Clubbing in Paris

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• 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
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Debt Restructuring
Debt to Multilaterals
Debt to official creditors
Debt to commercial Banks
Bond debt
Yes, London Club
No, it cannot be restructured except for HIPC
countries
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
Yes, with and without collective action
clauses e.g. Pakistan Ukraine Ecuador Belize
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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
• Neutral arbitrator and assessor
• Transparency
• Adequate representation of debtors and creditors
• Efficiency
• Symmetry between creditor groups

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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 creditors 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

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The changing role of the Paris Club

• The Paris Club today is dealing with three sets
  of problems
• Liquidity problems
• Solvency problems
• Debt relief for development expenditure
• The treatment accorded may sometimes be the same
  for all three sets of problems

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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

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• 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

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Issues in official debt restructuring

• ROLE OF IMF
• Role of IMF as gatekeeper
• IMFs 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

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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.) 
•  

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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

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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

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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

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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

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Critique of IMF Debt Sustainability Analysis

• The focus is on debt dynamics and not debt
  sustainability suited to flow restr.
• The new approach succeeds in giving a broader
  range of debt dynamics including additional
  variables
•  
• The optimal mix of the composition of debt and
  levels remain a problem
• The threshold levels to be used for the Evian
  Approach shrouded in mystery
• 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
• The approach is geared towards keeping current on
  debt servicing
• Cannot provide early warning signals for
  insolvency
• Contingent liabilities need consideration
• It does not take into account the ability to pay
  and development objectives

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Problems with IMF debt sustainability

• 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 governments 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.

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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.

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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???

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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?

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Serial Rescheduling A Gap in International
Financial Architecture ?
Increase in debt and debt servicing
  Agreement with the Paris Club
  Liquidity /Solvency Problems
  Agreement with the Fund - a new loan
 Agreement allows new credits from Paris Club
Creditors
Houston Terms   Repayment and Grace Periods 2-8
years non-ODA, 10 years ODA   Repayment Period
5-10 years
Increase in debt and debt servicing
- 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
This cycle continues leading to higher levels of
debt-stock and debt-servicing
In the near future repayment problems surface
again
A new arrangement with the Fund
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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

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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

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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 non-HIPCs by increasing the losses
  absorbed by bond holders.

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What are the lessons learnt?

• 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.

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• 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.

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ECUADOR Reschedulings (1996-2005) Date PC/LC Terms
ECUADOR Reschedulings (1996-2005) June 13, 2003 September 15, 2000 August 2000 Paris Club (Houston) Paris Club (Houston) London Club
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. 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. 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.
PAKISTAN Reschedulings (1996-2005) Date PC/LC Terms
PAKISTAN Reschedulings (1996-2005) December 14, 2001 January 23, 2001 January 30,1999 Paris Club (Ad-hoc) Paris Club (Houston) Paris Club (Houston)
Spreads fell by half after the December 2001 agreement. Data is still unavailable for previous agreements. 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. Spreads fell by half after the December 2001 agreement. Data is still unavailable for previous agreements. 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. Spreads fell by half after the December 2001 agreement. Data is still unavailable for previous agreements. 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.
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Peru Reschedulings (1996-2005) Date PC/LC Terms
Peru Reschedulings (1996-2005) November 1996 London Club
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 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 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.
Russia Reschedulings (1996-2005) Date PC/LC Terms
Russia Reschedulings (1996-2005) February 2000 August 1, 1999 November 1998 April 29, 1996 London Club Paris Club (Ad-hoc) London Club Paris Club (Ad-hoc)
Spreads rose for the 1999 PC agreement, while they fell for both LC agreements. 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. Spreads rose for the 1999 PC agreement, while they fell for both LC agreements. 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. Spreads rose for the 1999 PC agreement, while they fell for both LC agreements. 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.