Developing countries tend to be reluctant to participate in debt relief initiatives – such as the DSSI or some successor program - when the benefits of doing so seem small, and the costs risk ending up high. Arguably, some countries eligible for debt relief, when evaluating the net benefits of participating in a debt relief initiative may find the value of waiting and potentially participating later higher. The framework we develop suggests that to make debt relief more attractive to debtors, it is necessary to increase the expected benefits, reduce the costs of participation, and/or reduce uncertainty about the outcomes. This includes the possibility of temporary debt service standstills during restructuring negotiations, increased emphasis on post-treatment growth, and the provision of more new financing for the underlying adjustment programs. Moreover, a clarification of the debt treatment procedures and an indicative timeline for the various process steps involved would help to anchor debtor countries’ expectations.
The views expressed in this blog post are those of the authors and should not be attributed to the IMF, its Executive Board, IMF management, the National Bank of Belgium, or the Eurosystem.
Why are debtor countries hesitant to participate in debt relief initiatives?
Developing countries eligible for debt relief compare the net benefits of participating in a debt relief initiative now with the value of waiting and potentially execute their participation option later, when they may have more information on the benefits and costs. Anecdotal and analytical evidence shows this framing can help to understand countries’ reluctance to participate in debt relief initiatives. The framework suggests different ways in which debt relief can be made more attractive to debtors.
If left unaddressed, sovereign debt problems may intensify over time and result in defaults that have large economic costs for both debtors and creditors. So why then are debt restructurings often marked by long delays? Part of the answer may lie in coordination difficulties among creditors, which could give rise to strategic holdout behaviour.
However, also on the side of debtor governments there appears to be reluctance to restructure. Limited and delayed participation in recent debt relief initiatives is a case in point. When the G20 launched the Debt Service Suspension Initiative (DSSI) to assist low-income countries with temporary debt repayment moratoria during the pandemic, only about two thirds of 73 eligible debtor countries decided to take part – and some sooner than others. Even more strikingly, the G20’s Common Framework for Debt Treatments beyond the DSSI, set up to guide more comprehensive debt restructurings, has so far convinced only a handful of debtor countries to apply, despite many more eligible countries finding themselves in or close to debt distress.
In a recent paper (Cassimon, Essers and Presbitero, 2023), we take a debtor-centred point of view and study the potential motivations for participating, or not, in the DSSI and Common Framework. We do so by applying insights from real option theory.
A real option application
The basic intuition is that, in considering when to execute their option of participating in a debt relief initiative, eligible debtor countries only go ahead now when the expected net benefit of doing so exceeds the value of waiting and being able to gather more information about those net benefits (keeping the possibility of participating later).
The value of this so-called ‘real’ option depends on a few key parameters: the expected benefits of participation (temporary debt service savings under the DSSI, or the regaining of debt sustainability under the Common Framework); the expected costs (including damages to financial market reputation and administrative/negotiation costs); the uncertainty about the benefits and costs (such as doubts about the debt perimeter and treatment terms, and about market reactions); and the opportunity costs of not (yet) participating (like the foregone suspension of debt service, or missed investments). All else equal, higher uncertainty about the benefits of the DSSI or Common Framework for the debtor increases option value and leads to more delay in the participation decision.
Press statements by debtor government officials support this real option framing. For example, at the time the DSSI was launched, Benin’s Minister of Finance referred to the expected costs in an op-ed: “[T]hese solutions will further tarnish the reputation of our governments and jeopardize their access to future financing. Our countries will suffer from an implied deterioration of their perceived credit quality, which could impact their access to capital markets”. Ghana, which eventually applied to the Common Framework, was initially held back by the large uncertainties surrounding it. According to sources close to the Ghanese authorities, quoted by Reuters, “[they had] been hesitating due to the long delays faced by other countries using the process” and “had sought reassurances that the negotiations can be expedited before proceeding”.
Survival analysis of DSSI participation
To further test our real option framing, we conduct a ‘survival’ analysis using variation in the timing of debtor requests (if any) to participate in the first phase of the DSSI (May-December 2020). We start by looking at the evolution over time of the cumulative proportions of countries that requested DSSI participation, when splitting the group of DSSI-eligible countries along different variables (see below).
Debtor countries that stood to benefit more or had less to lose, were quicker to request DSSI support
(a) Debt service savings
(b) Risk of external debt distress
(c) Credit rating
(d) Involvement in IMF arrangement
Our first proxy of DSSI benefits are the (potential) debt service savings to GDP for 2020. A higher exposure to bilateral creditors should imply larger and more certain participation benefits, as most of those creditors were quick to subscribe to the DSSI. Second, any lowering of the risk of external debt distress by the DSSI would be most valuable for eligible countries deemed riskier. Hence, we construct a dummy variable for eligible countries classified to be at low risk of debt distress vs. those at moderate/high risk of or already in debt distress. We also look at eligible countries’ latest pre-DSSI sovereign credit ratings. Finally, we account for the formal DSSI requirement of having to request an IMF arrangement, which takes time to fulfil and could possibly carry stigma. This is of course only a concern for countries that did not yet have an active IMF arrangement at the time of the DSSI launch.
In line with the real option framing, we observe that debtor countries that stood to benefit more from DSSI participation, due to higher expected debt service savings, larger exposures to willing official bilateral creditors, or higher pre-existing risks of debt distress, were quicker to apply for DSSI support. Countries that faced less of a hurdle in having to request an IMF arrangement first moved quicker too. Conversely, debtor countries that had more to lose in terms of market reputation, because of larger exposures to bondholders or better credit ratings, were less likely to make an early DSSI request.
These results broadly survive when we estimate the effects of the different variables in multivariate survival models, and when including extra control variables in the model, such as GDP per capita, expected GDP growth, the expected fiscal balance or government health expenditures.
Making debt relief initiatives more attractive to debtors
Our real option framing can be used to structure ongoing discussions on how to make future DSSI- or Common Framework-(like) debt treatments more attractive for eligible debtor countries to join – and to join earlier rather than later.
A first set of potential policy interventions works through increasing the expected benefits and/or reducing the expected costs of debt treatment participation. This includes the possibility of temporary debt service standstills during restructuring negotiations, increased emphasis on post-treatment growth, the protection of new financing, and capacity building to lower the administrative costs of any debt restructuring.
A real option approach suggests different policy levers to encourage earlier requests for a debt treatment
Other policy proposals focus on the reduction of uncertainty for the debtor. For starters, a further clarification of the debt treatment procedures and an indicative timeline for the various process steps involved would help to anchor debtor countries’ expectations. Various other technical issues need to be spelled out more clearly, like the expected perimeter of the debt eligible for treatment, or how the required ‘comparability of treatment’ will be assessed and enforced in practice. Also, the likely consequences of a debt treatment for credit ratings and market access need to be better understood.
Several of these questions have been recently discussed in the Global Sovereign Debt Roundtable (GSDR), which aims to build greater common understanding among key stakeholders involved in debt restructurings and finding solutions to current shortcomings. While the GSDR may be able to resolve some of the technical problems raised, demonstration effects matter too. Above all, actual (and faster) progress on the ongoing restructuring cases would boost the confidence of debtor countries in seeking debt treatments under the Common Framework and beyond.