June 21, 2022

House of Commons – UK Parliament

Submitted via: https://committees.parliament.uk/call-for-evidence/2611/

Written evidence submitted by the Institute of International Finance for the House of Commons International Development Committee’s Inquiry on Debt Relief in Low-Income Countries

Dear members of the House of Commons,

The Institute of International Finance (IIF) welcomes the opportunity to respond to the House of Commons International Development Committee’s inquiry on debt relief in low-income countries (LICs). We commend the Parliament for taking this step in investigating this important issue.

The IIF is the global association of the financial industry, with around 400 financial institutions from more than 60 countries comprising our membership. Our mission is to support the financial industry in the prudent management of risks; to develop sound industry practices; and to advocate for regulatory, financial and economic policies that are in the broad interests of its members and foster global financial stability and sustainable economic growth. The IIF promotes global efforts to enhance sovereign debt architecture and closely monitors the implementation of the Principles for Stable Capital Flows and Fair Debt Restructuring – a set of guidelines formulated by a working group of representatives of emerging market borrowers and their official and private creditors. Since their endorsement by the G20 in 2004, the Principles have proven to be an effective framework for sovereign debt crisis prevention and crisis resolution that is widely referenced by debtors, official and private creditors, international financial institutions, and other stakeholders.

Debt levels are rapidly rising in low and lower-middle income countries. Total external debt of 73 DSSI-eligible countries rose from $330 billion in 2010 to near $870 billion in 2020, with Pakistan, Nigeria and Bangladesh seeing the sharpest buildup. Of that total, $568 billion was long-term public/publicly guaranteed external debt, with official multilateral and bilateral creditors accounting for over 78% of total public debt. China has become the largest official bilateral creditor of many low-income countries over the past decade.

Low-income countries have limited commercial debt: Commercial bank loans account for less than 8% of total external debt in DSSI-eligible countries while bonds represent around 12% of total public debt. In sharp contrast, private creditors (notably bondholders) are the largest external creditors to many middle-income countries. Of the 73 countries eligible for the DSSI, only 22 had outstanding Eurobonds and fewer than 50% had any private sector commercial debt at all. This means that private sector involvement in any potential debt workout in LICs cannot occur at the same scale as that of the multilateral financial institutions and official bilateral creditors—see Box 1 below

Lack of timely and granular information: Strengthening debt and fiscal transparency is a key responsibility for the public sector to help ensure that countries have stable and affordable access to international debt markets. Despite some improvements in recent years, debt statistics remain incomplete for most LICs; in many cases, improvements are occurring too slowly to match the needs of rapidly-growing global debt markets.

With new forms of lending scaling up and the investor base broadening for many debtor countries, the lack of granular data on debt beyond the central government’s debt obligations undermines investor confidence. In particular, the absence of timely disclosure of public debt obligations, limited coverage of contingent liabilities (including SOE liabilities) and the extensive use of confidentiality clauses in non-bonded debt are the major impediments causing information asymmetries between creditors and debtors. This lack of transparency often means higher borrowing costs and limited access to private capital markets for sovereign borrowers.

While enhancing transaction-level debt disclosure practices will increase borrowers’ creditworthiness, it will also significantly improve debt sustainability and cut the time it takes to resolve debt restructurings when they become unavoidable. Countries are strongly encouraged to maintain a publicly-accessible database of their domestic and external bond prospectuses, and publicly release key financial and legal terms on their project-related and other loan contracts with all external creditors. Public disclosure of relevant transaction-level information will improve the assessments of debt sustainability and enhance debtors’ credibility with creditors. The relevant transaction-level information could initially include the items listed in the Information Matrix Template that was developed by the IIF and OECD for the Implementation of the IIF’s Voluntary Principles for Debt Transparency.

