G20 Sovereign Debt Suspension: To Apply, Or Not To Apply
This report does not constitute a rating action.
That is the question many governments are asking–to apply, or not to apply. As the group of the world’s major economies met in mid-November to discuss a framework for debt treatments beyond the Debt Service Suspension Initiative (DSSI) scheme for low income countries, World Bank data showed that about 40% of eligible borrowers had not participated in the DSSI.
S&P Global Ratings believes cost-benefit considerations were behind some of the qualifying governments’ decisions not to apply for debt suspension. In some cases, sovereigns with access to commercial debt allegedly fear losing market access if they take up the offer to delay debt payments. Sovereigns could be seen as defaulting if debt suspension extends to commercial lenders (see “Credit FAQ: COVID-19 And Implications Of Temporary Debt Moratoriums For Rated African Sovereigns,” published April 29, 2020). Furthermore, the DSSI scheme is temporary–set up to help low-income economies cope with the fallout of COVID-19–and does not alleviate the structurally high debt burdens many sovereigns are facing; savings have been viewed to be small, offering only temporary liquidity relief.
With the G20 group of nations endorsing “debt treatments” and other sovereign debt relief programs being planned, if these considerations are addressed, it could help to broaden their appeal.
Rated Sovereigns In The Group Show Weak Credit Fundamentals
|Rating Score Snapshots|
|Issuer||Sovereign foreign currency ratings||Institutional assessment||Economic assessment||External assessment||Fiscal assessment: budget performance||Fiscal assessment: debt||Monetary assessment|
|Congo (the Democratic Republic of the)||CCC+/Stable/C||6||6||6||4||2||6|
|Papua New Guinea||B-/Stable/B||5||6||6||6||6||5|
The 73 sovereigns that qualify for the DSSI mostly show weak credit metrics, with many experiencing fiscal pressures. Of the 25 sovereigns in this group that S&P Global Ratings publishes ratings on, 21 are rated in the ‘B’ category or lower. The remaining four are all rated ‘BB-‘ (see table 1). Their credit quality often reflect low average income and relatively weak institutions. In several cases, sizable external borrowings also weigh on their external balance sheets. These credit attributes significantly constrain the debt sustaining capacity of these sovereigns.
Ten of these rated sovereigns carry relatively heavy debt burdens that equal or exceed 60% of GDP (see chart 1). We estimate that four of these will report net general government debt larger than their GDP in 2020. Low-cost concessional lending from bilateral or multilateral sources typically make up a significant share of their borrowings, helping to keep debt service more affordable. Even so, many of these rated sovereigns pay interest of at least 10% of revenue (see chart 2). These characteristics are also shared by many unrated DSSI-qualified sovereigns.
Even without COVID-19, the credit quality of DSSI-qualified sovereigns could benefit from reduced debt burdens. More fiscal resources could be applied to infrastructure improvements or much-needed social spending as a result. These countries should, in theory, welcome debt relief schemes that creditors extend. However, the number of countries that yet to apply for DSSI suggests that these sovereigns have reservations about the scheme.
Limited Participation Thus Far
The partial participation may reflect characteristics of the DSSI that are associated with its objectives. The initiative was launched mainly to help governments in low-income economies cope with the fiscal shock dealt by COVID-19. It provides fiscal room for governments by temporarily relieving them of some debt payment burden. Moreover, the G20 creditor nations wanted to be sure that the resources the DSSI releases go toward spending to meet the COVID-19 pandemic.
The World Bank estimated that about 10 of the 73 eligible countries would see reduced debt payment amounting to more than 1% of 2019 GDP (see chart 3). This initially included both interest and principal payment suspensions relating to official bilateral loans (between two governments) between May and December 2020. The actual reductions may be even smaller if these countries could refinance at least part of the principal payments maturing in this period, as is often the case in normal times.
