Jill Dauchy is founder and CEO of Potomac Group LLC, a Washington DC-based financial advisory firm for sovereign governments and public sector borrowers, as well as a podcast host.
To meet the demands of the 21st century, our international financial architecture requires urgent renovation.
The cornerstone of the architecture is paradoxically the piece that is now missing. Within the arcane and little understood policies of the IMF there is a concept of “financing assurances” that must be given before the IMF executive board can approve an IMF program and disburse funds. As a lender of last resort that is funded globally through taxpayer money, the fund must be assured that the country in question has a financing plan for the program period and will not use IMF funds to satisfy other creditors.
In the old days, financing assurances were easy to provide. The debtor country would normally call the IMF and apply for debt relief from the Paris Club of Official Creditors at the same time. Conveniently, the major shareholders of the IMF were the same countries that comprised the Paris Club, which meant that they had effective veto power over the program, and back in the day, they also enjoyed considerable influence over national commercial banks active in emerging markets. Official debt relief and comparability of treatment across creditor groups was therefore an efficient process and financing assurances could essentially be assumed from the onset.
But herein lies the problem. In the highly negotiated wording of IMF policies, financing assurances can only be given by a “representative standing forum” — and the only representative standing forum recognised by the IMF is the Paris Club. But the Paris Club is no longer representative. Most countries owe very little debt to its 22 permanent member countries after they provided debt relief under the HIPC Initiative of the late 1990s and early 2000s; in today’s world, emerging markets borrow heavily from China and the international capital markets. There is no forum — recognised or otherwise — that brings these diverse players together and no mechanism for providing assurances to the fund.
The Common Framework, introduced in response to the Covid-19 pandemic, is a valiant attempt to cut and paste the practices and approach of the Paris Club onto the G20. Developing countries however are not convinced. They watch in fear the downgrades and years of delay experienced by Chad, Ethiopia, and Zambia — the only three countries to initiate debt relief though the Common Framework. Zambia recently received IMF Board approval of its program, based on financing assurances of the Creditor Committee co-chaired by China and France, however, negotiations continue with official bilateral and private creditors on the terms of the actual debt relief. It does not inspire confidence that the IMF Executive Board itself continues to be reluctant to recognise the Common Framework as a representative standing forum.
All eyes are now turning to Sri Lanka, a middle-income country in undeniable debt distress that has just entered that limbo period between staff-level and Board-level approvals, where everything hinges on financing assurances. With rising rates in developed economies, other countries will probably soon follow.
It is time to think boldly and bravely and create a system that can deliver financing assurances — through debt relief, grants, and concessional finance — quickly and efficiently and targeted to meet the many needs of low and middle-income countries. Four proposed reforms include:
1. Automate debt service suspension on debt owed to G20 member countries. When a low-income country applies for the Common Framework, G20 countries should automatically grant a suspension of debt service during the IMF program period. This would provide immediate financing assurances from official bilateral creditors.
Enshrine early engagement with all creditors. The IMF debt sustainability analysis (DSA) is in essence an internal tool to determine the ability of a debtor country to repay the fund. In practice, it effectively sets the parameters of negotiations with other creditors. The IMF should at an earlier stage be more transparent with these creditors to allow them to understand the DSA’s underlying assumptions, permit them to formulate their own views and, at the IMF’s option, obtain input on the DSA. These are after all the people from whom financing assurances are sought and who will help make the IMF program a success.
Introduce automatic stabilisers into bond and other debt documentation to ensure private sector participation. Drawing upon lessons learned from collective action clauses and catastrophe bonds, as well as earlier designs of GDP-linked bonds, contractual terms and conditions could be developed to provide automatic debt service suspension if a ‘trigger event’ occurred. Staff-level approval of an IMF program could be such an event.
Use the global momentum around climate and nature. Debt swaps and sustainability-linked bonds are tools that we can use to provide credible and specific debt relief and new financing to countries in distress. Global players eager to support vulnerable countries should be brought in. Programs and instruments that will allow new money to flow into the country should complement the request for financing assurances which otherwise risk being synonymous for losses. UN agencies, the World Bank, regional development banks, global funds such as GEF and GCF, and others like The Nature Conservancy have shown interest and creativity in mobilising finance and supporting debt relief efforts by linking them to sustainable outcomes that can be specified, monitored, and verified. These techniques can be used to treat existing debt owed to official bilateral and/or private creditors, as well as to raise new financing with credit enhancements.
These innovations would reintroduce an element of automaticity currently lacking in the international financial architecture, while also providing information to all parties early in the process and allowing them to find creative solutions beyond haircuts. By bringing in other global players and investors, it also allows for the mobilisation of new money that can used for a wide range of development goals.