Making sense of Belize's Blue Bond Proposal
Lauded by its proponents as a “ground-breaking” and “innovative approach,” the proposal raises concerns upon closer review and is likely to turn into a costly missed opportunity for everyone involved.
Belize, like most Small Island Developing States (SIDS), has been overwhelmed by the Covid-19 pandemic. The combination of the health, economic and social impact of Covid-19 and climate change have left the country facing its “most severe economic, fiscal and debt crisis”. In response to this dire situation, Belize recently announced its intentions to restructure part of its sovereign debt.
The proposal aims to buy an outstanding bond back at a discounted rate. The bond is worth US$ 546 million and is due in 2034. The bondholders will then be paid in cash with the proceeds of the issuance of a so-called “blue bond". This relatively new type of instrument links financing to investments in ocean conservation projects. To meet this criteria, Belize has proposed to establish a trust fund worth US$ 23.4 million (1.27 per cent of GDP) to protect its coral reefs. The inclusion of the conservation trust seems to have played a key role in securing support from a binding majority of the bondholders for a restructuring that imposes a 45 per cent haircut on the principal of the 2034 bond.
Belize’s Blue Bond Proposal (BBBP), developed with the support of The Nature Conservancy and Credit Suisse, has been lauded as a “ground-breaking” and “innovative approach” to sovereign debt restructuring. However, a closer look at the details raises concerns regarding its benefits for the country, its creditors, and more broadly for future sustainability-linked debt restructurings. The restructuring merely shifts the risks of losses from old to new creditors while leaving the country saddled with an unsustainable debt burden. Rather than serving as an advertisement for this type of operation, the BBBP may turn it into a cautionary tale.
Belize’s unsustainable debt dynamics
A quick glance at Belize’s recent economic history serves as an explanation of why the BBBP is unlikely to solve Belize’s debt problems. The country is an unfortunate, but perfect, example of the “too little, too late” problem of sovereign debt restructuring. This refers to a recurring feature of restructuring processes that fail to provide enough relief to secure debt sustainability and take place long after a country is in financial distress.
Over the last fifteen years, Belize has restructured its debt three times -- in 2007, 2013 and 2017. Each of these debt restructurings has been beset by the same type of problems, including overoptimistic assumptions, insufficient relief and a selective approach to creditor participation which explicitly excludes multilateral, bilateral and domestic creditors. The BBBP fails to learn these lessons and repeats the same mistakes of the past.
The IMF currently classifies Belize’s debt as “unsustainable”. To address this situation, the multilateral institution recommends a combination of fiscal adjustment and debt restructuring. The BBBP follows this outline relying on make-believe fiscal adjustment assumptions. These translate into insufficient relief to achieve debt sustainability.
An analysis of the debt dynamics of the country shows the extent of the illusion. This is done using a standard debt sustainability model based on data from the IMF, World Bank and Refinitiv. Figure 1 displays projections of public debt of Belize under two initial scenarios. The baseline scenario shows the evolution of public debt in the absence of the BBBP and assuming a fiscal balance in line with the IMF World Economic Outlook (WEO) projections. Under this scenario, debt levels would decline from 123 to 94 per cent of GDP between 2020 and 2031. The blue bond scenario includes the BBBP and its assumptions for fiscal consolidation. In this second scenario, debt levels would decline from 123 to 68 per cent of GDP between 2020 and 2031. This would allow Belize’s debt to fall below the debt to GDP ratio of 70 percent and meet the criteria used by the IMF to assess debt sustainability.1
The price of the BBBP conservation trust in terms of long-term fiscal adjustment
The central role of fiscal projections in different scenarios raises three interrelated questions regarding their differences, realism and their impact on the overall debt trajectory. Starting with the issue of the difference between the different scenarios, Figure 2 shows the evolution of Belize’s fiscal primary balance2 since the turn of the century as well as projections for the next ten years. The recent fiscal performance of the country is characterised by the IMF as “volatile”. Through the ups and downs, Belize has registered an average primary deficit of 0.7 per cent of GDP between 2000 and 2020. With this figure in mind, it is possible to compare it to different projections of fiscal performance for the next decade. Oxford Economics (OE) projects an improvement of the fiscal balance over the next three years, stabilising around an average deficit of 0.5 per cent of GDP after 2023. The IMF WEO projections follow a similar dynamic, stabilising at a primary surplus of 1.2 per cent of GDP after 2023. Finally, the BBBP assumes a primary surplus of 3 per cent of GDP over the same period.
To put these figures in context, the difference between the IMF WEO and OE primary balance projections with respect to the BBBP is equal to between 1.4 and 2.7 times the resources provided for the conservation trust every year into the future. As a result, the required adjustment, in the form of either higher revenues or lower expenditures in areas such as health, education or climate, would be extremely large in comparison to other scenarios. Under the BBBP, Belize would have to set aside over the next decade between 11 and 22 times as much resources to meet creditor claims in alternative scenarios as the equivalent of what the country would be able to secure now to protect its environment through the blue bond.
Furthermore, the capacity of Belize to achieve the fiscal performance assumed by the BBBP is highly questionable on several grounds. First, large and persistent primary surpluses of this magnitude tend to be a relatively rare occurrence. Second, the capacity of the country to undertake precisely this type of adjustment is limited, as recent history shows. Third, Belize’s economy is highly vulnerable to external shocks, being particularly exposed to fluctuations in tourism, commodity prices and climate events. Fourth, the proposed adjustment would take place at a time when the prospects of recovery remain uncertain due to high Covid-19 contagion rates and an adverse international environment. In a best case scenario, the country would only be able to return to pre-pandemic levels of economic activity by 2025.
