Appendix 3
Commercial debt restructuring

Developments in 1997
Debt and debt service reduction operations in low-income countries
Swaps in middle-income countries
Other restructuring in middle-income countries
Debt conversion programs
Debt for equity
Debt for development

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Since 1989 the restructuring of developing country debt to commercial banks has occurred largely through buybacks supported by the International Development Association’s (IDA) Debt Reduction Facility for low-income countries1 and through officially supported debt and debt service reduction programs (Brady operations) for middle-income countries.2 These programs have helped resolve long-standing concerns of debtors and commercial bank creditors and have improved these countries’ creditworthiness, in some cases contributing to the restoration of market access. Some middle-income countries have recently come full circle, entering the market to retire collateralized Brady bonds through exchanges for uncollateralized instruments and through debt buybacks.

Officially supported programs and associated market swap operations reduced developing countries’ debt to commercial banks by $53.2 billion between 1989 and December 1997 (table A3.1). This reduction, equivalent to 23 percent of the $231.2 billion of eligible commercial bank debt (including interest arrears), was effected through buybacks, cash payments, and writeoffs. Since 1989, 33 countries have completed 41 debt and debt service reduction operations under the aegis of the Debt Reduction Facility, the Brady Plan, and, most recently, voluntary swap operations by major Latin American countries. Eighteen low-income countries have extinguished $12.6 billion of the $18.2 billion of eligible principal and interest arrears due to commercial banks under the Debt Reduction Facility and, more recently, under debt and debt service reduction operations. Fifteen middle-income countries have eliminated nearly 20 percent of their $213.0 billion in commercial bank debt.

Financing costs of officially supported operations—funds expended for buybacks and other cash payments and for principal and interest collateral needed to guarantee the debt exchanges—have totaled $23.6 billion. Financing, net of the $3.7 billion of concerted new money provided by commercial banks, came in almost equal shares from debtor countries and official lenders. The World Bank’s participation amounted to $4.7 billion, or about 37 percent of foreign financing requirements net of concerted commercial bank lending.

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Developments in 1997

Nine debt reduction agreements between debtor countries and their commercial bank creditors were concluded in 1997, restructuring $19.1 billion in debt and reducing outstanding debt by $6.9 billion (see table A3.1). Among low-income countries, Togo bought back $46.1 million at an average price of 12.5 cents per dollar in a deal supported by the Debt Reduction Facility (table A3.2) and Côte d’Ivoire and Vietnam restructured $7.3 billion under the Brady initiative. Bosnia and Herzegovina concluded an agreement with commercial bank creditors to restructure $1.3 billion, including $0.7 billion in interest arrears. Among middle-income countries, Argentina, Brazil, Ecuador, Panama, and Venezuela retired $10.4 billion of collateralized Brady bonds through debt buybacks and discounted swaps for unsecured bonds. The Russian Federation concluded an agreement, initiated in 1995, to restructure $33.0 billion of debt due to commercial banks.

Debt and debt service reduction operations in low-income countries

Côte d’Ivoire. On 6 May 1997 Côte d’Ivoire completed a debt and debt service reduction agreement to restructure $6.5 billion of debt owed to commercial banks (table A3.3). Of the $2,271.5 million of eligible principal, Côte d’Ivoire bought back $681.5 million at 24 cents per dollar and exchanged $159.0 million for 50 percent discount bonds and $1,431.0 million for front-loaded interest-reduction bonds. The $4,190.3 million in past-due interest was restructured as follows: $30.0 million was paid in cash at closing, $867.3 million was exchanged for past-due interest bonds, and $3,293.0 million was written off.

The principal component of the discount bonds was collateralized with 30-year U.S. Treasury zero-coupon bonds delivered at closing. Both the discount and the front-loaded interest reduction bonds required a six-month rolling interest guarantee, calculated at a fixed rate of about 2.5 percent and secured by cash or permitted investments. The principal component of the front-loaded interest reduction bonds was not guaranteed. Neither principal nor interest securitization was required for the past-due interest bonds.

