Sovereign Debt Relief Momentum is Accelerating

Thursday, April 02, 2020 / 10:21 AM  / By Fitch Ratings / Header Image Credit: Fingyan

Momentum for debt relief for coronavirus-affected low-income countries is building, says Fitch Ratings; but if relief is applied only to debt held by official creditors it will not be counted as a default under our Sovereign Rating Criteria. A default rating could result if, as is being discussed for vulnerable countries, such initiatives also lead to restructuring of debt to private creditors.

In recent statements, leaders of the IMF and World Bank called for official bilateral creditors to suspend debt payments for countries eligible for support from the International Development Association (IDA) that request it, and declared that they were preparing to present a framework to move this forward by mid-April. The IMF is also moving ahead with debt-service relief under its Catastrophe Containment and Relief Trust (CCRT).

Negotiations on debt relief may be complex, particularly given the rising importance of non-Paris Club creditors, in particular China, which has not previously engaged in collective official sector debt-relief initiatives. According to the World Bank, of the USD14 billion bilateral debt-service payments due in 2020 from IDA-eligible countries, only USD4 billion is owed to members of the Paris Club of mostly western creditors. We believe China accounts for a large part of the remainder.

Nevertheless, the momentum for broad support has accelerated dramatically in response to the coronavirus. The IMF has reported that donors, such as the UK, Japan and China, have come forward with contributions to replenish the CCRT. Under its Coronavirus Aid, Relief, and Economic Security Act, the US has also signed off additional resourcing to the IMF's New Arrangements to Borrow scheme, under which certain countries stand ready to extend additional lending to the Fund to boost its capacity to provide support.

In some countries, the coronavirus has added financial stresses on top of those created by existing high external debt levels, and IMF and World Bank leaders have indicated significant debt restructuring could be required. In some cases, creditor countries may be reluctant to offer relief to states unless debt owed to private creditors is also restructured, which would add time and complexity to the process. This is more likely to be the case for countries that the IMF had classified as being at high risk of debt distress even before the coronavirus crisis.

Under Fitch's Sovereign Rating Criteria, we do not view debt relief from official sector creditors as a default, and rating actions would be based on the extent to which the coronavirus shock - the main trigger for the accelerated debt relief - has fundamentally exacerbated credit risk. While not in itself implying default, if official debt relief is tied to restructuring of private-sector debt, such a restructuring could qualify as a distressed debt exchange and thus trigger a move to 'RD'. If debt relief is expanded to cover obligations to the IMF and other multilateral institutions, we anticipate that these entities would be compensated by their shareholders, reflecting their preferred-creditor status.

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