it would not be immediate, but once such a judgment would be taken it would be assumed to thereafter apply (absent new developments to suggest otherwise). The proposal would apply to all cases where such creditor commitments are currently sought including: (i) pre-default cases; (ii) strand 1 cases where the representative standing forum is giving the Fund assurances; and (iii) the proposed enhanced strand 4 cases where the Fund would seek commitments from a "sufficient set" of creditors.

30. The reform proposal can be operationalized in a relatively straightforward way. Staff would need to understand: (i) the steps in the official creditor's internal process; (ii) the key decision makers involved (i.e., those with authority to commit the creditor); (iii) the information provided to inform decision making at the relevant stage (i.e., macroeconomic outlook, debt targets, possible restructuring approaches);²¹ and (iv) the timeframe over which the decision would be expected to be executed (which should be in line with the Fund's expectation that a restructuring would be agreed promptly, normally by the time of the first program review). Guidance would stress the need for staff to interact with and support a creditor's internal process (by providing information on a timely basis upon request, and by answering questions). Guidance would defer to the authorities' representation that a key stage of decision making had been passed, with the aim to just identify the nature of the decision and who took it. Having observed a few cases—the track record—staff would be in a position to establish the credibility of the "key stage” in the specific creditor's process in terms of delivering outcomes (i.e., contractually finalized debt relief and/or new financing consistent with program parameters).

31. Defined in this way the application of the COCP standard would mean the same standard, but with slightly different manifestations across different member circumstances:

• It would take account of specific features of creditor or creditor coordination mechanisms. It will be straightforward where the PC is involved, given its track record, including where it is involved via the CF process (and thus would help support use of the CF).^22,23 In the case of nonPC official bilateral creditors (or the CF without PC involvement) the approach would allow for a faster determination as track record builds (and the key decision-making stages in those processes, and their ability to deliver, become better known). Note that since any restructuring case typically involves multiple non-PC creditors, the process of establishing a track record for each of their processes could in principle move broadly at the same speed.

• It would take account of the type of treatment being sought from creditors and the track record with such specific treatments. For example, creditors may (already) have a longer track record for timely Net Present Value (NPV)-neutral reprofiling than for deeper treatments.

• To further illustrate how it may lead to different judgment across creditors (and over time), Appendix III describes the internal creditor processes in three PC members (setting aside the inter-creditor coordination stage at the Paris Club).

32. This proposal to assess COCP for official claims would differ from the existing standard for assessing “private creditor credible process” for restructuring of private claims. In the private sector context, there is generally a diverse set of small creditors subject to the contractual framework for resolving debt distress. The debtor country and its advisors play a critical role in managing this process, and the Fund's assessment can thus focus on the debtor's actions. The contemplated reforms would not affect the Fund's approach towards private creditors, which intentionally does not give such debtors a veto over Fund assistance and accepts that arrears may finance the program and may be outstanding for an extended period of time.²⁴ In contrast, in the official sphere, creditors enjoy greater leverage, including under Fund policies, and there may be significant creditors or groups of creditors with substantial additional leverage over the debtor in the case of hand. In such cases, the debtor's actions can no longer be relied on exclusively to guide the process forward, arrears can no longer be relied on to finance the program or be outstanding for extended periods of time, and a greater focus on the actions of the creditors and their processes is thus needed.

33. The Board would make the assessment advised by management and staff. Note that this is no different from what the Board does with an SCA. Importantly the fact that the standard may manifest in different ways in different circumstances implies that any such judgment needs to be made in the context of a specific country case. Management and staff would need to explain to the Board the basis for their judgment, citing the key elements of the process, and explaining the track record. Subsequent similar cases for the same creditor would not need to repeat the full explanation, absent new developments, and would just refer to the attainment of the key stage. Importantly, in the event the committed debt treatment is not delivered in a timely manner or at all, then staff would need to revisit the assessment and key in on a later stage in the creditors' process (looking for evidence that once that later stage is passed a restructuring gets concluded in a timely manner). This constitutes a key safeguard against incorrect application of the COCP (since any incorrect application would not set a precedent or lower bar for future cases).

34. In the absence of enough information and/or track record to reach a COCP judgment, it could be satisfied by a SCA. This would ensure a smooth transition to the new regime. Since this would involve continuance of the frictions and problems related to SCAs, Staff Reports would be expected to provide greater context to the SCA, also with a view to help establish the track record needed for an eventual COCP assessment and to ensure that modalities across creditors would be uniformly applied (i.e., that two similarly situated creditors received similar consideration for a credible process assessment).