The debt and debt service reduction agreement allowed Côte d’Ivoire to reduce its debt to commercial banks by $4.1 billion in nominal terms, or close to 63 percent of the total amount restructured. The operation, including a cash payment, buyback, and principal and interest collaterals, cost $226 million, of which $19 million was provided by Côte d’Ivoire and $207 million was funded by foreign loans and grants. Key lenders included the IMF ($70 million through the Enhanced Structural Adjustment Facility), France ($52 million concessional loan), and IDA ($50 million credit). In addition, the Institutional Development Fund provided a $35 million grant, of which $20 million came from the IBRD, $10 million from Switzerland, and $5 million from the Netherlands.

Vietnam. On 16 December 1997 Vietnam signed a debt and debt service reduction agreement to restructure $797.1 million of debt owed to commercial banks, including $486.2 million of past-due interest (table A3.4). Eligible principal of $310.9 million was rescheduled according to a menu of choices that included $51.6 million of discount bonds (at a 50 percent discount) and $238.9 million of par bonds. In addition, $20.4 million was bought back at 44 cents per dollar. Past-due interest of $486.2 million was discharged as follows: $15.0 million was paid at closing, $294.8 million was exchanged for past-due interest bonds, $21.8 million was tendered for a buyback, and $154.6 million was forgiven following the recalculation of interest at a lower spread and the waiving of penalty interest.

The principal component of the discount and par bonds was collateralized with 30-year U.S. Treasury zero-coupon bonds delivered at closing. But while 100 percent of the discount bonds is guaranteed, only 50 percent of the par bonds is collateralized. Payment of six months of interest is guaranteed on a rolling basis by cash or permitted investments only on the discount bonds. The past-due interest bonds do not carry a principal or interest guarantee.

These operations reduced Vietnam’s debt to commercial banks by $237.6 million in nominal terms. Taking into account interest service savings and cash payments resulting from bond collateral, the debt reduction value of the debt and debt service reduction (excluding additional official lending) was equivalent to 30 percent of the nominal amount restructured. The upfront costs of the operation (including cash payments and bond collateral) totaled $54 million, of which $19 million was funded by Vietnam and $35 million by an IDA credit.

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Togo. On 12 December 1997 Togo concluded an agreement (sponsored by the Debt Reduction Facility) to restructure $75.0 million due to commercial banks, including the writeoff of $28.9 million of past-due interest and a buyback of $46.1 million at 12.5 cents per dollar. Almost 70 percent of the eligible principal stemmed from 1980 and 1983 rescheduling agreements, some 25 percent originated from debt owed by public enterprises, and the remaining 5 percent resulted from promissory notes issued by the government to foreign contractors. The operation cost $6.4 million, of which $5.4 million came from the IBRD and $1.0 million came from France.

Bosnia and Herzegovina. On 30 December 1997 Bosnia and Herzegovina finalized an agreement to restructure $1.3 billion, including $0.7 billion in past-due interest owed to commercial bank creditors under the aegis of the London Club. Past-due interest, including penalty interest, was forgiven. Eligible principal of $600 million was exchanged for $400 million of uncollateralized discount bonds. An innovative feature of the agreement links scheduled repayments to the country’s economic performance.

Servicing of interest due on $150 million of the new bonds begins in mid-1998, and the repayment of principal is subject to a stepped-up amortization schedule. This tranche of the bonds has a grace period of seven years, concessional fixed interest rates of 2.0–3.5 percent for the first 10 years and LIBOR + 13/16 thereafter, and an amortization schedule that rises from 1 percent in years 1–2 to 7 percent in years 11–20.

Bosnia and Herzegovina is not required to make debt service payments on the remaining tranche of $250 million for at least ten years. In addition, no debt servicing will be required thereafter until per capita income exceeds $2,800 for two consecutive years.3 The agreement initially reduces nominal debt by 69.2 percent and may reach 88.5 percent throughout the life of the bonds if the per capita target is not exceeded.

Swaps in middle-income countries

In 1996 Mexico and the Philippines swapped $4.4 billion of Brady bonds for uncollateralized long-term bonds. This important development continued in 1997, when such swaps more than doubled in value. These voluntary deals show the renewed confidence of foreign investors in these countries’ prospects—particularly significant in Mexico given the uncertainties of recent years. Such swaps offer two benefits to debtor countries. First, the collateral associated with Brady bonds, including interest earned on escrow accounts, is released on a pro rata basis and can be used to meet other obligations. For example, in 1997 Ecuador used the freed collateral to clear debt service arrears with Paris Club creditors. Second, because the swap is effected at a discount based on secondary market prices, debt outstanding is commensurately reduced. The advantage to the original bondholder lies in higher yields on the uncollateralized bonds.

