By Ishac Diwan & Jules Devie
Wilton Park’s Dialogue on 'Advancing Sovereign Debt Sustainability'
Current financial conditions and the search for an effective new initiative
There is currently a mistaken belief that the financing problems of the LLMICs are easing as global interest rates decline, but this is not true.
Commercial loans remain expensive and above these countries' growth rates. In effect, LLMICs now face a choice between two adverse options: refinancing their debt-service obligations at high interest rates, even if this increases the risk of rapid solvency deterioration; or allocating scarce fiscal resources to meet large debt payments, even if this requires deep cuts in human development spending and strategic investments in infrastructure and resilience.
Since 2022, market refinancing has effectively come to a halt, and what has been described as a “silent development crisis” has begun to unfold. In 2023, proposals put forward by FDL, the U.S. Treasury, and the Brazilian G20 presidency converged into a joint World Bank–IMF articulation of the “three-pillar” approach.
The 3-pillars framework was meant to promote:
- A strategy centered on ambitious, growth-oriented reforms (pillar 1);
- Greater official-sector financing and guarantees (pillar 2); and
- A commitment from bilateral and commercial creditors to maintain net exposure stable during the adjustment period (pillar 3), thereby avoiding destabilizing capital outflows.
So far, the three-pillar approach has fallen short. The IFIs, which had increased their support around 2020-21, reduced their transfers prematurely. At the same time, borrowing costs for LMICs stayed very high, and refinancing was limited. As a result, pillar 1 also failed: LMICs did not receive enough financing to prompt ambitious structural and pro-growth reforms beyond domestic resource mobilization.
A new effort to find ways to make the 3-pillars approach work is necessary, especially because the early hope of a quick reversal of the interest rate cycle has been dashed by various new sources of uncertainty regarding the outlook for growth and monetary policy worldwide.
By now, LMICs have split into two groups: one still hopeful of accessing capital markets soon, and another unable to do so even in the medium term. They both need to adapt to a new world, and this requires a substantial push of IFIs’ support to help them recover and overcome their financing problems. Their goals concerning commercial creditors differ. The first group needs support to access refinancing loans, including more generous access to guarantees. The second group requires coordinated flow relief from commercial creditors through long-maturity reschedulings.
Concerted reschedulings are possible under current practice, but they are not carried out. When debt-stock vulnerabilities threaten a Fund-supported program's viability, restructuring becomes necessary. Conversely, when binding constraints come from debt-service flows—known as “grey zone” cases—no similar requirement exists. This asymmetry should be addressed. Due to the ongoing stigma surrounding preventive restructurings, the best approach is to set a clear, rules-based trigger instead of depending on discretionary judgment. In grey-zone countries, official financing should be increased if commercial creditors provide enough flow relief to ensure program viability when senior debt surpasses a set threshold, such as 60 percent of total external claims.