35. Once the transition has happened, the approach would make the Fund more agile without taking significant additional risks:

• It would provide the Fund with a uniform way of interacting with creditors and creditor coordination mechanisms, while accounting for their varied circumstances. Note that the approach can align with the CF's processes (which may in fact be its first application), or with creditors' own processes, rather than imposing a particular form of assurances.

• In principle it can shorten the time needed for arrangement approval or review completion. For example, the Fund, in its assessment, would not need to wait for a creditor to meet the domestic legal requirements for giving SCA. That would allow the Fund to proceed in situations where there is a high degree of certainty that the treatment will materialize, but where SCAs would only be provided after lengthy internal authorizations fully run their course.

• In fact, with a sufficient track record, the Fund may be able to move its assessment earlier in the process. In this context, this could encourage non-PC creditors or any new creditor coordination mechanism to further refine their processes with greater efficiency in mind. And it would provide a strong incentive to build (and maintain) a track record of two-way communication and collaboration between the Fund and those creditors.

• Finally, it would provide at least as strong a safeguard as the current approach of seeking SCAs (indeed for a mature creditor process, like the PC, the two overlap perfectly). In this context, it is important to note that SCAs also represent a judgment by the Fund (i.e., that the assurance provided will lead to the restructuring outcome desired).

D. Proposed Reforms to Pre-Default Policies

36. Staff proposes extending key elements of financing assurances reforms to a predefault context. The same problems that appear in a post-default context exist in a pre-default context: the application of financing assurances requirements in a consistent and even-handed manner; and the depth of consideration given to debtor-creditor developments in program reviews (and whether safeguards remain adequate). The financing assurances requirement is further complicated in a pre-default context by limited guidance about who should provide a SCA i.e., the "materiality" test.²⁵ Overall, evening out requirements between pre- and post- default is important to avoid arbitrage opportunities across Fund policies. That is, in a pre-default state arrears may well lie ahead (as cooperative creditors push the debtor to stop payouts to other creditors, and sustainability considerations dictate a financing program with little space for repayments until a restructuring deal is reached).

37. Staff proposes to limit the request for financing assurances pre-default to a “sufficient set” of creditors. This would be defined in the same way as is proposed for the LIOA policy, strand 4 (see paragraph 22). The remaining creditors would be considered not material for the purposes of the assurances and assumed to restructure on program terms. This would bring transparency to the process of judging that adequate assurances are in place, without loosening the requirement versus present practice nor versus the LIOA approach.

38. Staff further proposes that, for debt restructuring cases in a pre-default context involving arrears to official creditors, a financing assurances review would be required under the financing assurances policy at each program review until agreement in principle on the debt restructuring agreement has been reached. In particular, a financing assurances review would help to document at each program review staff's assessment that the assurances provided about the official sector debt treatment's progress continue to meet the debt sustainability and financing assurances requirements. At such a review, staff would be expected to consider whether safeguards in place were adequate, and scaling them up, if necessary, in the manner described in paragraph 20, bullet 4.

E. Proposed Reforms to AIP

39. The Fund has a procedural tool—AIP—to bridge engagement gaps while safeguards are sought, but it is under-utilized due to design shortcomings. AIP was not designed to support extended efforts of debtor-creditor engagement in a restructuring context:

• AIP is a procedure that involves a first decision by the Board approving a Fund arrangement in principle based on a complete understanding between the Fund and the member on policies, but where financing assurances have not been secured. Once the financing assurances have been obtained, a second decision of the Board is required for the arrangement to become effective, and this is adopted on a Lapse of Time (LOT) basis. The original 1984 policy called for this second decision to be taken in a period normally not to exceed 30 days from the first decision but recognized that the period should reflect the member's circumstances.²⁶ The practice has varied, including some cases where the initial approval did not set a deadline and a few extending the deadline usually on a LOT basis. With the adoption of the 1989 Lending into Arrears policy for private creditors (LIA), the improved coordination among Paris Club creditors, and the adoption of the LIOA policy in 2015, AIP became less relevant, and the 1984 policy itself lapsed, but the practice is still available (with one recent use).²⁷

• In any event, AIP as currently designed cannot effectively be used in cases with lengthy creditor processes. AIP is only effective so long as the underlying economic program reflects circumstances on the ground and is being implemented. It can quickly become stale. Even setting aside that targets may be missed, a debt crisis typically involves a large flow of new information and high macroeconomic uncertainty, such that the program framework needs to be regularly updated. This is exactly why the Fund applies quarterly program reviews in cases with fast moving developments.²⁸ However, a review is not possible under AIP because the arrangement is not legally effective. Thus AIP, as currently designed, can be relied on for a few months at best, which cannot cover the time it takes for lengthy creditor processes to play out, based on recent experience. Not surprisingly it has been used rarely in the last 25 years.

