May.04.2020
The COVID-19 pandemic has wreaked havoc across the globe, with a rising human and economic toll. Containment of this crisis has warranted unprecedented government intervention in public health and in the economy. This situation raises special challenges for the poorest countries, many of which have weak public health systems and lack the fiscal space and monetary policy tools needed to sustain a fight against the pandemic on the social and economic levels. These countries are the subject to the G-20 initiative, which proposes that an eligible country could request a time-bound suspension of debt service, thereby freeing-up financial resources for use in containing the crisis. May 1, 2020 was the launch date for the initiative.
The G-20 initiative limits eligibility to those countries qualifying for World Bank concessional financing and countries meeting the UN’s definition of “least developed countries.” Many of these eligible countries are in Africa. Notably, the G-20 not only includes countries, such as France, Germany, UK and US that have been longstanding creditors and donors to developing countries, but also includes China, India, Russia and Saudi Arabia that have increasingly become active in their financial relations with developing countries, particularly in Africa. Alongside their collective commitment to participate in debt suspension, when requested by an eligible country, the G-20 countries have called on private creditors voluntarily to participate on “comparable terms.” The Institute of International Finance is coordinating the private sector’s consideration of the initiative.
The G-20 initiative raises legal and policy complexities. We offer some context to governments and creditors considering these complexities and an analysis of which issues should be tackled head-on now, and which issues can be reserved for later.
Distinction between crisis containment (fighting) and crisis resolution
As noted by the IMF, the challenge for all countries is to do “whatever it takes” in order to counter the effects of the COVID-19 pandemic. We note, however, that one cannot do everything at once and trying to do so may be counterproductive. There needs to be a sequencing of responses and allocation of responsibilities among the relevant actors—this is true on the social level as it is on the economic level. In the current crisis-containment phase, one cannot get away from the exigency that governments would need to do the heavy lifting—this is true in the domestic context as it is in the international context. The first line of financial support to the poorest countries will need to be grants or highly concessional loans. Such financing can only come from the governmental sector, principally through the multilateral institutions, such as the IMF, World Bank and African Development Bank. The shareholder governments in the multilateral institutions have committed to augment the concessional financing resources of these institutions so that they can more effectively carry out the rapid response for the poorest countries.
The main charge for the private sector in the crisis-containment phase is to avoid exacerbating the situation. In the context of the financial challenges of the poorest countries, this would imply debt service forbearance, where requested. In principle, forbearance could include suspending debt service for a period of time, forbearing from collecting on claims or from engaging in legal actions against the eligible country, or from declaring a default on the debt or accelerating the debt obligations.
Some may say that such a response by the private creditors is not very much. However, the scale and type of financial action to contain the fallout from the COVID-19 pandemic requires a macro response, which only the governmental sector is empowered to perform; the private sector cannot discharge this responsibility through the micro tools available to it (e.g., rescheduling of individual claims to which the private creditor is a party). Furthermore, while the G-20 initiative is explicitly subject to the application of national laws, the implications of this qualification is very different for the governmental sector than for the private sector. Government creditors have broad authority to exercise their prerogative to forbear claims on any basis that they choose. In contrast, private creditors may be subject to legal and regulatory obligations (such as investor fiduciary duties) and collective action requirements, which constrain the circumstances in which they can suspend the contractual financing terms.
When the height of the crisis abates, a crisis resolution phase will follow in which an accounting of the costs of fighting the crisis and the responsibilities for resolution will be apportioned. During that second phase, both the governmental and private sectors will be faced with addressing debt sustainability issues that have emerged across all sectors of society; the debt service challenges of the poorest countries will need to be earnestly tackled at that time. In his April 9, 2020, open letter, IIF President Tim Adams appropriately noted the importance of distinguishing the crisis containment (fighting) and crisis resolution phases when considering the application of the G-20 initiative.
