A Principled Approach to Domestic Debt Restructuring

Note to finance ministers for the global sovereign debt roundtable of October 2023

The global sovereign debt roundtable (GSDR) provides a unique platform for debtor countries to request changes in the restructuring process. Domestic debt restructuring (DDR) is probably one of the most difficult choices for a finance minister, particularly when facing unhappy external creditors whilst dealing with challenging circumstances at home. This paper proposes simple principles that debtor countries could voice in this forum. Domestic debt is defined as market debt instruments issued in local currency under domestic law, regardless of the residency of their holders. These can be domestic (banks, pension funds, individuals, etc.) And, sometimes, external investors.

When in crisis, restructuring domestic debt is always a difficult decision, both economically and politically. Yet, there is limited consensus on the best paths forward to effectively deal with domestic debt. Citizens in highly indebted countries end up “paying” several times what they should. This is due to the adjustment process but also to inflation and depreciation, or accumulated domestic arrears. Restructuring domestic debt will add to this already heavy burden. It might be necessary at times, but it is in the interest of the borrowing countries to ensure that economic growth and poverty gains remain protected in the process.

DDR is increasingly gaining importance but there is no practical guide that can be followed to ensure its effective implementation. No consensus has yet been reached on sequencing or on the parameters. Some principles related to External Debt Restructuring (EDR) are already well-established but they often turn out difficult to implement in practice. In theory, the quantity and the structure of treated debt should aim to re-establish external debt sustainability, whilst losses are allocated to creditors based on the comparability of treatment principle. There is no common interpretation for these terms when it comes to each particular restructuring. They are the subject of fierce negotiations  but at least they exist and in the absence of anything better, they have provided a framework for numerous Paris Club restructurings and are also reflected in the Common Framework.

When it comes to domestic debt, there are no guiding principles, be they soft or hard. This is opening the door to important questions : when should domestic bondholders bear some of the burden of a debt adjustment? To what extent? Whenever there is a technical void in the process, politics often take over, and the coalition with the strongest voice usually tends to win; this may be foreign creditors. The current focus on global financial reforms, including those related to debt treatment, offers an opportunity to fill this vacuum.

What principles should be adopted to take advantage of this opportunity? Many competing needs lie in the balance during a DDR but long-term growth and protecting gains in poverty reduction should always remain the utmost priority. Programs should be designed to protect the poor, avoid domestic macro-economic, financial or social doom-loops. The development of well-functioning domestic debt markets is essential in providing the financial foundation for economic growth. Sharing the burden of adjustment also equally means that restructuring parameters should ensure the gains stemming from reforms or positive exogenous shocks are fairly shared between domestic and foreign creditors.

Those principles may seem simple and obvious, but they are not always necessarily central in domestic debt restructuring. Ministers should propose two reforms to ensure they are included:

1. DDR should be considered as part and parcel of the domestic adjustment program. This should imply the same level of consultation, preparation and ownership as other policies included in a program. It should remain a separate process from external restructuring considerations.
2. The costs of DDR implementation should be fully assessed, relying on a careful cost-benefit analysis, including on distribution of losses. This assessment should be anchored in Debt Sustainability Analyses

What is the global sovereign debt roundtable?

In early 2023, the IMF, the World Bank and the Indian G20 presidency established the “Global Sovereign Debt Roundtable” (GSDR).  This is an ad-hoc group of country officials with a mix of Paris Club and non-Paris Club members as well six “borrowing” countries at various stages of debt negotiations (Ecuador, Ethiopia, Ghana, Sri Lanka, Suriname, Zambia). The private sector (banks, bondholders) is also represented.

Since debt resolutions were too slow and conflictual, the aim of this forum is to provide a platform to discuss debt restructuring matters at both political and technical levels. While they do not have an official status, GSDR discussions offer an opportunity to get to a common understanding on restructuring processes.

The GSDR is an opportunity: it offers the possibility for finance ministers of developing countries to express their views. To do so, they need a united perspective, and the technical background to defend positions that will apply in their own negotiations and beyond. This is where think-tanks play an important role: providing policymakers with the knowledge and tools to defend a fairer debt restructuring process.

The first meetings of the GSDR took place in March and April 2023 – they helped clarify the Preferred Creditor Status of Multilateral Development Banks, requested the IMF to speed up the publication of its Debt Sustainability Analyses, etc. Those are small and fragile agreements, but they have provided enough reasons to continue the process into 2024.

The next important agenda item is that of domestic debt restructuring (ddr). In a workshop in mid-September, the IMF discussed with country representatives, private creditors, experts, what should be the rules around the involvement of domestic creditors.

During the 2023 IMF/World Bank annual meetings in Marrakech, finance ministers will meet and chart a path forward on structural issues linked to domestic debt restructuring (DDR). This briefing puts forward a few principles that ministers from the six participating countries could defend to improve the architecture in favour of future debtor countries.