40. The proposed adjustments to AIP are designed to help it bridge a longer period where needed.²⁹ They would set a time period for the AIP to apply, conditions for the AIP to be renewed, and broaden the conditions for the second AIP decision from "financing assurances” to "adequate safeguards” (as defined in the section on LIOA reforms). It would entail specifying several elements:

• The period between approval in principle and effectiveness of an arrangement. The first decision to approve in principle would be required to specify a date by which AIP would lapse, i.e., a deadline by which the second decision must be adopted on a Lapse of Time (LOT) basis. Factors in determining the deadline include the need to ensure that the program would not become stale, the need to ensure that the program was indeed being implemented and the need to ensure that delay would not distort the phasing under the arrangement. This deadline can usefully align with the expected timeline in a program for a review, which is about 3-4 months in rapidly evolving situations.

• A timeframe and circumstances under which the AIP could be renewed. Such a renewal would normally be subject to a limit of 3-4 months (implying a maximum AIP period of 6-8 months) and such an update would only be allowed once with respect to an arrangement request.

• Renewal. An AIP could only be renewed if the use of the AIP tool was still considered worthwhile; that is that the effort to establish necessary safeguards would still be on track and likely to deliver. To complete a renewal, staff would need to assess that the overall program is being implemented and remains on track. Concerning the latter, new information may require minor updates (e.g., to adjust availability dates and test dates), but could also require more significant macroframework updates, and/or updates where there are implementation issues to be corrected. Prior actions would be expected to correct any implementation shortfalls, and could draw on conditions in the original program, with any use consistent with the Guidelines on Conditionality. The proposed extension and new LOI/MEFP/TMU would need to be put forward for full Board consideration, supported by a new staff report. The Board would need to be informed if AIP would be allowed to lapse without renewal or achievement of the second condition, including an explanation of the reasons for this.³⁰

• The required safeguards. Under the current AIP, once the necessary financing assurances are obtained and the Fund determines that debt sustainability is being restored on a forwardlooking basis, a second decision of the Executive Board (adopted on a LOT basis) is required for the arrangement to become effective. In a restructuring context, the proposals in this paper mean that the new requirements under the financing assurances policy and the LIOA policy would have to be met to proceed. As discussed above, these could be broader than just financing assurances. The Fund would require adequate safeguards to proceed (either pre- default, or under LIOA). These safeguards accordingly would need to be clearly specified in the conditions required for the second decision under AIP (i.e., to make the arrangement effective) for such a program involving a debt restructuring.

41. Program design under the proposed adjustments to the AIP framework would need to recognize and be robust to the possibility that the safeguards noted above might only be received during the extended period of the AIP. This can be handled with suitably conservative financial programming combined with the use of adjusters (i.e., on targets that would be affected if the financing assurances and thus Fund disbursement arrive earlier or later than expected). Note that it would be possible for program design to be based on semi-annual reviews notwithstanding a possible AIP renewal in three months (and in this instance a set of Indicative Targets at the three-month point would be essential to support AIP renewal).

42. It is important to emphasize that AIP would continue to be a potential tool, not a requirement. Its use would be governed by the circumstances. In all cases staff should aim to bring a UCT program forward as fast as possible (utilizing the proposed strand 4 under the LIOA reforms, and tools like stand-alone DSA approval to overcome information sharing barriers towards securing safeguards).³¹ In some circumstances, consultations with a standing forum, other official bilateral creditors, and the debtor countries' debt advisors may reveal that more time would be needed to secure the necessary safeguards, especially if enhanced safeguards proposed as part of strand 4 are deemed necessary. In these instances, the revised AIP could be a good option to pursue. The Fund's Executive Board would have the opportunity, through the Summing Up, to calibrate the message to the debtor and creditors about the urgency in supplying the necessary safeguards.

