IIF Private creditor participation proposal: A cure worse than the disease

5 June 2020 by Daniel Munevar

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Following the G20 Debt Service Suspension Initiative (DSSI) announced during the 2020 Spring Meetings, the International Institute of Finance (IIF) has released a template for the voluntary involvement of private creditors in a debt service suspension. The proposal is the result of a consultation with over 100 private creditors representing over US$ 45 trillion in assets under management. It is a useful guide to assess the willingness of private creditors to provide meaningful debt relief to countries affected by the dual health and economic shock of Covid-19.

A review of the proposal reveals that no actual relief is being offered to developing countries. The IIF proposal entails the provision of short-term cash support by private creditors to countries included in the G20 G20 The Group of Twenty (G20 or G-20) is a group made up of nineteen countries and the European Union whose ministers, central-bank directors and heads of state meet regularly. It was created in 1999 after the series of financial crises in the 1990s. Its aim is to encourage international consultation on the principle of broadening dialogue in keeping with the growing economic importance of a certain number of countries. Its members are Argentina, Australia, Brazil, Canada, China, France, Germany, Italy, India, Indonesia, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, USA, UK and the European Union (represented by the presidents of the Council and of the European Central Bank). DSSI in exchange for higher debt burdens down the road. The proposal presents additional problems: it fails to address creditor collective action problems; doesn’t include provisions for Middle Income Countries (MICs); and is unlikely to be triggered by countries, even in cases where it could provide short-term relief. The IIF effectively compounds the problems already identified in the G20 DSSI.

To understand the problems with the IIF proposal is useful to analyse each of the issues highlighted.

First, in the case of the NPV of the claims, private creditors are requesting terms that are not aligned to those of the G20 DSSI. On the one hand, suspension of payments to official creditors is Net Present Value (NPV) neutral. This means that countries are asked to pay back to their official creditors an equivalent amount to the debt service Debt service The sum of the interests and the amortization of the capital borrowed. suspended over a longer period of time. On the other hand, the suspension of debt service payments to private creditors proposed by the IIF claims to adhere to the principle of NPV neutrality, but fails to do so. In the IIF proposal, suspended interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. payments by sovereign debtors are added on to the original amounts owed and will accrue extra interest. Under the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

Low Income Country Debt Sustainability Framework (LIC DSF) this would increase the NPV of the debt stock Debt stock The total amount of debt of participating countries. The net impact on NPV of public debt would depend on both the rate of interest applied to the capitalization of deferred interest payments and the discount rate.* Countries participating in the initiative would experience an increase of their debt burdens.

Second, participation by private creditors remains voluntary. This leaves collective action problems unaddressed. Furthermore, the proposed structure of postponed interest capitalization creates incentives for borrowing countries to offer sweeteners (such as high interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
on deferred payments) to increase creditor participation. Given the high risk of debt distress present in a number of countries, this incentive structure may end up increasing the costs of an eventual debt restructuring process by raising the NPV of public debt stocks.

Third, MICs’ challenges remain unaddressed. The IIF has replicated the limited efforts of the G20 and adopted a narrow focus for the scope of countries eligible for the private creditor scheme. This represents a short-sighted approach given the overwhelming dependency of MICs on market-based financing. Coupled with the identified gaps in the Global Financial Safety Net (GFSN) that prevent a number of these countries from accessing multilateral financial support in a timely and adequate fashion, this heralds a wave of debt distress episodes. Thus, a piecemeal approach to their rising levels of financial stress will only create additional costs for creditors and debtors alike and reduce the likelihood of a strong global recovery.

Last but not least, it is unlikely that a large number of countries will decide to request suspension of payments to private creditors under the IIF proposed terms. A prerequisite for private creditor involvement is active participation in the G20 DSSI. As of May 28, only 36 out of 77 eligible countries have applied to participate in the G20 initiative. The slow rate of application is a direct result of the actions taken by credit rating agencies Rating agency
Rating agencies
Rating agencies, or credit-rating agencies, evaluate creditworthiness. This includes the creditworthiness of corporations, nonprofit organizations and governments, as well as ‘securitized assets’ – which are assets that are bundled together and sold, to investors, as security. Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organization will be able to repay both the principal and interest as they become due. Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc. A rating of BB or below is considered a ‘junk bond’ because it is likely to default. Many factors go into the assignment of ratings, including the profitability of the organization and its total indebtedness. The three largest credit rating agencies are Moody’s, Standard & Poor’s and Fitch Ratings (FT).

Moody’s : https://www.fitchratings.com/
, such as S&P, Moody’s and Fitch. The reluctance of these agencies to adapt to the crisis is placing additional pressure on developing countries. Credit rating downgrades are being applied to countries such as Ethiopia, Pakistan and Cameroon as a result of their decision to apply for the G20 DSSI. The nature of the downgrades is disconcerting given that the G20 DSSI is designed to cover payments due to official creditors only. This makes it clear that in the event that a country decides to approach its private creditors under the terms of the IIF, credit rating agencies would not hesitate to apply a stringent assessment on the request. As borrowing costs can increase substantially in the aftermath of a downgrade, this effectively eliminates the incentives for any country to even think of approaching the IIF.

Thus, while the efforts in terms of coordination and communication by the IIF are welcomed, the cure proposed is worse than the disease. Given the moral imperative to prioritize Covid-19 response efforts, it is unconscionable that private creditors are requesting terms that will increase the debt burdens of developing countries. Furthermore, the threat of loss of market access associated with credit downgrades is being used to cower debtor countries into submission and force them to repay their debts regardless of public health and long term debt sustainability consequences.

The inability of the G20, IFIs, IIF and credit rating agencies to respond to the magnitude of the crisis is leading us into a situation in which countries will not ask for help until is too late and defaults become inevitable. The costs of that failure will be unfortunately measured in the millions of jobs and lives lost, not due to a devastating virus, but to unwillingness to address the unfair and inefficient nature of the global financial system.

* The discount rate is an interest rate used to convert a future income stream to its present value. The higher the discount rate, the lower the NPV value of a claim.

Daniel Munevar

is a post-Keynesian economist from Bogotá, Colombia. From March to July 2015, he worked as an assistant to former Greek Finance Minister Yanis Varoufakis, advising him on fiscal policy and debt sustainability.
Previously, he was an advisor to the Colombian Ministry of Finance. He has also worked at UNCTAD.
He is one of the leading figures in the study of public debt at the international level. He is a researcher at Eurodad.



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