DSSI and the Common Framework: Addressing debt vulnerabilities

Romanie Peters, Senior Company Lawyer, Legal and Claims Coordinator at Credendo, updates on sovereign debt levels and the impact of both DSSI and Common Framework in the current climate.

Sovereign debt levels have undoubtedly been on the rise in most low-income countries since the era of deep, comprehensive debt relief under the Heavily Indebted Poor Countries (HIPC) initiative. Even if this rising trend precedes the pandemic, the COVID-19 crisis and, more recently, the Ukraine-Russia conflict are pushing sovereign debt to new heights.

In this article, we review the results of both the G20 Debt Service Suspension Initiative (DSSI) and the Common Framework for Debt Treatments beyond the DSSI and ask what could be done better. Further to the operation of the Common Framework, we look at one of the core principles of sovereign debt restructuring, being comparability of treatment, which has recently come under pressure. We also address the need for more debt transparency.

DSSI

This debt relief scheme was launched in April 2020 and came to an end in December 2021 after two extensions. It provided a temporary and net present value (NPV) neutral suspension of debt service payments on claims owed to official bilateral creditors. Therefore, in essence, it was considered to address a liquidity crisis rather than addressing solvency issues.

In terms of results, the DSSI was open to 73 very poor and vulnerable countries and two-thirds of these countries actually sought suspension. Altogether, the scheme resulted in a $12.9 billion deferral by G20 creditor countries.

The DSSI stands out in two ways: i) it was implemented very swiftly after the start of the COVID-19 crisis and ii) it gathered G20 creditors in a coordinated and unprecedented way for debt rescheduling.

However, other than the subsequent Common Framework, the DSSI did not require the application of a comparable debt treatment to other creditors. While private sector creditors were asked to participate on comparable terms, ultimately they did not engage in any equivalent debt treatments. The major concern for borrowing countries to approaching private creditors was the potential negative impact on credit ratings and financial market access. However, in the end no such effects materialised.

Another issue raised in the application of the DSSI was the non-participation by multilateral development banks (MDBs). Although MDBs stayed out of debt treatments, thereby referring to their preferred creditor status, some of the MDBs have complemented these with further financing.

Common Framework

In November 2020, it had already become apparent that liquidity issues for some countries could result in solvency issues. Therefore, the G20 introduced the Common Framework for Debt Treatments beyond the DSSI.

The Common Framework addresses unsustainable debt situations of DSSI-eligible countries, and it focuses on longer term solutions, on a case-by-case basis. It draws heavily on the long-standing Paris Club architecture and one of its most important features is the conditionality, for instance, debt treatments under the Common Framework require an active IMF programme.

Today three countries have requested a Common Framework treatment. The status of the negotiations is at different stages due to very different problems these countries face.

• Chad was the first country to request a treatment under the Common Framework and the creditor committee started its activity in April 2021. This resulted in delivering financing assurances and it facilitated an IMF programme, which will soon be reviewed. However, certain creditors are now questioning the need of such a debt treatment, because Chad’s fiscal outlook has improved by the increase in oil prices, which leads to an understanding that there is no financing gap anymore. Negotiations continue nevertheless.
• For Ethiopia, a creditor committee was formed in September 2021, but the severe political instability in the country has, as of now, impeded progress under the Common Framework.
• Lastly, for Zambia, on June 16, 2022, 16 countries formally formed a creditor committee under the Common Framework, co-chaired by China and France and vice-chaired by South Africa, to discuss the Zambian authorities’ request of a debt treatment. One of the key challenges of the Zambian case will be to cope with the very large and diverse creditor base and the wide variety in debt instruments.

In terms of results, the main critique of the Common Framework is the lack of progress in the ongoing cases and the call for an acceleration of the process. Indeed, the presence of ‘new’ and large creditors involved in these restructurings, notably China, leads to increased complexity of the discussions. This is not only on the level of (debt) data reconciliation, but also with respect to understanding the technicalities of a sovereign debt restructuring process.

