Following the G20 Debt Service Suspension Initiative (DSSI) announced during the 2020 Spring Meetings, the International Institute of Finance (IIF) has released a template for the voluntary involvement of private creditors in a debt service suspension. The proposal is the result of a consultation with over 100 private creditors representing over US$ 45 trillion in assets under management. It is a useful guide to assess the willingness of private creditors to provide meaningful debt relief to countries affected by the dual health and economic shock of COVID-19.
A review of the proposal reveals that no actual relief is being offered to developing countries. The IIF proposal entails the provision of short-term cash support by private creditors to countries included in the G20 DSSI in exchange for higher debt burdens down the road. The proposal presents additional problems: it fails to address creditor collective action problems; doesn’t include provisions for Middle Income Countries (MICs); and is unlikely to be triggered by countries, even in cases where it could provide short-term relief. The IIF effectively compounds the problems already identified in the G20 DSSI.
To understand the problems with the IIF proposal is useful to analyse each of the issues highlighted.
First, in the case of the NPV of the claims, private creditors are requesting terms that are not aligned to those of the G20 DSSI. On the one hand, suspension of payments to official creditors is Net Present Value (NPV) neutral. This means that countries are asked to pay back to their official creditors an equivalent amount to the debt service suspended over a longer period of time. On the other hand, the suspension of debt service payments to private creditors proposed by the IIF claims to adhere to the principle of NPV neutrality, but fails to do so. In the IIF proposal, suspended interest payments by sovereign debtors are added on to the original amounts owed and will accrue extra interest. Under the IMF Low Income Country Debt Sustainability Framework (LIC DSF) this would increase the NPV of the debt stock of participating countries. The net impact on NPV of public debt would depend on both the rate of interest applied to the capitalization of deferred interest payments and the discount rate.* Countries participating in the initiative would experience an increase of their debt burdens.
Second, participation by private creditors remains voluntary. This leaves collective action problems unaddressed. Furthermore, the proposed structure of postponed interest capitalization creates incentives for borrowing countries to offer sweeteners (such as high interest rates on deferred payments) to increase creditor participation. Given the high risk of debt distress present in a number of countries, this incentive structure may end up increasing the costs of an eventual debt restructuring process by raising the NPV of public debt stocks.
Third, MICs’ challenges remain unaddressed. The IIF has replicated the limited efforts of the G20 and adopted a narrow focus for the scope of countries eligible for the private creditor scheme. This represents a short-sighted approach given the overwhelming dependency of MICs on market-based financing. Coupled with the identified gaps in the Global Financial Safety Net (GFSN) that prevent a number of these countries from accessing multilateral financial support in a timely and adequate fashion, this heralds a wave of debt distress episodes. Thus, a piecemeal approach to their rising levels of financial stress will only create additional costs for creditors and debtors alike and reduce the likelihood of a strong global recovery.
Last but not least, it is unlikely that a large number of countries will decide to request suspension of payments to private creditors under the IIF proposed terms. A prerequisite for private creditor involvement is active participation in the G20 DSSI. As of May 28, only 36 out of 77 eligible countries have applied to participate in the G20 initiative. The slow rate of application is a direct result of the actions taken by credit rating agencies, such as S&P, Moody’s and Fitch. The reluctance of these agencies to adapt to the crisis is placing additional pressure on developing countries. Credit rating downgrades are being applied to countries such as Ethiopia, Pakistan and Cameroon as a result of their decision to apply for the G20 DSSI. The nature of the downgrades is disconcerting given that the G20 DSSI is designed to cover payments due to official creditors only. This makes it clear that in the event that a country decides to approach its private creditors under the terms of the IIF, credit rating agencies would not hesitate to apply a stringent assessment on the request. As borrowing costs can increase substantially in the aftermath of a downgrade, this effectively eliminates the incentives for any country to even think of approaching the IIF.
Thus, while the efforts in terms of coordination and communication by the IIF are welcomed, the cure proposed is worse than the disease. Given the moral imperative to prioritize COVID-19 response efforts, it is unconscionable that private creditors are requesting terms that will increase the debt burdens of developing countries. Furthermore, the threat of loss of market access associated with credit downgrades is being used to cower debtor countries into submission and force them to repay their debts regardless of public health and long term debt sustainability consequences.
The inability of the G20, IFIs, IIF and credit rating agencies to respond to the magnitude of the crisis is leading us into a situation in which countries will not ask for help until is too late and defaults become inevitable. The costs of that failure will be unfortunately measured in the millions of jobs and lives lost, not due to a devastating virus, but to unwillingness to address the unfair and inefficient nature of the global financial system.
* The discount rate is an interest rate used to convert a future income stream to its present value. The higher the discount rate, the lower the NPV value of a claim.