Clubbing in Paris
Is Debt Sustainability an Illusion ?
Benu Schneider
The views expressed are those of the author and do not necessarily represent those of the
Financing for Development Office, Department of Economic and Social Affairs, UN
Debt Restructuring
Debt to Multilaterals
No, it cannot be
restructured except
for HIPC countries
Debt to official
creditors
Yes, at the Paris Club
The terms of treatment
are determined on
the basis of per capita
and debt ratios
(require bilateral
agreements after
Paris Club agreements)
or
Bilateral
agreements
Debt to commercial
Banks
Yes, London Club
Bond debt
Yes, with and
without collective
action clauses
e.g. Pakistan
Ukraine
Ecuador
Belize
Challenges
in restructuring debt
• The challenge to maintain contractual obligations
• The challenge of servicing debt according to
ability to pay and maintaining debt sustainability
• The challenge of maintaining growth
Basic principles required for restructuring
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Neutral arbitrator and assessor
Transparency
Adequate representation of debtors and creditors
Efficiency
Symmetry between creditor groups
Existing Machinery
• The Paris Club is an ad hoc machinery which emerged
as a result of international cooperation and not an
international agreement on financial architecture
• No legal status of agreements
• No voice for debtors. An OECD “creditor’s club”
• No in house technical capacity – reliant on IMF
• IMF “preferred creditor status” with significant role in the
Club
• Comparability of treatment from other creditors
• Negotiations are influenced by the foreign policy
objectives of the creditor countries
• Conditionality
The changing role of the Paris Club
The Paris Club today is dealing with three sets
of problems
1. Liquidity problems
2. Solvency problems
3. Debt relief for development expenditure
The treatment accorded may sometimes be the
same for all three sets of problems
Historical background of reform efforts
• Late 1970s at the TDB – G77 called for a
process sensitive to developing country
needs
• G77 proposed and International Debt
Commission
• Ended in failure for the G77
• UNCTAD granted “observer status”
• Codified principles and procedures of 20
yrs in a UN resolution
• Second international debate in 2002
• SDRM (2002) IMF proposed to incorporate
the Paris Club in a permanent machinery
• Ended in failure
Strains in Paris Club
• New creditors
• Dominance of private capital flows
• Serial rescheduling
Issues in official debt restructuring
ROLE OF IMF
• Role of IMF as gatekeeper
• IMF’s Technical support
• Conditionality
PARIS CLUB
• International financial structure for official debt has flaws,
leading to serial rescheduling and unsustainable debt
• Transparency an issue
• Signals to the private sector
• No legal status for comparable treatment form other
creditors
The role of the IMF in Paris Club negotiations
 The IMF mediator in debt-restructuring agreements between debtor
countries and official creditors
 But a country negotiating does not necessarily reflect debt distress.
The financing of Fund Programs became dependent on debt relief –
protected its own balance sheet
 This coincided with the build-up of arrears
 Bi-lateral flows have increasingly been used to pay International
Financial Institutions
 The amount of debt relief is contingent upon a Fund Program and its
estimate of financing gap and in recent times debt sustainability
analysis. There problems with both these sets of estimates by the IMF
(Cont.)
The role of the IMF in Paris Club negotiations
• No compatibility between role as gatekeeper for
concessional resources and creditor and therefore
a stakeholder in the inflow of the same resources
• This conflict of interest entails that countries do
not receive resources because of good policies and
governance, but because they have a high debt
burden. The problem of adverse selection. Bad
policies receive more resources
• Except for HIPC, multilaterals as a creditor class
are excluded from debt negotiations because of
their preferred creditor status
IMF Forecasts Overoptimistic
• The dominant bottom-up (surveillance has a
strong country orientation) approach yield
consistently overoptimistic forecasts for certain
regions
• Does not sufficiently pick policy spillovers in a
global context
IEO, IMF, September 2006
• U.S. General Accounting office (2003) found that
between 1990 and 2001, WEO forecasts for
growth and inflation were optimistically biased
for 57 countries under IMF supported programs
Conditionality
• Too many conditions led to weak
compliance
• Did not lead to FS reform in many
countries
• Shifting emphasis – from austerity –
cutback in social investments - to
investments in the social sector
The IMF's Approach to Debt sustainability:
Middle income countries
Debt Sustainability means that the borrower is expected to be able to continue
servicing the debt without requiring a large future correction in income and expenditure
An unsustainable debt is generally associated with continually rising debt ratios over
time
For countries with assess to international capital markets, the concept of debt servicing
is used rather than the distinction between liquidity and solvency
Provided that market access is maintained liquidity is not a problem
But liquidity problems can turn into solvency problems as a rise in cost and/or
availability of finance feed into debt dynamics
IMF also examines debt sustainability in the context of a given path of primary balance
Sustainability assessment reflects cost and availability of finance, thus continuing debt
servicing
Critique of IMF Debt Sustainability Analysis
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The focus is on debt dynamics and not debt sustainability suited to flow restr.
