IMF financing assurances: no quick fix
The financing assurances policy is proving to be the main roadblock towards IMF program approval in recent sovereign restructuring cases, such as Zambia and Sri Lanka. The Fund is walking a fine line between risking to give reluctant creditors a veto over IMF disbursements, and letting them be repaid with said disbursements instead of contributing their fair share in the restructuring.
Lee Buchheit proposed in an Alphaville piece to reform the financing assurances policy by pushing back their provision after Board approval – as opposed to the current custom of seeking them between the Staff-Level Agreement and the Board – while withholding IMF disbursements until financing assurances have been provided.
In this blog post I try to show that such a proposal could amount to little more than moving the goal posts, because disbursements matter more than Board approval per se. More focus should be given to increasing the transparency of the financing assurances process, or designing a multi-step approach towards program approval relying on emergency financing, which could reduce the leverage of reluctant creditors.
Some background on financing assurances
When a country’s debt is not sustainable, the IMF will require financing assurances from creditors before approving a program, usually in the form of a commitment to provide debt treatment in line with the IMF DSA parameters.
The aim of the Fund is to strike a difficult balance: if the requirement is too stringent, this gives reluctant creditors an effective veto over IMF programs, and hence undue leverage over the debtor to strike a deal on more favorable terms. If the requirement is too loose, this heightens the risk of IMF disbursements being used to repay creditors at the expense of restoring macroeconomic stability. The latter option also risks derailing restructuring negotiations: other creditors might consider that holdouts are not contributing sufficiently, and therefore withdraw the commitment to restructure their claims.
As noted by Lee Buchheit, it was much easier when the creditor lanscape was dominated by Paris Club creditors and a reasonable number of commercial banks. The new paradigm is more complicated, with emerging bilateral lenders like China, complex commercial claims involving collateral, or plurilateral institutions claiming preferred creditor status. This new normal is characterized by less coordination across and within creditor classes, but also various forms of leverage that creditors can use to extract a better restructuring deal from the debtor, jeopardizing both IMF program and restructuring negotiations.
To illustrate with a concrete example, when approving a program for Suriname in 2021 the IMF said in a footnote that no escrow account had been funded . Then the Fund learned between the Board approval and the first review that (i) the authorities had funded an escrow account as part of a China EXIM loan arrangement, and (ii) China EXIM had drawn on said account, jeopardizing the IMF financing assurances and arrears policies, as well as comparability of treatment and restructuring negotiations.
Lee Buchheit’s proposal: probably no silver lining
In order to put an end to this conundrum, Lee Buchheit proposes the following:
There is an obvious solution. Instead of asking lenders to give financing assurances as a condition to taking a program to the IMF’s Executive Board, let the Board approve the program but withhold any significant cash disbursements until existing lenders have agreed to provide the needed debt relief.
Indeed, for now the provision of financing assurances is expected between the Staff-Level Agreement (SLA) and the Board approval. During this same period, the government is also expected to implement so-called prior actions – steps that the IMF will require before any disbursement such as the removal of price controls or the presentation of a new budget.
An important point raised by Lee Buchheit is that the current application of the policies can put governments in an awkward position, forcing them to implement politically difficult reforms only to see the IMF program held up for months by reluctant creditors – in Zambia it took 8 months for creditors to provide these assurances after the SLA, and in Suriname they never did so the IMF waited for months until the country fell into arrears.
Say a country is required as a prior action to unify parallel exchange rates or devaluate its currency. The political support for such a measure will usually be found in the belief that it will trigger a fresh flow of financing from the IMF and its partners, enabling the government to alleviate the short-term socioeconomic impacts. If the government implements the reform but financing is still withheld, this is a perfect recipe for social unrest.
However, enabling Board approval right after prior actions have been implemented, as proposed by Lee Buchheit, would do little in this view so long as significant disbursements are still withheld until financing assurances are received. The Board approval is so important precisely because it is tied to the first significant disbursement: separating the two would barely add a layer of complexity in the program approval process.
This reformed process would risk giving the illusion of victory when the program makes it to the Board, whereas the heavy lifting – obtaining financing assurances – would remain to be achieved. Citizens would hence be in a position to question what it means for a program to be “approved” if the country still cannot access significant disbursements despite implementing all prior actions at a significant social cost.
Finally, there is also a risk that the proposed reform would dilute the catalytic effect of IMF Board approval, usually thought to restore confidence and foster support from a wide range of partners. Indeed, the financing assurances also contribute to reassuring multilateral lenders that they are not merely subsidizing some Chinese policy bank or holdout hedge fund.
Increasing the transparency of financing assurances
Once acknowledged little can be done in terms of the sequencing of financing assurances within program negotiations, we should instead focus our attention on reforming other aspects of the process. For instance, the transparency of what the IMF considers as specific and credible financing assurances could be greatly enhanced, streamlining the process and enabling precious time gains.
Below are a few ideas of what the IMF could do.