The G-20 initiative implicitly assumes that the crisis containment phase will continue until the end of this year, during which time some debt service for eligible countries may be suspended. In the interim, private sector representatives, including financiers and lawyers, can shape the established market-based sovereign debt restructuring tools and work on designing innovations in advance. One innovation could be in the design of value recovery instruments (VRIs), which generally can bridge uncertainties in projections of economic recovery in sovereign debt restructurings. Given that the economic recovery that will determine debt payment capacity in many of the poorest countries will be dependent on external factors, such as international demand for commodities, innovative VRI design to reflect these external factors would be crucial.
Exclusion of the most vulnerable countries
While the G-20 initiative is appropriately circumscribed to those countries eligible for concessional financing, it is regrettable that the initiative excludes countries that are already in arrears to the World Bank concessional financing window, such as Sudan and Zimbabwe. The depth of the protracted economic crisis in these countries would rather argue for greater—not lesser—support to stem COVID-19 health and economic shocks and mitigate potential contagion to other countries. To the extent that Sudan and Zimbabwe have relevant debt service falling due during the terms of the G-20 initiative, they too should be eligible for requesting debt suspension under the initiative on the same basis as other countries. We understand that a fallback position that the multilateral institutions are considering is to establish donor trust funds to deliver grants to Sudan and Zimbabwe in their time of heightened need.
Resolved and unresolved issues
Following the G-20’s call to action, the governmental sector and private sector, convened by the IIF, have sustained tremendous effort to resolve many operational details of the debt suspension initiative. We now understand that eligible countries’ domestic debt will be outside the initiative and that only claims against the central government (or guarantees called against the central government) will be included. While the Paris Club forum for official bilateral creditors has led the design of an operational template for these creditors, private sector creditors may devise their own term sheets on the modalities on their participation. Given the diversity of private sector creditors and their financing models and the governing contract laws, we caution against a so-called model term sheet, which could inappropriately collapse every situation into an “one size fits all' approach.
The Paris Club creditors also have helpfully clarified that they will not follow their usual practice of imposing a legal obligation on debtor countries to require comparable treatment from private creditors as a condition for the Paris Club providing debt suspension. However, the G-20 initiative does call on private creditors to participate on “comparable terms”, while respecting the principle that the debt suspension would be “neutral in net present value terms.” It is important that the private creditors determine the application of these concepts within the context of their market-based lending. In this ongoing exercise, uniformly applicable solutions are not reasonably feasible nor can all inter-creditor issues be resolved at this stage. Rather, we recognize that there will be a later stage in which, for example, the terms of a private creditor’s forbearance during the crisis containment phase would be taken into account if there is a subsequent restructuring in the crisis resolution phase.
More thought is needed on the potential reaction of credit rating agencies to requests by eligible countries for debt suspension. How much weight in a country rating assessment would be accorded to the application of the debt suspension when many of the economic fundamentals in the respective country have evidently deteriorated? And what would be the implications of a downward country rating when new financing is constrained by the economic fundamentals, independently of whether debt suspension is requested? These questions should not be conflated with the credit rating for the particular sovereign debt obligation whose payment is suspended.
Lawyers have a penchant for uncovering issues and identifying complications (and hopefully solutions). But now is not the time to make the perfect the enemy of the good, nor to delay the rapid collective financial response that the governmental sector has undertaken to provide. The effectiveness of the G-20 initiative should be measured in broad terms. One example for comparison is the Heavily Indebted Poor Countries (HIPC) Initiative, which has approved debt reduction packages to 36 countries, 30 of them in Africa, providing around $75 billion in debt-service relief. In many ways, HIPC is much more elaborate than the G-20 initiative in that it is not just a crisis containment initiative but is designed to address longer term debt sustainability issues. However, in the framework establishing HIPC, the international community accepted that the participation of creditors holding 80 percent of the present value of the eligible debt would be sufficient for the official sector to go ahead with debt reduction operations. There is no reason why the G-20 debt suspension initiative cannot be applied with a similar degree of pragmatism.
Creditors to the poorest countries should continue in the concerted effort to do all that they can, while recognizing that all creditors cannot do the same, all at once.