Another key aspect is that DSSI is not offering debt relief, only postponement. The suspended payments have to be repaid in the future. The scheme is meant to be neutral to lenders in terms of net present value, and borrowers were initially expected to repay the suspended amounts within four years from the end of the period of the DSSI. This repayment period was extended to six years in October. The initiative, therefore, helps to address liquidity problems faced by sovereigns but does not reduce their overall debt burden (see “The G20 External Interest Payments Moratorium Will Partly Ease African Sovereign Debt Service Burdens,” published June 24, 2020).
The relatively slow progress in implementing the DSSI may have lessened its attractiveness further. In early October, the World Bank said that the scheme had delivered more than US$5 billion in debt service deferral in 2020. This is some way short of the US$8.9 billion potential savings that the institution estimated for countries that have signed up for the initiative. If the scheme had not been extended by another six months, it would have left little time for participating countries to access its full benefit.
Sovereigns Borrowing From Commercial Sources Have Additional Misgivings
For sovereigns that expect to be able to seek financing on commercial terms, the costs of participating in the initiative could be greater than the potential DSSI benefits, due to limitations being imposed by the DSSI process on commercial borrowing. With global interest rates likely to be very low in the foreseeable future, some higher-yielding emerging market sovereign bonds could find favor with investors. Mongolia (B/Stable/B), for instance, issued a 5.5-year US$600 million bond with a relatively low coupon rate of 5.125% in July. This issue would not have been possible if the country had applied for the DSSI suspension. In return for receiving US$68 million of debt service relief this year from bilateral creditors, Mongolia would have been restricted by the DSSI from contracting new non-concessional lending during the period of suspension.
This could be why, like Mongolia, none of the qualifying sovereigns with relatively high ratings of ‘BB-‘ (that increases their likelihood of successfully tapping international bond markets) or those with market access (such as Kenya or Nigeria) have so far sought DSSI relief. Although the restriction on non-concessional borrowing was eased after the recent G20 meeting, DSSI participants are still subject to limits to taking on such debts.
Sovereigns with outstanding international bonds or loans may also prefer to avoid the DSSI for another reason. Provisions in some such debt agreements could trigger credit events if the sovereign seeks debt suspension from official creditors. Nigeria (B-/Stable/B) and Kenya (B+/Negative/B), opted out of the DSSI partly because some restrictive terms on external commercial obligations could trigger an “incidence of default.” Nevertheless, officials of some non-participating countries had expressed interest in joining the program if the DSSI terms are revised to allow greater financial relief. Other sovereigns, however, do not appear to face similar constraints. Countries such as Angola, Pakistan, and Papua New Guinea participated in the DSSI despite having outstanding international bonds (see end note 1 on how we view sovereign defaults on commercial debts and official debts).
Some Sovereigns Are Wary Of Seeking Commercial Lenders’ Participation In DSSI
When the DSSI was launched, private sector debt holder’s participation was strongly encouraged. The World Bank estimated that commercial lending accounted for about 20% of external debt of DSSI-eligible countries (see chart 4). For some members of the group, however, commercial debt accounted for as much as half of external debt (see chart 5).
The effort to include commercial creditors, however, has been largely unsuccessful. The large number of private creditors that lend to these governments make negotiations difficult. Even when they are part of some organization or creditor group, such as the Institute of International Finance (IIF) and the Africa Private Creditor Working Group, this task is not made easier. The IIF, for instance, suggested that private sector participation should be on a case-by-case basis, voluntary on the part of the creditor and sovereign borrowers should approach relevant creditors themselves.
Since the start of DSSI, Zambia (SD/SD) has been the only sovereign rated by S&P Global Ratings to officially seek debt relief from commercial creditors. Even before Eurobond holders officially rejected the request in November, Zambia missed its coupon payment in October and had indicated that it was unlikely to pay within the grace period (see “Zambia Foreign Currency Ratings Lowered To SD/SD on Suspension Of Debt Service Payments To External Commercial Creditors,” published Oct. 21, 2020).