F. Fund Financial Support to Members Facing Exceptional Circumstances

43. There is a gap in the Fund’s ability to support members with urgent BoP needs who are undertaking debt restructurings and have arrears to official creditors. This reflects the need for greater clarity about the application of the LIOA exceptional circumstances clause, and further guidance about the qualification requirements under the Rapid Credit Facility (RCF) and Rapid Financing Instrument (RFI):³²

• LIOA exceptional circumstances clause. Under the LIOA policy, in emergency situations such as in the aftermath of a natural disaster, where the extraordinary demands on the affected government are such that there is insufficient time for the debtor to undertake good faith efforts to reach agreement with its creditors, the Fund may provide financing under the RCF or RFI despite arears owed to official bilateral creditors without assessing whether the LIOA criteria are met or obtaining the creditor's consent. In particular, under this clause it would be expected that "Fund support provided to the debtor...would help advance normalization of relations with official bilateral creditors and the resolution of arrears.” However, staff need to clarify in what circumstances to apply this clause and how to make this judgment, and this takes on added importance when dealing with cases where creditor processes are lengthy and uncertain.

• Applicable RCF/RFI requirements. Any request for EF would need to satisfy qualification requirements under the RCF/RFI. In particular, the RFI and RCF can only be approved where a UCT-quality program is either not necessary (because the BoP need is expected to be resolved within one year and no major policy adjustments are necessary to address underlying BoP difficulties) or not feasible (inability to design or implement a UCT quality program due to the urgent nature of the BoP need or the member's limited implementation capacity).^33,34 Thus, qualification requirements would not be met in cases where a UCT-quality program is needed and sufficient implementation capacity exists for such a UCT-quality program, but financing assurances from official bilateral creditors are required and would take time (typically 79 months at present) for the program to move forward. This situation would appear to leave the Fund essentially unable to provide EF to such a member experiencing an urgent BoP need and facing a long restructuring and Fund financing engagement process, an important gap in a world where emergencies are expected to become more frequent (e.g., due to extreme climate events).

44. The “exceptional circumstances” clause in the LIOA policy focuses on emergencies such as natural disasters and applying it would require a clarification of what could constitute such emergencies. Emergencies could in theory cover exogenous and endogenous shocks. Staff proposes to focus on exogenous shocks (e.g., adverse shocks to key commodity markets or even developments with or in a key trading partner), and natural disasters (e.g., hurricane, widespread flooding, etc.). Otherwise, staff would not propose to define a precise set of events nor specific triggers, consistent with the standard Fund policy on emergency financing which leaves room for some judgment. Importantly, staff would not propose to cover urgent BoP impacts arising from sources common to all restructuring situations (i.e., the policy-driven endogenous dynamics of a debt crisis), because debtor-creditor engagement to resolve those arrears is the whole essence of addressing the crisis. Note that, under existing RCF/RFI policy, the projected BoP impact of the shock would define access, up to the applicable EF limits and subject to the relevant policies.

45. To apply the “exceptional circumstances” clause under the LIOA policy also requires a judgment about debt resolution prospects. The requirement that "Fund support to the debtor would be expected to advance normalization of relations with official bilateral creditors and resolution of the arrears” was not set as a high bar given that there is insufficient time for the debtor to undertake good faith efforts due to the extraordinary demands on the affected government in emergency situations. The Fund essentially chose to have a higher risk tolerance in such situations. However, this needs to be clarified. Staff would thus propose that this requirement be assessed based on a commitment from the debtor authorities in the LOI to not only make good faith efforts towards resolving the arrears, but also to conduct themselves in a way to promote and encourage creditor coordination (e.g., a commitment to CoT). However, for countries facing emergency situations with long standing arrears experience shows that it is difficult to assert that Fund support would help normalization of relations with creditors and of arrears. It would also be difficult to say that there has been insufficient time for the debtor to undertake good faith efforts to reach agreement with its creditors. In these instances, and consistent with current practice, additional safeguards would be needed for the Fund to provide EF. For post-default cases, this would mean application of one of the three strands under the LIOA; in the pre-default context, capacity to repay assurances would be needed (i.e., per Iraq 2006).

46. Regarding RCF and RFI qualification requirements, staff proposes no change, and to just provide additional guidance on how to apply them in emergency financing situations in a restructuring context. In a typical restructuring situation, the member is already engaged with the Fund when faced by an emergency situation and may even have reached an SLA or AIP. This has been seen as a signal that a UCT program is needed and feasible. However, the emergency situation arising after such an SLA/AIP would render the SLA or AIP invalid and require the program to be redesigned. In this context, an infeasible combination of more adjustment and lower total financing would be necessary in order to meet the financing assurances/safeguards requirement for an immediate UCT program. Thus, a UCT program could not be designed within the emergency timeframe and the infeasibility test would be met. The additional guidance would clarify this understanding.

