Sovereign restructurings: a logjam long in the making
In September 2022, Sri Lanka reached a Staff Level Agreement with the IMF. Six months later, the program is moving to the Executive Board on March 20 after China provided financing assurances that were deemed as sufficient by the IMF – the first time it does so outside of the Common Framework. While this progress is most welcome, there’s still a long way to go as noted by Mark Sobel: financing assurances need to be turned into a concrete restructuring deal, the most difficult step where Zambia has been stuck for more than 7 months now.
In this blog post, building on data from Jorgelina do Rosario, I take a look back at previous country cases to try and show that today’s stalemate experienced by Sri Lanka or Zambia was long in the making.
To better understand the hurdles that Sri Lanka faces towards a restructuring after the IMF Board approval, I look at the reasons for China’s reluctance to participate in restructurings, both foreign and domestic. Some of them are expected to be dealt with at the newly launched Global Sovereign Debt Roundtable and other forums, potentially further delaying the final resolution to Sri Lanka’s debt overhang.
An unprecedented logjam…
Data gathered by Jorgelina do Rosario at Reuters sheds a crude light on the current inability of the IMF to play its role as lender of last resort and provide timely support to countries in need, due to the difficulty of seeking financing assurances from non-traditional creditors. The latest series of sovereign restructurings have led to unprecedented time gaps between the Staff Level Agreements (SLA) and the approval of IMF programs by the Executive Board, Sri Lanka being one such example.
During this time spent in the grey zone, governments are on the hook, having to implement politically difficult reforms without the relief of new money flowing in. They also have to resort to alternative avenues to keep public services running – that’s for instance part of the explanation of why we saw foreign holdings of domestic debt instruments shoot up in Zambia from $1 billion to $3 billion after the default.
… which should have materialized earlier?
Speaking at a webinar in 2022, a deputy director of the SPR department at the IMF said the following about Chad’s Common Framework process: “It was the first case ever in the entire history of the Fund where China provided financing assurances to the Fund for us to be able to lend”.
This begs the question of how the IMF was able to approve programs beforehand whenever China was a significant creditor. Indeed, while China’s overseas lending ramped up in the wake of HIPC and then after the launch of the Belt and Road Initiative in 2013, some loans started going south earlier than the COVID-19 pandemic.
The Republic of Congo’s 2019 IMF program is one of the first test cases with China having too much skin in the game to be overlooked within IMF policies. Reuters data indicates that the time gap between the SLA and the Board for Congo’s program was 63 days, from May to July 2019.
However, looking at the 2019 staff report, the first footnote says that “This report provides a full update to the July 2018 Staff report that could not be considered by the IMF Board due to lack of sufficient financing assurances.” This means that the July 2019 Board approval was actually the conclusion of a SLA reached not in May 2019 but in April 2018. Even though governance issues surely played a part in the delays, this would be among the highest time gaps with 448 days.
It appears that, unable to get specific and credible financing assurances, the IMF waited instead for Congo to strike an actual restructuring deal with China before approving the program, i.e. a more stringent requirement than financing assurances which merely constitute a commitment. As per Reuters, the deal only touched part of the Chinese debt stock, with a significant chunk to be repaid by 2021, that is before the end of the IMF program. It was achieved, as we have been accustomed to with China since then, through a maturity extension and no haircut.
Following that initial roadblock, the IMF stretched its policies on a case-by-case basis to try and prevent China from gaining a veto over IMF programs while limiting the risk that new money would just pay off Chinese debt service.
For instance, Ecuador’s 2020 IMF program was approved on the back of expected new disbursements from China to offset part of the debt service during the program period, and only a partial rescheduling of the claims. The comprehensive restructuring of Chinese claims would only be achieved two years later in September 2022, with the details available here in Annex IV.
It is interesting to note though that despite these difficulties the IMF indicated in the 2020 staff report that it had received specific and credible financing assurances from bilateral official creditors. The later acknowledgement by the staff that Chad was the first ever case of textbook financing assurances from China can support the idea that Ecuador was not dealt with by the book.
Suriname in 2021 can be considered as the first program where the cracks really started to show, as discussed in an earlier blog post. The IMF waited for almost one year until the country fell into arrears to China. Then, the IMF used its arrears policies to override the need for affirmative financing assurances from China, despite its internal policies still requiring these assurances for important or recalcitrant bilateral creditors even in arrears.
Further delays after IMF program approvals
Even after programs are approved, financing assurances shenanigans sometimes prevent reviews and subsequent disbursements from happening in a timely manner: it took more than a year for the first review to take place after the program was approved in Chad, as restructuring discussions stalled.