Demand For Equal Treatment Among Creditors
The need to balance the interests of official and commercial creditors can sometimes complicate debt relief negotiations. In refusing Zambia’s request for a payment suspension, international investors in Zambia’s Eurobond cited concerns that any relief that they grant could be used to repay the Zambian government’s arrears to some Chinese banks. Media reports said they viewed as unequal treatment the Zambian government’s nonpayment on their debts while payments to Chinese lenders continued. On their part, Chinese official lenders wanted the Zambian government to clear its arrears with them before granting debt relief, according to news reports.
China had also joined the DSSI, in principle, negotiating on a case-by-case basis. However, based on media reports, the Chinese government has said that it did not consider some loans from Chinese financial institutions as official lending. The Export-Import Bank of China (A+/Stable/A-1) and the China Development Bank (CDB; A+/Stable/A-1) have been active lenders to projects in the DSSI-eligible countries. Although widely recognized as China’s policy financial institutions (and therefore noncommercial in nature), they have been making nonpolicy loans for many years in an effort to generate profits to offset the financial drag of policy-related lending. The diminishing government-directed lending at the CDB also led the Chinese government to re-designate it a development finance institution instead of a policy bank in 2008. Consequently, any debt relief from these banks will have to be examined by S&P Global Ratings to determine if the obligations concerned are to be classified as official credit or commercial debt in nature (see End note 2).
Credit Impact May Be More Important In Future
The initiative provides a helping hand in the form of liquidity assistance to sovereigns that most need it in the face of the economic and other pressures brought about by the global pandemic. The increased transparency required of participating countries is also helpful for better assessments of their credit strengths. However, DSSI does little to ease the heavy debt burden that many of these countries shoulder and some sovereigns have not participated.
This situation may not change much with the “Common Framework for Debt Treatments beyond the DSSI” announced in mid-November at the extraordinary meeting of G20 finance ministers and central bank governors. The announcement listed “where applicable, debt reduction in net present value terms” as a key parameter to be agreed on by creditors. However, it considered debt write-off or cancellation to happen only in the “most difficult cases.” This could mean that reliefs are likely to come in the form of maturity extensions and lower interest rates.
Concluding an agreement under this framework may also take some time. Any agreement has to be signed with all creditors in a “Memorandum of Understanding” that would have to be implemented through bilateral agreements between the debtor country and each participating lender. The framework also specified that debtor countries needed to “seek from all its other bilateral creditors and private creditors a treatment at least as favorable as the one agreed in the MoU.” If this means that all creditors need to agree to the same debt reduction (or more), getting any debt reduction agreement signed would not be easy.
Apart from the G20 Framework (to which the Paris Club creditors also agree), other organizations have also proposed various alternatives. The U.N. Conference on Trade and Development, for instance, has argued for a temporary standstill of sovereign debt repayments for some countries. Another U.N. agency, the Economic Commission for Africa, has floated the idea of a sovereign debt exchange. And a group of economists have proposed a central credit facility, which is a mechanism by which a multilateral agency oversees a comprehensive sovereign debt standstill to ensure the resources released are directed toward fighting COVID-19.
Debt reduction alone, however, may not be the solution. These debt declines could reverse if governments ramp up borrowing again. But debt reduction can be combined with other measures that improve debt capacity and put in place mechanisms for better external monitoring of fiscal and debt activities. These additional measures could cement the credit improvements provided by debt reductions.
1. S&P Global Ratings’ sovereign credit ratings address the risk of default on commercial debt obligations and a failure to service commercial debts on time and in full could lead to a default under our criteria. A failure to service official debts (i.e., bilateral or multilateral loans) according to the terms of the debt contract does not have a direct and immediate impact on sovereign credit ratings. Consequently, such failures to pay on bilateral obligations do not constitute a sovereign default by our definition. Nevertheless, defaults on official debts often accompany credit stresses that have negative implications for sovereign ratings.
2. A significant debt write-off of China’s loans to DSSI countries is unlikely to be a serious hit to China’s financial system. Chinese official loans to the 73 DSSI qualifying countries amounted to about US$120 billion. Even if a sizable portion of this was written off without compensation, it would still amount to much less than the US$130 billion bad debts written off by Chinese banks in 2019.
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