Appendix 2
Official debt restructuring

Evolution of terms for low-income countries
Rescheduling agreements in 1997

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Most agreements to restructure official source debt have been reached under the aegis of the Paris Club. Paris Club debts are mostly export credit loans—commercial debts at market interest rates that become official debt upon default by the debtors, and after export credit agencies have paid out claims to the private policyholders who had insured the commercial loans against nonpayment. Paris Club agreements cover government-guaranteed debt and intergovernmental loans, including aid loans.

Evolution of terms for low-income countries

Until the late 1980s official creditors addressed the repayment difficulties of heavily indebted poor countries by helping them overcome liquidity problems.1 The debt relief granted was a rescheduling or refinancing of some portion of the payments and arrears falling due during an adjustment program supported by the International Monetary Fund (IMF)—in most cases a period lasting between one and three years. But repeated rescheduling and the refinancing of interest falling due on pre-cutoff date debt did not solve the debt problem. Instead, it contributed to a steady increase in the stock of outstanding debt for many of the poorest countries.

By the late 1980s it had become evident that in some of the poorest countries the problem was not liquidity but solvency and that some debts were unlikely to be repaid in full. In October 1988, following an agreement at the 1988 Toronto summit of the Group of Seven (G–7) industrial countries, Paris Club creditors started to provide debt relief on concessional terms to the poorest rescheduling countries by forgiving up to a third of debt payments rescheduled or by reducing the interest rate charged on rescheduled amounts to below the prevailing market rate. At the same time, many creditor governments forgave some or all of the development aid debts owed by the poorest countries and increasingly provided new development aid on grant rather than loan terms.

In response to the increasingly difficult situation of the poorest countries, G–7 leaders agreed at the 1991 London summit to increase the degree of concessionality in reschedulings for the poorest countries. In December 1991 Paris Club creditors adopted London terms, under which the maximum available debt relief on eligible pre-cutoff date debt was increased from one-third to one-half in present value terms. Following the G–7 summit in Naples in 1994, Paris Club creditors agreed that, where necessary, concessionality could be increased to two-thirds on debt eligible for restructuring—arrangements known as Naples terms (box A2.1).

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Creditors also agreed in principle to go beyond repeated flow rescheduling and to restructure the full stock of eligible debt outstanding for poor countries that established a track record of good macroeconomic adjustment policies and debt service payments. The aim of such stock-of-debt operations is to allow a debtor to exit the rescheduling process and manage its future debt service obligations without additional relief. Although payments requested from the debtor are not necessarily higher under a stock operation than under a flow rescheduling, a stock-of-debt deal may require an increase in the actual payments being made to creditors, as debtors forgo the opportunity to negotiate future comprehensive flow reschedulings of payments falling due. An important motivation for a debtor to negotiate such a deal is that the reduction in the stock of outstanding debt to levels judged to be sustainable reduces uncertainty about future external debt service and so reduces the concern that foreign creditors might appropriate some of the benefits accruing from stronger future growth. Through the reduction of uncertainty—and by making an eventual return to creditworthiness a real possibility—stock-of-debt deals improve a country’s ability to implement economic adjustment.

Creditors have implemented stock-of-debt operations on Naples terms since 1995. There have been six such operations—Uganda and Bolivia in 1995 and Mali, Guyana, Burkina Faso, and Benin in 1996—covering more than $2 billion. In addition, 25 flow reschedulings worth more than $11 billion have been concluded on Naples terms—6 of them in 1997 (table A2.1).

Although Naples terms provide for a net present value reduction of 50 or 67 percent on eligible debt, the effective net present value reduction on total debt to Paris Club creditors is typically lower, for two reasons. First, post-cutoff date and short-term debt are normally excluded from eligible debt (although in some cases creditors may provide exceptional treatment on these debt categories, principally by deferring or reprofiling such debts without cancellations). Second, official development assistance (ODA) debt is rescheduled over 40 years, with 16 years’ grace, at an interest rate at least as concessional as the original loan rate. The net present value reduction on rescheduled ODA debt depends on the interest rate on the rescheduled debt compared with the interest rate on the original loan and the current market interest rate, as well as the remaining maturity of the loan. A number of creditors, however, have systematically forgiven all ODA claims, resulting in substantial debt relief for poor countries and more debt relief than is required under Naples terms.

Depending on the financing needs of a rescheduling country, Paris Club reschedulings on Naples terms typically involve a comprehensive restructuring of pre-cutoff date debt including, where necessary, arrears and debts outstanding resulting from earlier rescheduling agreements with Paris Club creditors (known as previously rescheduled debt). Some previously rescheduled debt may already have been treated concessionally, under either Toronto terms (up to 33 percent net present value reduction) or London terms (up to 50 percent net present value reduction). Naples terms agreements often grant an additional reduction in order to raise the total net present value reduction granted on previously rescheduled debt (including nonconcessional previously rescheduled debt) to 67 percent. The coverage of the agreement and extent of topping up is negotiated on a case-by-case basis.

In the context of the Debt Initiative for Heavily Indebted Poor Countries (HIPC), Paris Club creditors agreed to support the efforts of the international financial community to ensure that the debt problems of the world’s poorest countries are dealt with in a comprehensive way so as to reduce their debt to sustainable levels. Following the Lyon summit of 1997, creditors agreed to augment the support provided to the poorest countries by implementing concessional debt relief (especially Naples terms) and bilateral debt relief programs for eligible heavily indebted poor countries. Lyon terms increase the concessionality of debt relief on flow reschedulings and stock-of-debt reschedulings to up to 80 percent in net present value terms. Countries that qualify for support under the HIPC Debt Initiative—that is, countries that have demonstrated a sound and continuing record of economic performance, and for which traditional debt relief mechanisms would not be sufficient to reach a sustainable external debt position in the medium term—will be considered for Lyon terms.

In September 1997 the Russian Federation became a full-fledged member of the Paris Club as a participating creditor country. To make Russian claims comparable with the claims of other Paris Club members, Russian claims inherited from the former Soviet Union are reduced by an upfront discount that will be implemented when these claims are first treated by Russia within the Paris Club framework. The discount takes into account a debtor’s financial and economic situation. Thus a higher discount is applied to the poorest countries, given the need to ensure their financial sustainability. In addition, Russia will provide debt reduction or debt relief on the discounted value of these claims in accordance with the terms of the applicable Paris Club agreement for that country. Russia’s participation in the Paris Club paves the way for the resolution of a substantial amount of claims that were previously being dealt with on a bilateral basis. Thus Russia will be able to contribute to the efforts of Paris Club creditors to help heavily indebted countries.

Rescheduling agreements in 1997

In 1997 six agreements were signed with heavily indebted poor countries under Naples terms (see table A2.1). Four countries (Ethiopia, Madagascar, Tanzania, and the Republic of Yemen) received a 67 percent reduction (in present value terms) on eligible pre-cutoff date debt, while two (Cameroon and Guinea) received a 50 percent reduction (in present value terms). Four of the agreements (Cameroon, Guinea, Madagascar, and Tanzania) also included topping-up arrangements, whereby arrears and debt outstanding from earlier Paris Club reschedulings (that is, previously rescheduled debt) on Toronto or London terms would be eligible for a further reduction in order to achieve a total net present value reduction of 67 percent. Creditors also agreed to consider the eligibility of these countries for a stock reduction after a three-year period. Only one agreement was signed with a middle-income country (Jordan) in 1997.

Note

1. The Paris Club also restructures the debt of middle-income countries but not on concessional terms. Middle-income countries, however, have largely graduated from official rescheduling, and in 1997 there was only one nonconcessional rescheduling, for Jordan.

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