Debt Restructuring In Low Income Countries

How likely are low-income countries to need debt restructuring?

Debt challenges in low-income countries are far from where they were in the 1990s before the Heavily Indebted Poor Countries (HIPC) initiative, both in terms of debt levels and accumulation of arrears. However, they have been on the rise for the last decade, in a context of low interest rates, high investment needs, limited progress in domestic revenue mobilization, and often constrained public financial management capacity. They have been further aggravated by the COVID-19 crisis and now by the fallout of the war in Ukraine.

What will debt restructurings in DSSI countries involve?

Debt restructurings in DSSI countries will raise complex issues for both external and domestic debt.

On the domestic side, there will be difficult trade-offs between the need to restructure sovereign debt owed to domestic banks, in some cases, and the impact of those restructurings on financial stability and domestic banks ability to finance growth. Local currency debt for the median DSSI country rose from 7 percent of GDP in 2010 to 15 percent of GDP in 2021. For those DSSI countries with market access, local currency debt increased from 8 percent of GDP in 2010 to 28 percent of GDP in 2021. Many of these DSSI countries have also experienced a deepening of sovereign-bank links, with larger holdings of domestic sovereign debt at domestic banks.

On the external side, increased diversity in creditor composition raises important coordination challenges. DSSI countries used to borrow mainly from Paris Club official bilateral creditors and private banks, alongside multilateral institutions. Paris Club creditors and private banks had strong coordination mechanisms, including through a shared understanding on how the two creditor groups interacted.

Today, external creditors are much more diverse, with a significant rise of China and private bondholders. This makes coordination significantly more challenging:

• In 2006, 28 percent of DSSI countries’ external debt was owed to Paris Club creditors. By 2020, this share had fallen to 11 percent.
• Over the same period, the share of DSSI countries’ external debt owed to China rose from 2 to 18 percent and the share of Eurobonds rose from 3 to 11 percent.

What does the creditor landscape in DSSI countries look like?

Creditor composition varies significantly among DSSI countries. This is reflected when looking at the distribution of the share of each major creditor or group of creditors in the total external debt of the 68 DSSI countries for which data is available.

What mechanisms need to be put in place to improve debt restructurings?

Debt restructurings in DSSI countries are likely to become more frequent and will need to consider the increased diversity of the creditor landscape in these countries. Having in place mechanisms that ensure coordination and confidence among stakeholders has become urgent. Improvements in the G20 Common Framework could play an important role in this objective. Being able to provide, where necessary, timely, orderly, and efficient debt restructurings is in the interest of the debtor countries as well as their creditors, and more broadly global stability and prosperity.