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The new approach succeeds in giving a broader range of debt dynamics including
additional variables
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The optimal mix of the composition of debt and levels remain a problem
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The threshold levels to be used for the Evian Approach shrouded in mystery
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Even if a threshold level was defined, a ratio which is good for one country maybe a
signal of distress for another or the same ratio may not be good for a country at a
different point of the economic cycle
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The approach is geared towards keeping current on debt servicing
Cannot provide early warning signals for insolvency
Contingent liabilities need consideration
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It does not take into account the ability to pay and development objectives
Problems with IMF debt sustainability
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For a middle income country the ability to pay depends on the degree of trade
openness. Threshold levels for debt to export ratios cannot be uniformly apply to all
countries.
GDP that is used as a dominator for threshold levels only reflects the size of the
economy. Resources cannot be diverted from the non-tradable sector to the tradable
sector to generate foreign exchange.
Taxes are collected in domestic currency and debt payments are in foreign currency.
A currency mismatch in the government’s balance sheet.
The IMF computes public debt to GDP ratios. Private sector liabilities are important,
which may become public liabilities.
The analysis is limited in capturing the spill-over effects in debt currency and banking
problems.
Extrapolation exercises cannot factor in the variability caused by increase in interest
rates and fiscal tightening.
Contingent liabilities are not considered in the exercise.
Stable ratios may not necessary mean that debt is sustainable. Sustainable at what
level?
In the long run exchange rate misalignments in the region affect trade and capacity to
repay.
Debt sustainability analysis for low-income countries:
A new World Bank approach
The World Bank has set out a debt Sustainability Framework (DSF) in June 2004 and IMF and World
Bank (2006) for identifying countries in actual or potential distress situations leading to a formula for
determining grant eligibility within the amounts allocated during the fourteenth replenishment of IDA.
The key principle in the framework is to reduce the risk of debt service problems though grant funding
while facilitating access to finance required by these countries to achieve the Millennium Development
Goals
The IDA allocations will be based on a Performance based evaluation system and per capita income.
The level of debt distress estimated by these methods will determine the eligibility for access to grants.
The DSF selects three debt ratios to judge debt sustainability. These are the ratio of present value of
public and publicly guaranteed external debt to gross domestic product and to exports, and debt service
on the same debt to exports.
The framework further uses Country Policy and Institutional Assessments (CPIA) for country polices and
institutional capability, and vulnerability to shocks and to classify countries by performance and different
thresholds for different indicators. Governance factor given a higher weight relative to other factors.
Policy dependent — conditional upon summary measure of policies (CPIA).
To serve as a guide to lending and policy advice.
Critique of Joint Fund-Bank
DSF
• What about returns on investments –
too focused on the cost of funds
• Domestic and private debt not part
of framework
• CPIA problematic – too much
emphasis on governance
• It is more to do with IDA allocations
• Why a separate framework???
What is debt sustainability?
Ability to pay without compromising on long-term
development objectives or ability to service debts?
A level of debt that is growth enhancing and not a
hindrance to growth?
A threshold level that aims at crisis prevention and
takes the cyclical nature of capital flows into account?
Chart 1: Debt Treatments Accorded at the Paris Club 1998 - Jan. 2008
Note: Evian Approach was used in 9 countries since 2004
Jan-08
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0
2
Source:
Data from www.clubdeparis.org/
4
6
Ad-Hoc
8
Classic
Cologne
10
Houston
12
Lyon
Naples 50%
14
16
Naples 67%
18
20
Serial Rescheduling: A Gap in International Financial Architecture ?
Increase in debt
and debt servicing
Liquidity /Solvency
Problems
Agreement with the
Fund - a new loan
Agreement with the
Paris Club
Houston Terms
Repayment and Grace Periods:
2-8 years non-ODA, 10 years ODA
Agreement allows
new credits from
Paris Club Creditors
Increase in debt
and debt servicing
Repayment Period: 5-10 years
- Further increase in debt servicing
because non-ODA is negotiated at
market interest rates
- Bunching of repayments
Estimates of financing gap
are based on forecasts of
growth and other variables
that are over optimistic
In the near future
repayment problems
surface again
A new arrangement
with the Fund
This cycle continues
leading to higher levels
of debt-stock and debtservicing
Serial rescheduling
• Short consolidation periods to keep debtors on a
short leash
• Mistakes in projections by the IMF
• Problems diffrentiating between liquidity and
solvency problems
• «Snowballing» debt because of bunching of
repayments due to lower grace periods; market
interest on non-ODA on new reschedulings; and new
credits issued after rescheduling
Salient features in the 1980s
• In the 1980s the realization that serial
rescheduling is futile in low income
countries and debt reductions necessary
• Beginning of the process of debt
reductions in low income countries
• A realistic approach to middle income
countries was not considered
Salient changes in the 1990s
• For the low income heavily indebted countries, generous
debt reductions with a view to finance development
expenditure
• For middle income countries and upper middle income
countries the PC did not engage indebt reduction but
began to apply the principle of burden sharing more
broadly and unilaterally to force bondholders to reduce
their claims on individual countries.