The IIF Debt Transparency Working Group (DTWG) is actively partnering with the OECD to operationalize the IIF Voluntary Principles for Debt Transparency, which are designed to promote transparency in private sector lending to vulnerable Poverty Reduction and Growth Trust (PRGT) countries. The UK government has provided donor funds to conduct a pilot project that involves the development of a repository for data provided by IIF members. Full implementation of the Voluntary Principles for Debt Transparency will require the full support of debtor countries, official bilateral creditors and the International Financial Institutions (IFIs), including the IMF and World Bank. Education and capacity building on the merits of debt transparency will be key: for example, the extensive use of confidentiality clauses in loan agreements continues to be a constraint on private sector lenders’ ability to contribute data to the repository.

More granular data from the international financial institutions would help: The IMF and the World Bank provide technical assistance (TA) through a range of channels to address common transparency problems. These efforts involve advice on the legal and regulatory frameworks to broaden sector and instrument coverage, including on the definition of public debt. The IMF and the World Bank’s advisory services and analytics require the collection of a significant amount of qualitative and quantitative information to bridge the large information gaps stemming from the absence of consolidated public debt data in LICs. However, public access to this additional information is limited. Although the recent enhancements in the IMF/WB’s Debt Sustainability Analysis (DSA) and the IMF’s Debt Limits Policy aim to enrich the content of published DSA information (debt holder profile, composition of debt service by instrument and creditor), many DSA inputs appear to remain publicly unavailable due to confidentiality clauses or non-disclosure agreements used by official lenders.

While there is no shortage of public sector initiatives, databases or repositories, these initiatives could benefit from greater coordination: At present, LICs report debt data to four main databases, managed by the IMF and the World Bank: International (External) Debt Statistics (IDS), Government Finance Statistics (GFS), Quarterly External Debt Statistics (QEDS) and Quarterly Public Sector Debt Statistics (QPSDS).  These official databases vary in their scope, although they track similar statistics.  Comparing data across these sources is a significant challenge, as definitions and coverage differ. While these differences reflect the various purposes of the databases, the data offered is far from complete in coverage of debtors, creditors, and debt characteristics, and is often at low/yearly frequency when present at all. Data reporting to the IDS is mandatory on a loan-by-loan basis. This makes it the most comprehensive data source on external debt. Yet, it is released at an aggregate level and a significant portion of the database is not publicly available.  Data reported to the other databases by developing countries remain quite limited, as it is on a voluntary basis: Out of 82 low-income and lower-middle-income countries, only 15 countries report to the QPSDS, and there are substantial differences across countries in national debt definitions and coverage.

Dissemination of ESG data and policy information: Achieving the Sustainable Development Goals (SDGs) will require a significant increase in investment. Without such efforts, the SDGs will remain out of reach and could jeopardize urgently needed actions to combat climate change, particularly in fragile climate-vulnerable LICs. While comprehensive tax and public investment reforms at the national level in LICs could generate more domestic resources, the majority of future climate finance will still need to come from the international community, particularly from the private sector. However, large-scale expansion in cross-border private capital flows for climate action requires LICs to maintain a timely flow of information on governments’ ESG policies and progress. Countries should disseminate information on the environmental and social dimensions of budgetary and fiscal policies. This includes disclosure of climate commitments, targets, forecasts, scenarios, and outcomes in a clear and timely manner.

Duration of debt workouts: Debt restructurings are associated with a substantial retrenchment in economic activity, domestic credit creation, and capital flows; and delays in debt workouts can lead to even bigger economic losses. The duration of debt restructuring cases vary widely, ranging from a day to a multi-year process, and depends in part on the composition of the creditor base—and the debtor’s capacity and will to repay. However, recent sovereign debt restructurings including only privately-held bonds and commercial bank loans have had shorter average duration than previous restructurings. Since 2014, the duration of renegotiations on privately-held bonds and loans stands at approximately 1.1 years and 1.3 years, respectively. This was much lower than the average duration of 3.5 years over the 1978-2010 period. In sharp contrast, defaults to official creditors still take much longer to resolve compared to defaults on bonds and commercial bank loans, highlighting coordination problems among official creditors. Indeed, many low-income countries have remained in default to bilateral official creditors for long periods. Recent years have also seen a pickup in the number of defaults to non-financial private creditors, such as commodity traders. This type of default typically takes much longer to resolve than defaults to bondholders and commercial banks.