In addition, the strict requirement of fair burden sharing through the ‘comparability of treatment clause’ (explained below) slows down the process. That notwithstanding, the case-by-case approach, which is emblematic for Paris Club treatments and is also a core aspect of the Common Framework, has clear advantages too – especially given the need for tailormade debt treatments for the increased heterogeneity in creditors and instruments. Striking a fine balance is the mission here.

In any case, official creditors, borrowers and the IMF and World Bank agree and are actively discussing how to implement the Common Framework in a more timely and orderly manner, for instance by establishing a strict timeline for the various steps in the Common Framework and a central authority for following up with the practical implementation.

Comparability of treatment

In order to promote broad creditor participation and fair inter-creditor burden sharing, a debtor country that agrees to a debt treatment under the Common Framework is bound by the ‘comparability of treatment’ clause. Basically, this means involving and engaging all creditors into similar treatments of their claims on the debtor.

Under the Common Framework this comparability is a formal requirement and it actually means that the comparability of treatment principle is currently under pressure.

Indeed, this principle implies that any Common Framework debt treatment will demand a real contribution from private creditors, in contrast to the DSSI practice. New ‘official’ creditors at the negotiation table are fiercely insisting on the (strict) application of comparability among all creditors, including the private sector. As stated above, this will undeniably weigh on the speed of the Common Framework process.

In order to make this work and avoid blocking positions during the negotiation process, the basis on which the comparability of treatment is calculated is being challenged. Essentially private creditors, as well as the World Bank are calling for a more transparent and formal calculation based only on NPVs in order to assess comparability.

The discussion has been opened, and no straightforward off-the-shelf solution is currently available. But the positive element is that creditors express the willingness to i) safeguard the principle of fairness among creditors and ii) work together to solve the problem of the inertia of the Common Framework process.

Debt transparency

Finally, another element that has hindered the smooth progress of the debt treatment process is the collection of full and correct debt data. Unfortunately, the Common Framework lacks some of the Paris Club’s institutional features, such as its long-standing tradition and experience with information sharing, which makes debt transparency and creditor coordination in this framework even more important.

In the meantime, it is well known through cases of ‘hidden debt’ (notably in Zambia and Mozambique) that a lack of debt transparency entails adverse consequences for creditor trust and business confidence for the debtor countries involved.

Both borrowers and creditors have a role to play here. Borrowers could certainly strengthen their legal and regulatory frameworks for public debt management, for example by subjecting borrowing to parliamentary control. The IMF and World Bank strongly support such reforms in national legal and operational frameworks.

Official and private creditors also bear responsibility in the area of debt disclosure and public information sharing, therein supported by the G20 operational guidelines for sustainable financing.

Conclusions

• The DSSI served as an emergency response for short term liquidity issues, mainly caused by the pandemic. The coordinated action among various official creditors has been implemented very swiftly, but the absence of participation by private sector and other creditors has limited its benefits.
  
  The DSSI was not designed to deal with country cases of unsustainable debt. The G20 reacted with the Common Framework, a more structural solution to debt sustainability problems.

• The Common Framework enables more comprehensive debt relief. The requirement of comparable treatment from other bilateral and private creditors to ensure fair burden sharing is a key element for the framework’s success, but unfortunately, it also slows down the process.
  
  The lack of progress means that no conclusions could be drafted in terms of indicators for debt treatment as of today. The Common Framework comes with an IMF programme and, in principle, it can accommodate anything from short term debt re-profiling to a deep debt reduction.

• The need for debt transparency is a call to duty on both borrowers and creditors. Undisclosed debt should be avoided at all times as it impedes long term development. Better legal and institutional frameworks are necessary especially in low-income countries in order to serve public debt management and are actively promoted by the IMF and World Bank. The responsibility of sharing information equally falls on creditors.