Private and official creditors to the world’s poorest countries agreed to collaborate on a debt standstill beginning on May 1. Agreeing to collaborate is only the first step, though. Now they must work out how to implement the standstill.
The Debt Service Suspension Initiative (DSSI) applies to 73 countries – the majority in Africa. The 77 lowest income countries have outstanding debt payments amounting to $140 billion, though Eritrea, Sudan, Syria and Zimbabwe are ineligible as they are currently in arrears with either the IMF or the World Bank.
Little detail was offered on how the process would work, but the Institute of International Finance (IIF) and Paris Club proposed that it should be granted at the specific request of borrowing countries. Participation for private sector creditors will be voluntary, the IIF says.
“Everyone would like to help, there is a lot of willingness but [the IIF] is trying to figure out how this can be done,” says a source with knowledge of the conversations. “What are the best ways and incentives to make this happen?”
The Paris Club and IIF have jointly expressed support for the initiative, which proponents including the G20, World Bank and Africa’s finance ministers say will free up essential funds allowing governments to tackle the impending health and economic crises.
What started as a health crisis is quickly becoming an economic one. Global commodity prices are near their lowest levels in almost 50 years, and many of these countries are seeing export revenues plummet, while the strength of the dollar poses additional refinancing challenges.
But many say that a standstill on debt for low-income countries is likely to be only the beginning, offering countries a breathing space before reassessment of long-term debt sustainability. This will likely lead to debt relief and restructuring programmes.
At the end of April, the United Nations Conference on Trade and Development called for $1 trillion in debt relief, while the UN Economic Commission for Africa (UNECA) is calling for a blanket standstill on all debt payments due to all creditors, both public and private.
“Isolating countries for specific support is not the right way to go,” says Bartholomew Armah, UNECA’s chief of planning in its macroeconomic policy division. “The very fact that even the rich countries have given themselves huge stimulus shows this is not about poor countries exclusively.”
So far, the response has focused on forbearance for low-income countries from public-sector and bilateral creditors. The World Bank is offering relief to International Development Association (IDA) countries, while the G20 has named 76 countries plus Angola as the primary targets for support.
UNECA is now urging creditors to extend offers of forbearance to middle- and high-income countries.
“The crisis knows no boundaries, if the Seychelles is not capable of addressing the [coronavirus] pandemic because it is economically strapped, that then means that whatever happens to the Seychelles, in terms of containment, will likely happen to other countries,” says Armah.
“All the economies are interlinked and integrated, if Nigeria is no longer able to buy trade of other African countries, it affects them as well.”
Many analysts are concerned that a case-by-case approach to relief will see those countries that come forward locked out of capital markets or forced to pay exorbitant rates in the future.
BNP Paribas Asset Management’s head of emerging market debt, Jean-Charles Sambor, advocates a pragmatic sovereign-by-sovereign approach. But he says he is concerned that a heavy-handed approach to debt restructuring from the G20 could lead to ratings downgrades and risk shutting out countries from the international markets.
“When you talk to the frontier markets, they want to preserve access to capital markets,” he says. “I think the G20 is playing a very difficult balancing exercise. Everyone will agree we should relieve the burden for the poorest countries, but if they do that, it will be at the price of shutting these countries from the markets and downgrading the countries. It would be counterproductive.”
Senior advisers at the Brookings Institute have urged that the debt standstill must be bolstered by tasking the IMF to work with the IIF and the African Union to develop solutions guaranteeing debt sustainability and continued access to capital markets in the future.
Bailing in private-sector Eurobond investors will make a minimal difference in 2020 but will greatly reduce the chance that these countries can fund their investment needs in the coming decade- Charles Robertson, Renaissance Capital
UNECA argues that without collective action a debt standstill would be ineffective. They are calling for the inclusion of all commercial debt including bank lending, holders of international and domestic debt and those lending to infrastructure projects.
This approach, they say, would avoid the singling out or stigma attached to countries that come forward for relief.
“The more countries that are part of this process, then the less likely one can penalize them by saying this is a default,” says Armah. “You would have to downgrade everybody. If it is a collective effort, then the stigma is not as prominent.”