Enhancing official sector coordination: Today, over 60% of low-income countries are at high risk of—or already in—debt distress. Given that nearly 80% of their external debt obligations are to official creditors and LICs’ access to international debt markets remains very limited, it is crucial to enhance the coordination among official creditors to smooth the implementation of future debt workouts.  In this regard, the G20 Common Framework represents an opportunity to improve the global debt architecture, bringing Paris Club and non-Paris Club official creditors of low-income countries together. However, implementation of the framework has been slow to date, given coordination challenges among official bilateral creditors. Earlier engagement of with private creditors and specifying the mechanics of comparability of treatment is much needed.

Fostering greater transparency in debt restructuring: The Paris Club plays an important role in the coordination of debt treatments in LICs by official bilateral creditors. However, public access to the terms of debt treatments facilitated by the Paris Club remains limited. Greater information-sharing by the Paris Club would set the stage for truly open and transparent processes in debt workouts and would be instrumental in bridging debt data gaps.

Prevention and Resolution of Sovereign Debt Crises – the importance of market-based approaches: In the absence of a widely-acknowledged international mechanism for sovereign debt workouts, market-based approaches have a vital role to play. In this regard, the Principles for Stable Capital Flows and Fair Debt Restructuring are a key element of the international sovereign debt architecture. There are four building blocks of the Principles. The Principles aim to foster:

1. Enhanced debt transparency and the timely flow of information between creditors and debtors to promote and maintain sustained market access
2. Close debtor-creditor dialogue and cooperation, mainly to avoid debt restructurings (The IIF Best Practices for Investor Relations are a useful starting point for authorities in LICs seeking to build a close two-way dialogue with creditors)

In cases where debt restructuring becomes inevitable, the Principles aim to facilitate a voluntary, predictable, and orderly debt restructuring process based on:

3. Good faith actions and
4. Fair treatment of “all” stakeholders

Debt-for-nature swaps: The recent experience of Belize highlights the potential benefits of debt-for-nature swaps in tackling the triple threat of debt, climate change and biodiversity. Introduced in the 1980s, debt-for-nature swaps are financial instruments that allow portions of a country’s foreign debt (in hard currency) to be reduced or cancelled in exchange for commitments to invest (in local currency) in biodiversity conservation and environmental policy measures.

Although these swaps have often been proposed in recent decades as a source of climate finance in developing countries, particularly in the Caribbean, a replicable mechanism to layer ESG considerations into restructured debt markets has remained out of reach, partly due to country-specific challenges. Some challenges include imperfect commitment mechanisms, timing and logistical constraints, lack of transparency, divergent impact measures, debtor countries’ potential loss of legislative leverage and sovereignty to foreign entities, and lack of resource preservation for domestic development. Furthermore, criticism of debt-for-nature swaps may have contributed to the waning uptake in recent years. Critiques include mismanagement by the local conservation organization, overstated financial benefits of swaps, and misdirection of the funds generated.

Given the growing importance of ESG factors, identifying mechanisms that allow debt workouts to incorporate them will require close collaboration of various players: Paris-Club and non-Paris Club bilateral creditors, multilateral official creditors, credit rating agencies, and the private sector. Given the complexity of debt restructurings, these debt workouts should be narrowly-focused, under the responsibility of economic authorities, and inclusive of environmental and social budget disclosures. By using debt-for-nature swaps and other ESG-aligned instruments, sovereigns can establish a strong foundation for ESG engagement, expand their access to global capital markets, and develop the foundation for deeper and more targeted ESG KPIs.