Thus, not only is it unlikely that the country will achieve the fiscal targets set in the BBBP, but it also must be asked if such a degree of adjustment is desirable. The fiscal adjustment required to achieve a primary surplus of 3 per cent would equal 9.6 per cent of GDP over three years. The ocean conservation commitment embedded in the BBBP would then come at the expense of other pressing domestic priorities such as poverty reduction, health and education, amongst others. For example, the adjustment is comparable to a reduction in expenditures equivalent to more than two times the entire public health care budget of the country (4.4 per cent of GDP according to the latest figure available).
Against this background, relaxing the fiscal assumptions of the BBBP highlights its weak foundations. Figure 3 shows the projected evolution of Belize’s public debt under four different scenarios. First, the blue bond scenario as described previously. The second and third scenarios include the blue bond but change the fiscal balance assumptions to those provided by the IMF WEO and OE. And last, a fourth scenario that includes the blue bond, OE fiscal assumptions and a climate shock.
While this exercise clearly illustrates that the blue bond does little for Belize, the question remains about its implications for the creditors of the country.
What's in it for creditors and the investors in the blue bond?
Belize’s public debt reached US$ 2.1 billion at the end of 2020. Domestic, multilateral and bilateral creditors account for 73 per cent of the debts of the country (Figure 4). This large group of creditors is explicitly excluded from participation in a debt restructuring under the terms of the BBBP. In consequence, the losses arising from the restructuring are entirely borne by bondholders. This is problematic on several accounts. First, as mentioned earlier, this method has been already tried unsuccessfully three times in Belize. Second, a selective approach to creditor participation limits the potential amount of debt relief available under a restructuring. A reduction in the number of creditors that participates translates into higher and more difficult to bear losses for the remaining participating creditors. Third, the uneven distribution of losses breaks inter-creditor equity, one of the basic principles to ensure a successful debt restructuring.
Does this mean that holders of the 2034 bond are being treated unfairly with respect to the remaining creditors? No. On the contrary, the BBBP allows them to shift part of their exposure to other existing creditors while transferring the remaining to the new investors financing the blue bond. Figure 5 helps to illustrate this dynamic. According to the terms of the BBBP, existing bondholders have agreed to a 45 per cent haircut. However, as shown in the previous section, this amount of restructuring - equal to US$ 244 million - is insufficient to achieve debt sustainability under alternative fiscal assumptions.
The materialisation of larger losses implied by the unsustainable nature of Belize’s debt will eventually be borne by the remaining existing creditors and the blue bond investors. This explains why, on the one hand, existing bondholders were eager to accept the BBBP despite the large haircut that was on offer. A cash payment upfront that puts a floor to losses now is a much better alternative than being exposed to uncertain and potentially larger losses down the road. On the other hand, this also explains why Credit Suisse is having problems finding investors willing to finance the blue bond. Financial institutions interested in supporting Belize’s conservation efforts are probably taking a step back once the high risk of losses involved in this particular operation become clear.
What are the implications for future sustainability-linked bonds?
The degree of attention attracted by Belize’s blue bond highlights that despite the relatively small size of the transaction, its success or failure can have large implications for this type of debt restructuring going forward. Appetite for replication rests on the capacity of these processes to simultaneously support domestic policy goals, debt sustainability and an equitable distribution of losses, both between debtor and creditors as well as within creditors. Unfortunately for the BBBP, it appears to fail to meet any of these goals.
As a result, the BBBP is likely to turn into a costly missed opportunity for everyone involved. This is an unfortunate outcome given the pressing financial and social challenges faced by Belize. The country is in desperate need of debt relief. However, given the lack of multilateral support for struggling middle-income countries and that of a multilateral debt workout mechanism, the country is stuck with this type of piecemeal approach to debt restructuring. Not only will the country fail to receive enough relief to achieve debt sustainability but will also endure the costs of additional years of financial distress before a new restructuring attempt takes place. These costs include, but are not limited to, its capacity to attract additional financing to support its recovery from the pandemic and achieve adequate levels of investment in climate resilience and adaptation over the next decade. In other words, the BBBP will work at cross purposes of its stated goal of supporting Belize’s efforts to tackle climate change.
From the perspective of creditors and potential investors in the blue bond, the proposal leaves much to be desired. A comprehensive approach to debt restructuring, involving all creditors, would distribute the losses arising from the restructuring equitably amongst them. More importantly, it would ensure that new investors interested in supporting Belize’s sustainable development efforts can do so in a country with a blank slate and solid financial footing. Thus, while it is a positive development that both current and prospective creditors seem to be responding to conservation efforts by developing countries, the shortcomings of the BBBP might end up stigmatising sustainability-linked restructurings: this is a proposal made with good intentions which is actually terrible for everyone involved.
1 Eurodad has criticised the narrow approach to debt sustainability used by the IMF as it explicitly prioritises creditor claims over domestic policy priorities. However, to simplify the analysis, this article uses the IMF definition of debt sustainability as a benchmark to assess the implications of the BBBP.
2 The fiscal primary balance is equivalent to government revenues minus expenditures, net of interest payments.
3 The assumptions for the climate event follow those used by the IMF for Belize. These include that the financing of the costs arising from the climate shock takes the form of debt. It is important to highlight that Eurodad and other CSOs have made the case that contrary to IMF assumptions, developing countries should be provided with grants to address loss and damage after a climate event.