Sovereign Debt Challenges: Global Developments and IMF Approach

Friday, October 29

Ms. Dalia Hakura Deputy Division Chief, Strategy, Policy, and Review Department, International Monetary Fund
Mr. Manrique Saenz, Deputy Division Chief, Strategy, Policy and Review Department, International Monetary Fund 

Ms. Barbara Dutzler, Senior Economist, Joint Vienna Institute

The COVID-19 pandemic has pushed sovereign debt to historically high levels. Many low-income countries and some emerging market economies are already in or at high risk of a debt crisis. Defaults, capital flight or forced adjustment of monetary and fiscal policies, however, could seriously undermine the economic recovery.

The webinar therefore focused on two topics: 

First, Dalia Hakura, IMF, presented the global mechanisms in place to assist low-income countries with debt resolution. The Debt Service Suspension Initiative (DSSI) has helped alleviate immediate liquidity challenges. More than 60 percent of the eligible 73 countries benefited from USD 10.3 billion in debt service relief (between May 2020 to June 2021), about half from China. As the monitoring of the DSSI showed, however, COVID-related spending (1.6 percent of GDP) far exceeded the liquidity support provided by the DSSI in 2020. 

The DSSI will expire at the end of 2021, and countries will face increased fiscal pressures as they re-start debt service payments in an environment of continued uncertainty due to the coronavirus pandemic. Therefore, the effective and timely implementation of the new G20 Common Framework for Debt Treatments (CF) is urgent. As Hakura showed, not only could debt service payments in 2022 be back to the 2019 level of USD 47 billion, but they are projected to rise further in 2023 due to DSSI repayments and maturing Eurobonds (see figure 1). 

The CF closes an important gap in the international debt architecture and aims to coordinate Paris Club and non-Paris Club official bilateral creditors to achieve timely and orderly sovereign debt restructurings for DSSI-eligible countries. Turning to the first experiences with its implementation, Hakura noted that despite achieving important milestones, the first three cases have experienced delays in the formation of the creditor committees and in obtaining official financing assurances. The latter are, however, crucial for obtaining IMF financial support, as the IMF can only lend when a program is fully financed, and public debt is sustainable. Private creditor participation and increased confidence by the debtors in the CF as well as early engagement of borrower countries is vital for the CF’s future success.  

Figure 1: Liquidity pressures rise in 2022

Source: Hakura (2021), Low-Income Countries Sovereign Debt Challenges, Presentation at JVI, 28 October 2021

Second, as the COVID-19 crisis is impacting debt sustainability in a diverse group of countries, the webinar also spotlighted the steps the IMF has taken to improve its debt sustainability framework for market access countries. Manrique Saenz, IMF, presented the key reforms being introduced, including a new probability-based toolkit to assess sovereign risk and debt sustainability, at a critical time of rising debt vulnerabilities due to the pandemic. 

The new framework called ‘Sovereign Risk and Debt Sustainability Framework for Market Access Countries’ (SRDSF) follows the lines set out in the review by the IMF’s Executive Board in January 2021. As the title indicates, the framework includes a new ‘early warning system’ based on a battery of tools to alert surveillance countries against the risk of sovereign debt distress. The core innovations include:

Horizon-based approach, including long-horizon analysis: Greater focus on the timing of risks and more attention to longer-term issues providing for a richer and more nuanced assessment. The impact on debt of population aging, for instance, is analyzed as part of the long-term modules. 

Emphasis on debt transparency: Improved debt disclosures and reporting to avoid debt surprises and support more evenhandedness in debt sustainability analyses. The general government perimeter becomes the default institutional coverage. 

Improved techniques and predictive power: Strengthened methodologies for greater overall capacity of the framework to detect sovereign debt risks. A logit model provides early warning of short-term risks. Two other modules—a debt fan chart and a financing-risks tool—are used to assess the probability of sovereign stress in the medium term.  

Clearer bottom-line results: Clear communication supported by mechanical signals, three-way (low, medium, or high risk) assessments at each horizon, and an overall judgment-based sovereign risk assessment. The new framework is critical in supporting IMF lending decisions too, as it underpins the judgments on whether debt is sustainable (or sustainable with high probability, in exceptional access cases).

Figure 2: SRDSF overview

Source: Saenz (2021), Introducing the Sovereign Risk & Debt Sustainability Framework for Market Access Countries, Presentation at JVI, 28 October 2021.

In terms of the roll-out for the new framework, it is expected to go live by the end of March 2022. The template and guidance note are currently being developed. As the discussion during the webinar indicated high interest in training on this new tool, Saenz indicated that the IMF was exploring how to deliver such training, possibly with the support of the JVI. 

Barbara Dutzler, JVI


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