The Change Nature of Debt Renegotiations

joeleebassy | Jan 18, 2010 |

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There are two main institutional arrangements for debt relief: the Paris Club for debts to or guaranteed by government; and ad hoc consortia of commercial banks (sometimes called the London Club) for uninsured debts to financial institutions.

The Paris Club

The Paris Club was born in 1956 when a group of creditor countries met in Paris to renegotiate Argentine debt owed to export credit guarantee institutions, which had reimbursed private creditors following delays in Argentina's debit service to them. Although the club has no written rules, it has evolved a standard approach based on experience and precedent, one objective being equitable treatment of all creditors.

The scope of the club's debit relief covers service on all bilateral official loans, including concessional credits and officially guaranteed export credits. Consolidation periods are normally for one year, but successive agreements are common: debt relief has been extended more or less continuously during the past decade to Liberia, Senegal, Sudan, Togo, and Zaire. Previously rescheduled debt has been consolidated when circumstances required.

Debt relief is normally reschedule restricted to current maturities. The proportion typically rescheduled varies from 80 to 100 percent. This consolidated portion is repaid over eight to ten years, with a grace period of four to five years. For countries with severe balance of payments problems, the nonconsolidated portion may be repaid over the grace period; in such cases, debt relief approaches 100 percent of eligible maturities. Arrears are occasionally rescheduled, but they are normally repaid at a faster rate.

The Paris Club arrangements help restore normal trade and project finance to debtor countries. When the debtor countries experience severe international liquidity difficulties resulting in a breakdown in relationships with their creditors, a Paris Club agreement sets the framework for rescheduling arrears to official creditors and clears the way for direct or guaranteed new credits. It is followed by bilateral agreements with each of the participants in the Paris Club meeting within the agreed framework. After bilateral agreements are concluded (sometimes a lengthy process), each agency concerned restores export credit cover to the rescheduling countries. Indeed, debtor countries can approach the Paris Club even before encountering liquidity problems that would lead to the cessation of trade finance; ideally, they should do so. The Paris Club requires that debtor's countries take prompt and effective measures to address their underlying economic problems; an IMF-support adjustment program that will give a country access to the upper credit tranches is, typically, a prerequisite to a Paris Club agreement. The Paris Club, while still considering debt relief mainly in the context of short-term liquidity problems, has shown flexibility in its response to the debt-serving problems of developing countries that are willing to take steps to address their problems.

The Paris Club has worked best, however, for countries where temporary liquidity difficulties were due principally to a bunching of debt service payments. The Paris Club has been less successful in sub-Saharan Africa, where debt service difficulties are related to structural economic problems. When prospects for restoring normal debt service are dim for many years, successive annual rescheduling of payments for a decade often has served only to postpone the problem. The flexibility that the Paris Club has demonstrated provides the basis for expecting that it will adapt its practices to address these problems as well.

Commercial bank debt

By contrast to the Paris Club, arrangements for renegotiating debt owed to commercial banks have developed only since the late 1970s. Since much of this debt consists of syndicated loans, as well as uninsured trade or project finance, and the number of creditor banks may be in the hundreds, the banks are represented by an "advisory" committee that negotiates with the government of the debtor country. An agreement, when reached, must be approved by each creditor bank. The process has become increasingly streamlined in the 1970s, with small advisory committees now the rule and with coordinated actions to seek rapid agreement from all participating banks.

Commercial banks reschedule mainly current maturities of long-term debts, and occasionally arrears of principal as well. They do not reschedule interest; any arrears of interest must be settled before rescheduling agreements become effective. Some agreements have consolidated short-term loans and trade credit facilities have been extended as part of a debt relief package, in effect offsetting interest payments. The negotiations have been flexible; some have arranged year to your year deferments of debt while comprehensive longer-term agreements were still being discussed. Repayment of consolidated debt typically ranges from six to nine years, including two to four years of grace. Interest charge charges vary from a margin of the one and seven-eighths to two and one-half points over LIBOR. Debt rescheduling is normally accompanied by a commission charge of 1¹/₄to 11/2 percent.

Year to year rescheduling has effectively overcome immediate debt-serving

difficulties, but it leaves uncertainty over the debtor's future position, which can prevent its returning to normal market financing. In Mexico's case, the commercial banks signed an agreement in March 1985 to consolidate public sector debtor falling due in 1985-90 and to accept repayment over fourteen years, with lower spreads for the early years of repayment period and no restructuring fees.