The issue is that financing assurances are a commitment to provide adequate debt relief on a broad level, but they do not lay out how the relief will be achieved. This can be done in several ways, and each creditor will have specific preferences among them, e.g. maturity extension, grace periods, interest rate reductions, and nominal haircuts.
With the IMF Board approval achieved, countries need to negotiate with creditors and strike a final deal that is agreeable to all lenders while respecting the parameters of the program and the DSA. There might be another stalemate if, say, some DSA threshold requires a maturity extension longer than what a creditor is willing to accept.
The problem of delays after the Board approval was, in my view, reinforced with the Common Framework due to an original sin in the communiqué which said that the IMF DSA would be complemented with “the participating official creditors’ collective assessment” – opening the door to pushbacks from recalcitrant lenders on the framework of the negotiations.
This is exactly what happened in Zambia: China provided its (weak) financing assurances alongside other bilateral creditors in July 2022, yet subsequently started to push back against IMF assumptions in restructuring negotiations, as reported at length in the press.
Understanding the roots of China’s feet dragging
Even though Sri Lanka is not eligible for the Common Framework, it will probably face similar issues raised by China when the negotiations start in order to hammer down the terms of the restructuring. These difficulties appear to be quite generic and not country-specific – as a result, recent policy discussions provide valuable insights on what they could be.
For some time, delays were partly attributed to China’s lack of experience in coordinating across different entities such as the PBOC, the MoF and Policy banks. This argument becomes weaker as time goes by, and more fundamental roadblocks remain. It can be useful to divide them between geopolitical disagreements on the one hand and domestic constraints on the other hand, both requiring different kinds of solutions.
The first category of demands relates to China’s longstanding disagreement with the rules forming the bedrock of the international financial architecture for sovereign restructurings. These include pushbacks against the IMF’s methodology to assess debt sustainability, such as the definition of thresholds or the use of the residency criteria and its impact on the accounting of foreign holdings of domestic debt. It also includes China’s widely discussed demand for the World Bank and other multilateral institutions to take losses in restructurings, threatening their preferred creditor status.
The most difficult problem with China though seems to be the domestic political economy. Policy banks do not want to take losses for various reasons, which might include genuine internal KPIs of department managers or not-yet-allocated political cost distribution and blame games across different institutions, as well as among their respective political supervisors – for instance it was reported that some bankers viewing themselves as commercial actors did not want to take losses on shaky policy loans that they had been forced to make by the political leadership.
Non-exclusive to those hypotheses, the leadership in Beijing might be reluctant to take any action that could be perceived as a form of debt-forgiveness to other developing economies, something the tightly monitored public discussion in China has historically been very sensitive too.
These domestic issues are especially hard to tackle because they are mostly insulated from any lever that Sri Lanka or the international community might have. As a result, absent a plan to allocate the political and financial losses domestically, it is uncertain that China would come to an agreement in sovereign restructurings even if other stakeholders gave in on its outside demands.
The Global Sovereign Debt Roundtable as a partial answer
Faced with this conundrum, the IMF announced the launch of a new forum called the Global Sovereign Debt Roundtable (GSDR), to try and agree on common rules that would help unlock country cases. It brings together all major stakeholders, including private creditors and debtor countries. Additionally it was reported that China would send representatives from several institutions (MoF, PBOC, Exim), potentially limiting coordination issues among Chinese entities.
There is a clear risk that the roundtable will not achieve its objective of moving forward country cases, instead freezing them for another few months. As long as the roundtable is ongoing, the IMF could be disincentivized to apply maximal pressure on China in order to keep the Chinese parties at the table. Similarly, China will be wary of transforming vague commitments, like these made in Sri Lanka, into concrete deals since any compromise at the country level would in turn weaken its position at the roundtable.
An additional problem is that, looking at the roadblocks listed above, it is unclear how many can actually be answered within this new forum. For instance, the demand to make MDBs take losses in restructurings might well be related to a broader willingness of China to gain more power in these institutions that they consider as merely a US proxy. In this case, they will be discussed at the G20, or the Board of these institutions, with a longer time horizon.
A way to alleviate this risk could have been to define clear objectives and deadlines for the GSDR from the start, to avoid successive rounds of protracted negotiations during which some participants continue to move the goalposts. Only time will tell if the roundtable was the last step before an inevitable reckoning.
Then, if a consensus emerges that China will not be ready to play ball in the foreseeable future, this would bring the IMF in uncharted territories. While the arrears policies can help countries muddle through for a while, it is not realistic to envision a world where debtor countries would simply remain in arrears to China indefinitely. There would, in fact, still be significant risks: countries could repay Chinese lenders after the end of IMF programs when the Fund and other creditors still have skin in the game but the oversight is reduced.
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