• In effect the G-7 used the PC for cutting back public
resources required to resolve financial crisis in nonHIPCs by increasing the losses absorbed by bond
holders.
What are the lessons learnt?
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A neutral body is needed to make assessments of the amount
and type of relief required.
The technical work to support official debt restructuring needs
to go beyond models based on those applied by the private
sector that give exclusive priority to assessments of liquidity
situations in countries affecting their debt servicing.
More transparency is needed in official debt restructuring
operations to include information on interest rates, the list of
debts covered and penalty costs.
There is a need to harmonize debtor and creditor reporting
systems on bi-lateral debt to reconcile differences in the list of
debt and amounts due.
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A simplified process is needed so that
the Paris Club negotiation and bi-lateral
negotiation process can be merged into
a single process.
Keeping countries on a short leash with
burdening conditionality is self-defeating.
Debtor voice is needed both in the
design of the machinery and in
negotiations.
Serial-rescheduling leads to rising debt
service requirements and makes debt
sustainability targets an illusion.
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A fair debt restructuring mechanism
needs to look at repayments made on
the original loan contract and amounts
due from the costs of rescheduling.
The pros and cons of using Paris Club
procedures for financing development
expenditure in counties that do not have
an existing debt problem need to be
understood. A comparative cost-benefit
analysis with other sources of finance is
needed. The Paris Club rescheduling is
seen as a signal of debt distress and
impacts spreads and future costs of
borrowing from the private sector.
A possible step
Set up a committee at the UN
examine options for reforming the
financial architecture for debt negotiations
and
re-examine the proposal the G-77 made in
the late 1970s for an International Debt
Commission along with other proposals
that have been tabled by experts in the
intervening years.
ECUADOR
Date
PC/LC Terms
Reschedulings
(1996-2005)
PAKISTAN
Date
PC/LC Terms
Reschedulings
(1996-2005)
June 13, 2003
Paris Club (Houston)
September 15,
2000
Paris Club (Houston)
December 14,
2001
Paris Club (Houston)
January 23,
2001
London Club
August 2000
Paris Club (Ad-hoc)
Paris Club (Houston)
January 30,1999
Spreads fell by half after the December 2001 agreement. Data is still
unavailable for previous agreements.
Spreads in 2003 fell slightly on longer-term debt, while rising more on
shorter-term debt.
Bank lending increased after 2000, going against regional and
aggregate trend (e.g. all developing countries). No data on bank
lending for 2003 agreement.
Trade credits increased after 2000.
Bank lending rose after every Paris Club agreement. For the 1999
agreement, this went against the general fall in regional and
aggregate banking flows. For the 2001/3 agreements, it followed the
trends. There are no London Club agreements in the GDF files.
Multilateral Claims rose after the 1999 agreement, and fell after the
2001 agreements.
Trade credits fell, stayed level and rose for the 1999, jan 2001 and
Dec 2001 agreements respectively.
Peru
Date
PC/LC Terms
Reschedulings
(1996-2005)
Russia
Date
PC/LC Terms
February 2000
London Club
August 1, 1999
Paris Club (Ad-hoc)
November 1998
London Club
April 29, 1996
Paris Club (Ad-hoc)
Reschedulings
(1996-2005)
November 1996
London Club
Spreads rose for the 1999 PC agreement, while they fell for both LC
agreements.
Bank lending increased after the 1996 PC agreement. For the LC
agreement, it fell sharply the month after the agreement.
Multilateral claims increased slightly after the 1996 PC agreement,
then rose substantially after the LC agreement.
Trade credits rose after the 1996 PC agreement, and fell after the
LC agreement.
Bank lending rose for each LC agreement and fell for each PC
agreement. For the PC agreements, this went against regional
trends, and aggregate trends in the 1996 case. For the LC
agreements, this was in line with both trends in 1998 and against in
2000.
Multilateral claims did not move significantly except for a fall after
the 1998 LC agreement, although this was part of a previous
negative trend.
Trade credits did not move significantly except for a large increase
after the 1996 agreement.