Others warn that blanket relief will enable some countries to take advantage of the situation to mask policy weakness, passing off underlying problems as directly related to Covid-19.
Tellimer research shows that seven of the 22 IDA-eligible countries with outstanding bonds are already classified as being at high risk of external debt distress or are already in debt distress. These are Cameroon, the Republic of Congo, Ethiopia, Ghana, Zambia, Laos and the Maldives.
Others say the process risks disproportionately rewarding those that are more indebted rather than those that are most in need.
“It does not make sense to give debt relief to a country that has no exposure to Covid,” says Paul Domjan, Tellimer’s senior contributing analyst.
“They should look at how the virus is impacting countries, not just their debt levels. Rwanda has very low debt levels but is very exposed to the economic impact of the virus because of the large role of Rwandair in the economy. In this case, debt relief is not a good way of targeting aid, which is what this is.”
The question of how such a standstill may be achieved without triggering a default is also unclear.
Stuart Culverhouse, chief economist at Tellimer, says that bondholders could offer a tacit or explicit commitment not to declare a default, but that may become more difficult as the number of cases grows.
A second option would be to have a formal bondholder vote to change payment terms, which would be easier for bonds with collective action clauses.
Standard & Poor’s has said it will not treat debt relief from official creditors as a sovereign default, but a country’s failure to pay scheduled debt service would be viewed as a credit negative, which in some cases could constitute a sovereign default.
“We could view debt-restructuring or changes to the terms of commercial debt obligations held by private investors as a default under our criteria,” S&P said in a statement on March 29. “We will have to assess the specific characteristics of the restructuring on a case-by-case basis to draw our conclusions.”
Stakeholders are already looking at ways to engineer a process that will avoid triggering default clauses all together.
UNECA says it is looking at several measures, including bridge financing to address the implications of the debt standstill for commercial lenders. It is looking to create a special purpose vehicle that would be used to provide some financial resources to the lenders in the interim.
“The sources of those funds are still being discussed,” says Armah.
The Becker Friedman Institute for Economics at the University of Chicago has proposed a credit facility that would enable funds to be freed for emergency needs but would not constitute a default.
Led by an international financial institution with preferred creditor status such as the World Bank, bilateral and commercial creditors would be encouraged to reinvest interest payments falling due in 2020 on their existing credits in the fund.
To avoid default, recipient countries would continue to make interest payments on existing instruments, but the participating creditors would reinvest an amount equal to those payments into the credit facility.
This approach means that countries that need to default can do so using established mechanisms, but it will not lead to default status being forced on those countries that only need short-term relief.
“If the private sector works with public sector preemptively, you can avoid the default in theory,” says an emerging market debt expert. “This approach means that this happens without a default, so a country doesn’t suffer. The country should not be as negatively impacted.”
Some are against bailing in the private sector all together, arguing that private-sector investment is essential to the recovery of Africa.
“Bailing in private-sector Eurobond investors will make a minimal difference in 2020 but will greatly reduce the chance that these countries can fund their investment needs in the coming decade,” says Charles Robertson, chief economist at Renaissance Capital.
“Covid-19 will pass, but the $100 billion or more in Africa’s annual infrastructure financing needs will not,” he adds.
Rodrigo Olivares-Caminal, professor of law and expert sovereign debt consultant, agrees that stakeholders will have to be very careful about how the private sector is treated.
“MDBs’ [multilateral development banks] resources will be heavily depleted, bilaterals have problems of their own,” he says. “Who is going to finance the bounce back of African countries? This is where you need the private sector.”
Investment firms say they are fielding calls from anxious clients. Frontier funds are down some 20% to 30% this year, but even within that the market is differentiating between credits.
“The market is telling us which countries they are worried about,” says Anthony Simonds, fund manager at Aberdeen Asset Management.
Zambia, Angola, Ecuador, Sri Lanka, Belize and Suriname are worst underperformers. Zambian bond spreads have widened by around 2,500 basis points since the end of 2019, while Angola’s are just under 2,000bp wider.