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Now is the time to innovate in sovereign debt restructuring

Peter Breuer and Charles Cohen

November 19, 2020

When companies are over-leveraged and need to restructure their debt, creditors often end up swapping bonds or loans for stocks. They exchange an investment with a guaranteed fixed return for a participation whose return depends on the future results of the company. In other words, investors agree to take on some risk. Could a similar mechanism be considered when a state has to restructure its debt, making the gains on government securities dependent on the country’s future economic performance? A new IMF study looks at possible innovations in sovereign debt instruments that could allow both creditors and debtors to agree on debt restructuring by sharing potential gains and making a country’s debt portfolio more resilient to future shocks.

Due to the immense economic shock caused by COVID-19, nearly half of low-income countries and several emerging countries are already going through, or at high risk of, a debt crisis. Sovereign debt levels are expected to increase, by around 17% of GDP in advanced countries, 12% in emerging countries and 8% in low-income countries, compared to pre-pandemic expectations. The COVID-19 crisis also marked the beginning of a period of great macroeconomic uncertainty. Under these circumstances, the ability of countries to continue to service their debt is more uncertain than ever, which could discourage creditors from accepting a debt that is permanently impaired.

Long negotiations, inaccessible markets and the high degree of uncertainty that accompany the restructuring process could deprive countries of much-needed financing for an extended period and thus prevent them from making the priority spending and investments required to grow. economy and service their debt. In order to avoid this vicious circle, some countries might be tempted to agree to unfavorable restructuring terms that would quickly end up causing the same problems.

Emergency planning

The pandemic could prove to be the vector for pressing innovations in the sovereign debt restructuring market. This could shorten and simplify restructuring and avoid resorting to it in the future.

Debt instruments that adjust repayments to creditors based on a country’s future health (measured by GDP, exports or commodity prices) could help break this vicious circle. In an economic downturn, these “categorical contingent debt obligations” would maintain the debt relief a country would have obtained through restructuring. In good times, these instruments would automatically provide additional compensation as the country’s ability to repay its debt improves.

This guarantee could allow countries to achieve greater debt reduction early on and make debt more sustainable, especially once they regain market access. The creation of a symmetrical instrument providing greater relief in the event of an economic contraction could allow agreement on a more optimistic baseline scenario; this would ensure both recovery of initial value for investors and protection against a downturn for the country.

Implementation issues

Despite the appeal of these categorical contingent debt securities in uncertain times, they still present challenges in implementation and their design should take into account the lessons learned so far. In the past, creditors have ignored this type of instrument because they have not been tested, their risk profile is very specific and they are therefore difficult to liquidate. One way to address these concerns is to link variables such as GDP growth or commodity prices directly to the repayment capacity of debtors and ensure that the data on these variables are not manipulated.

A wider use of these instruments and a standardization of their modalities would allow investors to better understand them, would lead to better price formation and would encourage trade on the secondary market. In order to reassure borrowers, the formula for calculating repayments should be transparent and provide for counter-cyclical relief, while capping the amounts to be repaid.

Hurricane insurance

Restructuring can also improve the resilience of a country’s debt portfolio by including clauses similar to insurance policies that provide respite from shocks, such as hurricanes or other natural disasters. Lenders have been willing to provide hurricane insurance to some Caribbean countries in the form of interest relief and maturity extensions. These types of clauses strengthen a country’s repayment capacity when it goes through a crisis, which benefits both parties. A restructuring is the unique opportunity to exchange all of the debt for new securities through these mechanisms, which keeps all creditors on an equal footing.

We could go even further and develop instruments which provide for an automatic freeze on debt service in the event of a global crisis (such as the current pandemic), in order to help developing countries cope with a debt shock. an unexpected magnitude. However, it remains difficult to define the circumstances in which this mechanism would be triggered. One possibility would be to link private sector debt moratoria to official sector debt moratoria, as this would clearly indicate the severity of the crisis.

Categorical contingent debt securities can be useful in certain situations. But they are not the panacea for solving the difficulties inherent in restructuring sovereign debt. Further comprehensive reforms are needed, as illustrated by other recent studies on strengthening the debt architecture. The development of conditional instruments in the light of past experience could allow the latter to play an important role: they would make the restructuring process faster and cheaper and make countries more resilient to future shocks. Now is the time to take action.


Peter Breuer is Head of the Debt Markets Division of the IMF’s Monetary and Capital Markets Department. He oversees a team tasked with analyzing sovereign debt risks and advises on sovereign debt management and the development of local capital markets. Previously, he jointly led a team tasked with analyzing risks to global financial stability and writing the Global Financial Stability Report. He has led or co-led financial sector stability assessments for the United States, Luxembourg and Finland. Mr. Breuer was Head of the IMF Office in Ireland as Resident Representative during the EU-IMF program from 2011 to 2014. In his previous role he worked on a multitude of countries and strategic issues. He holds a doctorate and an MA from Brown University, an MA from the London School of Economics and a BA from Vassar College.

Charles Cohen is Deputy Head of the Debt Markets Division of the IMF’s Monetary and Capital Markets Department. He joined the International Monetary Fund in 2017, to work primarily on issues relating to the debt market and financial stability. He was previously on the Financial Stability Supervisory Board of the US Treasury. Prior to that, he worked at Bain Capital Credit, managing corporate and sovereign debt portfolios, as well as the Boston Consulting Group. He has extensive experience in the private and public sectors in financial market analysis and financial stability policy and regulatory issues. Mr. Cohen holds a doctorate in economics from Harvard University, as well as an MA and BA in mathematics from the University of Chicago and Stanford University.

EDITOR’S NOTE: This article is a translation. Apologies should the grammar and / or sentence structure not be perfect.

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