First, the IMF could clarify ex ante the concrete form of financing assurances, so that debtors know exactly what to ask from their creditors before they engage. The current situation, with a lot of room for judgement calls by the IMF staff, puts countries in a difficult position when they obtain something from their creditors only to be told by the IMF that it was actually not sufficient. The IMF could state clearly: is a friendly nod from the Executive Director at the Board enough? Should it be a signed letter? A signed term sheet?
A similar problem lies in the level of commitment the IMF requires: should the creditor commit broadly to a debt restructuring in line with program parameters – which apparently was not sufficient in the Zambia case – or should it agree to specific terms for its own claims? Should it commit to accept on its claims the target average NPV reduction of the overall debt stock? Should it commit to any NPV loss at all in the first place?
Of course part of the answer to these questions depends on the type of creditor and the characteristics of the claim, e.g. whether the creditor has control over some collateral, or whether it is unduly claiming to benefit from preferred creditor status and can hence be expected to be especially reluctant. However, these characteristics could probably be narrowed down in categories and fed into a decision tree enhancing the transparency of the whole process ex ante for all stakeholders.
Then as a public good, the IMF could improve the granularity of financing assurances reviews ex post, as proposed notably by Brent Neiman at the US Treasury: “Details about financing assurances – their form, scale, provenance, etc. – should be more transparently reported and tracked in staff reports.”
Such reporting would in turn feed into the previous steps, enabling the IMF and its shareholders to build a track record for each creditor and take it into account when telling debtor countries the kind of assurances they should seek from each of their creditors to access significant IMF disbursements.
For instance, building on the difficulties observed in the Zambia case, countries seeking financing assurances from Chinese creditors in coming months should be better informed by the IMF whether these assurances should be sought from the State Council, the Ministry of Finance, the top management of policy banks, loan officers, or a combination of these stakeholders which play different roles in China’s overseas lending.
PMB: the IMF’s secret weapon?
Faced with the financing assurances conundrum, the IMF has tried several approaches in recent years, which were not particularly successful and even drew the ire of its main shareholder:
In Suriname, the IMF tried to use the arrears policies to override the need for financing assurances, and the program went off-track before the Fund had to deal with the issue of the unforeseen escrow account blunder described above.
In Ecuador, the IMF accepted Chinese financing assurances which resulted in a subsequent restructuring two years later.
In Zambia, the IMF apparently lowered the bar and approved a program with assurance that ended up being not specific nor credible since we are learning from media reports that Chinese creditors are pushing back on IMF assumptions and restructuring negotiations are yet to start.
As said time and time again, Sri Lanka looks set to be the next major test case for the financing assurances policy, and the government is yet to receive these assurances from relevant bilateral lenders.
However, away from the limelights, the IMF could actually have another card up its sleeves, in the form of a two-step approach involving emergency financing instruments. These instruments, meant to be disbursed rapidly, have less stringent requirements than full-fledged IMF programs. For instance debt needs to be prospectively sustainable but the program does not need to be fully financed, meaning a financing gap can remain. Additionally, the IMF has empirically applied less stringent requirements in terms of debt restructuring assurances for emergency financing.
Concretely, in cases involving unsustainable debt and creditors reluctant to provide financing assurances, the IMF could approve a smaller-scale emergency financing package, relying on weak or non-existent financing assurances. This financing would provide the government with a time-bound lifeline, reducing the leverage of reluctant creditors during the next few months and laying ground for the conduct of good-faith restructuring negotiations. This would ideally result in the provision of specific and credible assurances, or even of a final restructuring deal, enabling the approval of a full-fledged IMF program with bigger disbursements.
This idea could actually be considered as a way to make Lee Buchheit’s proposal workable within the current IMF policies, since within the two-step approach the Board does approve a program without comprehensive financing assurances, and the most significant disbursements under the UCT program do come at a second stage after financing assurances have been received.
The missing piece in this process would be IMF oversight during the emergency financing period, since emergency instruments do not involve conditionalities. However, when unveiling its Food Shock Window in October 2022, the IMF also created a new form of Staff Monitored Programs with Board Involvement (PMB for short). While they were not widely discussed, PMBs are exactly meant to bring some form of oversight within the IMF’s emergency financing toolkit, and would be a perfect fit for the two-step approach described above.
Of course there is little chance this trick could be used in Sri Lanka now that the country has an SLA for a UCT program. The two-step approach also entails risks, increasing the resources that the IMF lends in the absence of adequate safeguards. PMB also risk diluting the catalytic aspect of IMF financing as I argued in an earlier blog post.
However, any innovation in the international financial architecture is worth looking at, especially in difficult times. There is room for cautious hope, and for instance Malawi looks set to be patient zero for this two-step approach, as the IMF noted that the emergency financing approved in November 2022 would hopefully pave the way for the subsequent approval of a UCT program.
If you want to discuss this further, please reach out: firstname.lastname@example.org
You can also follow me on twitter @TheoMaret