Rescheduling external debt

Making new contractual arrangements between debtors and lenders. Debt restructuring can be used as a means of altering the profile of debt service. Depending on its terms, restructuring may involve a simple deferral of debt service, leaving the discounted present value of total debt service unchanged, or it it may involve an element of debt relief. In the latter case, such relief may be "nonconcessional", where a trade in debt instruments allows the debtor to share in a market discount, or "concessional", which involves the provision of public funds or explicit forgiveness of debt. The type of debt restructuring which is needed and feasible will vary from country to country and over time.

When the debt crisis first became evident the problem was commonly viewed as a lack of liquidity; debt restructuring emphasized rescheduling with generally little relief. Only later was it realized that the debt problems of some countries involved more fundamental issues of solvency, and then a secondary market developed for the debt instruments of highly indebted developing countries. This resulted in the "menu approach", a range of nonconcessional instruments for debt restructuring and relief, which includes transactions such as debt-equity swaps, securitization and interest capitalization. These instruments have been used effectively for some highly indebted countries in combination with domestic policy reforms and new money packages from commercial and official sources. The World Bank actively supports these developments.

Concessional debt relief usually follows the recognition by creditors that a country's limited prospects for growth and expanded exports will limit its ability to regain solvency, even with effective domestic policy reform, injections of new money or changes in the timing and structure of debt. One example is the USA' cancellation of large war debts after World War II. This contributed to the successful postwar reconstruction of Europe. In contrast, the debts and reparation obligations after World War I were among the factors that led to protracted economic difficulties. Moreover bilateral official debts of some low-income developing countries have been forgiven by many industrial countries.

Expanded programmes of concessional debt relief for the poorest countries, complementing domestic policy reform and supported by additional aid, are especially needed for Sub-Saharan Africa. Their difficulties often arise from structural weakness compounded by a short-term lack of liquidity. The debt of these countries mainly consists of official claims, so decisions about debt relief lie with industrial country governments. The Venice economic summit of June 1987 endorsed the principle of concessional relief for the poorest countries.

The issue of debt relief for the highly indebted, middle-income countries is more complex because for some countries prospects for medium-term growth are reasonable while others have succeeded in significantly expanding their exports with realistic exchange rate regimes and appropriate incentive frameworks. The bulk of their debt is owed to commercial creditors. Because these countries have substantially better economic prospects and higher per capita income, most official donors have not been willing to provide concessional financing in face of the growing demands of low-income countries and the scarcity of aid resources. Under these circumstances restructuring and nonconcessional relief have usually been seen as the appropriate course of action. However, there are some highly indebted, middle-income countries whose per capita income figures are misleading because they reflect an enclave economy based on mineral exports. Here the debt is so great compared with the productive potential of the non-mineral part of the economy that with the nonconcessional instruments available a return to creditworthiness and growth remains very far off. If the international environment were to deteriorate substantially, many more countries could fall into this category.

The approach to rescheduling following the debt crisis of the 1980s varies in response to the concerns of the commercial banks, which require assurance of the soundness of a country's policies. Multilateral institutions - particularly the IMF - have designed packages that included policy reforms, debt restructurings and new money. Central banks contribute indirectly through the Bank for International Settlements (BIS) or directly, as in the case of the Federal Reserve Board. Latin American debtors have been the main beneficiaries of this approach. In 1993, Brazil signed agreements with its commercial bank creditors which will allow the country to reschedule US$ 35,000 million of debts, and needs the endorsement of the IMF to be implemented.

Debt-equity swaps and the renegotiation of interest spreads over LIBOR (London Interbank Offered Rate) and of loan maturities in debt reschedulings have set the legal precedents. One idea is to subordinate existing debt to future loans, thus giving the latter senior status. This could prevent new credits from being marked down in line with secondary-market prices and thus make it easier to attract new lenders. But current creditors might object if this practice became widespread. "Securitization" which transforms traditional bank loans into negotiable securities, is another legal variant. It can be a channel for debt relief if the exchange of securities for loans reflects market prices. Mexico's novel scheme of December 1987 was a hybrid. It combined the features of securitization (by exchanging existing loans for tradable securities) and subordination (by deeming the collateralized securities "senior" to the remaining old loans). Despite its limited success this scheme sets a precedent for market-based debt relief: it passed some of the market discount to the debtor.