47. It is important to emphasize that even in an emergency situation the best course of action in a restructuring situation remains to work towards a UCT quality program. This is generally the form of assistance that members need to help them address such situations (anchoring policies, helping to catalyze new finance, and involving the right volume of Fund support on the right terms and conditions). Thus, for a member undergoing a debt restructuring and in arrears to official creditors, if an urgent BoP need does arise (and requirements under the RCF/RFI and the LIOA exceptional circumstances clause are met), it is essential that the provision of EF should not undermine any broader effort underway to secure a UCT quality program.

48. The proposed clarification of the exceptional circumstances clause and RCF/RFI guidance would not affect the effort to ultimately secure a UCT program. To the extent the emergency has raised doubts about the authorities' capacity to implement a UCT program (e.g., because of political developments and/or emergency policy requirements overpowering standard Fund program objectives), then consistent with existing Fund policies a staff monitored program or PMB would be appropriate to help (re-)establish a policy track record for a UCT arrangement. Where there are no assessed implementation capacity problems, the policy proposal on AIP would help. For countries which had secured AIP, there would already be a built-in expectation that the program would be updated and renewed (promoting continuity in the dialogue towards a new program). For countries which just have an SLA, or where an SLA has not yet been reached, guidance can set a strong expectation of renewed engagement towards an arrangement. In any of these cases, the letter of intent for the EF should contain any macro critical actions identified in the SLA/AIP and these could involve prior actions where warranted, further ensuring continuity towards an arrangement.

G. Summary of the Package of Proposals and Its Implications for Fund Engagement and Safeguards

49. Under the reform proposals laid out above, the Fund’s modalities for engagement in a debt crisis would be notably clarified (Figure 3). The current pathways would remain available: (i) an adequately representative agreement involving a representative standing forum (strand 1); (ii) consent (strand 2) with perhaps the application of the three criteria to some creditors; and (iii) application of the three criteria, subject to existing guidance as elaborated in paragraph 16 (strand 3). When the current pathways would not be available, there would be a standard approach to additional safeguards, available when normal access is proposed; and an enhanced approach to additional safeguards when exceptional access is proposed, or when creditor signals point to a need for greater Fund support for coordination. The Staff Report would fully articulate the rationale for the strand and approach followed. Note that all of this can be done under current Fund policy, but clarifying how to apply additional safeguards is critical to ensure that the Fund’s approach is well calibrated to the circumstances, readily explainable, and that members are treated even-handedly (without creditor inter-dependencies blurring the rationales).

50. Importantly, the proposals scale the use of the Fund’s leverage and its safeguards to the circumstance. The two different approaches to safeguards under proposed strand 4 (i.e., (iii) and (iv)) directly achieve this at arrangement approval. The reforms to financing assurances reviews would ensure that expected progress within the program period is well-defined at the outset, and that if progress lags the safeguards are scaled up accordingly in a calibrated fashion.

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Interaction of Reform Proposals

Citation: Policy Papers 2024, 017; 10.5089/9798400273704.007.A001

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51. The package can help ensure that the Fund does not get caught in an engagement limbo when a path forward to medium-term viability has been identified. The indeterminate period between SLA and arrangement approval, and delays in program reviews, have been a key problem for the Fund, for creditors and for the debtor country. Strands 2/3 and strand 4 (standard) would be able to proceed rapidly to allow approval of an arrangement or completion of a review. Strands 1 or strand 4 (enhanced) could require time, but the revised AIP tool can be utilized to rapidly move the situation into a formal engagement. Moreover, if urgent needs arise due to exceptional circumstances, such as a natural disaster, the LIOA/EF clarifications and guidance give the Fund a way to provide EF notwithstanding arrears to official bilateral creditors (and while not disrupting the overall effort to support the members' restructuring efforts through a UCT program). Finally, at the financing assurances review stage, clarity would be provided about how to deal with lagging progress, promoting faster solutions. Note that it is expected that the use of AIP and EF would be limited, as programs will move more quickly to the approval of an arrangement with the proposed approach under LIOA strand 4, and once creditor processes become more established.

