IMF directors explain how they can lend to countries with unsustainable debt

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IMF directors explain how they can lend to countries with unsustainable debt

10:58 CAT | 27 Feb 2017

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The International Monetary Fund (IMF) believes that its regulations forbid loans to countries with unsustainable public debt such as Mozambique unless debt restructuring takes place and there are credible macroeconomic objectives.

An article on the IMF’s ‘Global Policy Forum’ website by the director of the legal department, the director of research and the director of the IMF’s European department explains the Fund’s approach to the issue of unsustainable debt which renders countries ineligible for relief.

“When sovereign debt is unsustainable, the IMF’s legal framework precludes it from providing financial support unless the program includes specific measures—normally including a debt restructuring—that credibly address the debt sustainability problem within the medium term,” the article by Sean Hagan, Maurice Obstfeld and Poul M. Thomsen explains.

Without specifically mentioning Mozambique, one of the countries facing this issue, the article explains that the concept of “unsustainable” essentially applies when “scheduled debt service exceeds the capacity of the member to service it, even taking into account both a strong adjustment program and significant financial support from the IMF”.

In January, Mozambique failed to pay a provision of nearly US$60 million on US$727.5 million of sovereign debt issued in April last year, which had already been subject to restructuring which extended the repayment term from 2020 to 2023 and increased the annual interest rate.

The government then argued that it was not able to make this and the other payments expected for this year, in an initiative that the holders of these bonds considered to be a move to force them to restructure the eurobonds.

Following this default, the credit rating agencies either lowered their rating of Mozambique’s sovereign debt or signalled the economy as evolving negatively. All gave Mozambican debt non-investment recommendation, commonly known as ‘junk’.

“Although considerable work has been done to establish a methodology to guide the IMF’s debt sustainability analysis, the application of this methodology still requires the exercise of judgement,” the article reads, namely the need to make a “a realistic assessment of the unique circumstances of each member country”.

With a public debt estimates by rating agency Standard & Poor’s to be currently at 137 percent of gross domestic product and expected to remain close to 120 percent by 2020, Mozambique is one of the countries facing the difficulty of needing IMF financial support and at the same time having to convince holders of sovereign debt to accept payment restructuring.

Creditors say that the country must reach an agreement with the IMF first, to ensure compliance with adjustment program budgetary targets and follow-ups, while the IMF, in the latest public statements and in this article now published, prefers debt restructuring to take place before the implementation of any support program.

On the methodology for assessing debt sustainability, the article authors o explain that they use two models. “The first methodology asks if, by the end of the IMF program and with debt serviced on the original terms, debt ratios to GDP will be sufficiently low or on a clear enough downward path to restore lender confidence and allow the government once again to tap financial markets.”

The second, “which is especially relevant when debt has a long maturity and particularly low interest rates, is to ask whether the country’s annual financing needs—to cover gross payments of interest and principal as well as its primary fiscal balance—can reasonably be met by the markets going forward”.

In both cases, say the authors of the article, projections on payments have to be realistic and should improve debt sustainability over the years, “rather than levels that would disrupt the economy so severely that tax revenues actually fall and fiscal targets are abandoned”.

Thus, ultimately, the IMF’s assessment of debt sustainability “will rely on both the country’s own circumstances and our extensive experience with other members in distress”, the authors conclude.

Source: Lusa