52. The package of proposed reforms would complement and underpin the existing architecture. The Fund would continue to seek the involvement of a representative standing forum as a first priority. Note that a standing forum is always possible in theory when any PC creditor is involved, with a key question being whether it can be established to represent a majority of finance during the program period in practice. This does leave room for strand 4 to be applied while efforts continue to establish representativeness, but this would need to be guided by communications with the standing forum. And to the extent representativeness is later established, strand 1 would thereafter automatically apply (with any agreed program conditionality on process adjusted to reflect the intended timeline and approach of the representative standing forum). Beyond strand 4, the revised AIP approach and LIOA/EF clarification and guidance would be well-positioned to assist in circumstances where a standing forum requires time to deliver assurances (e.g., the CF process). And the financing assurances review proposal is well designed to adjust (and scale up) the safeguards as needed, based on an understanding of where the process stands and expected next steps.

53. The Fund would continue to collaborate with official bilateral creditors and be able to better account for their internal processes. Collaboration is critical in that the Fund and debtor cannot alone solve the debtor's problems when a debt restructuring is needed. First, the Fund would move to strand 4 based on creditor signals, and within strand 4 would be guided to the form of safeguards by creditor communications (outside of exceptional access). This is important as creditors are in a better position to observe the type of support, they need from the Fund for their coordination efforts. Second, the shift in the modality for financing assurances from official bilateral creditors to an assessment that an COCP is in place would help account for creditors' different internal processes. This assessment would align with existing internal processes for current standing fora, and likely reduce timelines for and frictions with non-PC creditors, while leveling the playing field across creditors/creditor groups. Note that this aspect of the proposal would take time to come into full effect, implying a transition away from SCA. On the flipside, once it does come into full effect it would reduce the need for using AIP, and perhaps even the need for LIOA if UCT programs can be approved before arrears materialize.

54. Overall, the package of reforms can help incentivize a faster official creditor restructuring process. The proposals to strengthen safeguards represent a good use of the Fund's leverage to this end. In particular, the Fund would help overcome first-mover problems by securing commitments from the debtor to good faith efforts and by using conditionality to support a process for the restructuring (and adjust these as necessary at financing assurances reviews). The Fund would directly seek creditors' commitments where necessary to get the process moving and also shift this to a different and faster modality over time (an assessment of COCP). And the Fund would use AIP to nudge both the debtor and creditors in the right direction when indications arose that time would be necessary to initiate the restructuring process.

55. The package should preserve the relative leverage of official and private creditors under Fund policies but should help support more efficient private-sector processes. The proposals do not change the way the credible creditor process and good faith tests would be applied in the context of restructuring of privately held debt. The private sector would continue to not have a veto over Fund support. However, the revised engagement approaches should get information about the program into the public domain much faster, including the debt sustainability assessment and targets. This is a key input into private sector deliberations. As such, it would provide the option for them to seek an early agreement based on program parameters and an understanding about comparability of treatment (with the authorities' commitment also set to be expressed publicly under strand 4). To the extent the private sector or the authorities wish to wait for the official-sector process to conclude, the reforms should ensure that the latter proceeds faster, as noted above. The proposals for the Fund to better support CoT—which cover both the authorities' commitment to good faith efforts and the proposed treatment of new arrears due to CoT violations under the Fund's non-toleration of arrears policy—would promote creditor confidence in following different sequencings.

56. The revised modalities would be effective immediately upon approval by the Executive Board. They would be reflected in the guidance on lending into arrears and lending into official arrears (which is expected to be completed early in FY25), and in the staff guidance on the Guidelines on Conditionality when these are next revised. Note that for programs already underway where a debt restructuring is being supported, the provisions concerning financing assurances reviews would apply.

57. The proposals are expected on balance to have a small positive budgetary impact for the Fund. They would have little further net policy development or training cost (since LIOA guidance and training is already in the work program). On an operational basis, the reforms would be expected to reduce Fund workload. The policy changes would remove ambiguities in policy that at present generate a need for extensive discussions within staff, with creditors, and with the Board. To the extent that creditors better understand the Fund's requirements and adapt their processes over time to better work with the Fund, the benefits would be higher. Of course, the precise size of any benefit would be linked to how many new cases will be forthcoming, and the Fund does not predict such cases in its WEO baseline (the existing Ethiopia case would be the main application). So, the baseline benefit is seen as small, but budgetary benefits would likely be substantially higher in a global downside scenario.

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Summary of Proposals

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Summary of Proposals

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^{Table 1.}

Summary of Proposals