Argentina. On 12 September 1997 Argentina retired $2.4 billion of Brady bonds for $1.8 billion of uncollateralized 30-year bonds at an interest rate of 305 basis points above the U.S. Treasury rate. The offering allowed for direct exchange and cash sales of Brady bonds. Nominal savings of $1.1 billion resulted from the differential between the par and market values of these securities ($0.6 billion) and from the pro rata release of the collateral of the Brady bonds ($0.5 billion). Net present value savings stemming from the cash-flow differential between the Brady bonds plus the freed collateral and the replacement bond were estimated at $242 million.

Brazil. On 4 June 1997 Brazil completed a $3.0 billion, 30-year bond offering involving a $0.8 billion cash sale and a $2.3 billion exchange for $2.7 billion of Brady bonds. The new issue carries an interest rate of 395 basis point above the U.S. Treasury rate. Nominal savings of $1.0 billion resulted from the differential between Brady bonds’ par and market values ($0.4 billion) and from the pro rata release of the collateral of the Brady bonds ($0.6 billion). Net present value savings were estimated at $186 million.

Ecuador. On 18 April 1997 Ecuador issued a $150 million eurobond to buy $214 million of Brady bonds. The principal amount is due at maturity in April 2004 and carries an interest rate of 475 basis points above the U.S. Treasury rate. Nominal savings of $114 million resulted from the differential between Brady bonds’ par and market values ($164 million) and from the pro rata release of the collateral of the Brady bonds ($50 million). The $50 million saved from the collateral was applied toward clearance of debt service arrears with Paris Club creditors.

Panama. On 19 September 1997 Panama completed a $600 million offering of 30-year uncollateralized bonds for $713 million of Brady bonds that had been issued on 3 April 1996. The new offering carries an interest rate of 250 basis points above the U.S. Treasury rate. Nominal savings of about $1,320 million resulted from the differential between Brady bonds’ par and market values ($112 million) and from the pro rata release of the collateral of the Brady bonds ($20 million).

Venezuela. On 11 September 1997 Venezuela retired $4.4 billion of Brady bonds in exchange for $4.0 billion of uncollateralized 30-year bonds at an interest rate of 325 basis points above the U.S. Treasury rate. The operation—the largest to date by a single country—resulted in nominal savings of about $1.8 billion, of which $0.4 billion stemmed from the differential between Brady bonds’ par and market values and $1.4 billion accrued from the pro rata release of the collateral of the Brady bonds. Net present value savings stemming from the cash-flow differential between the Brady bonds plus the freed collateral and the replacement bond were estimated at $0.4 billion.

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Future Brady swaps. Whether the market for these transactions continues to grow at the pace observed in 1997 will depend, in the near term, more on demand than on supply factors. About $67 billion in collateralized par and discount bonds are potentially eligible for exchange. Latin American countries account for about 84 percent of these issues. Expansion of the market will depend, among other things, on investors’ continued confidence, secondary market prices, spreads on the new instruments, and accounting rules. Accounting rules limited demand for the Mexican issue by domestic banks, which in accordance with accounting guidelines list Brady bonds as assets at face value rather than as tradable instruments. As a result the books of any Mexican banks participating in the swap showed a loss equal to the difference between the face value and market value of the transaction.

Other restructuring in middle-income countries

Russian Federation. On 6 October 1997 the Russian Federation concluded an agreement that began in 1995 to reschedule $33.0 billion, including $7.5 billion of interest arrears to commercial banks. Eligible principal will be repaid over 25 years, including a 7-year grace period. A graduated amortization plan will result in annual payments of about 2 percent a year for the first two to three years following expiration of the grace period, peaking at 15 percent in years 9 and 10 and declining thereafter. Interest due will be calculated at LIBOR + 13/16 , with actual payments rising from about 25 percent of the amount due in 1996 to full payment beginning in 2002. The shortfall in interest payments will be covered by issuance of interest notes with a 14-year payment profile. About $2 billion of the past-due interest arrears will be paid up front into escrow accounts. Implementation of the agreement occurred in phases. In September 1996 the government announced that the London Club had agreed to complete the rescheduling of $20 billion. The remaining $13 billion were rescheduled in the fourth quarter of 1997.

Debt conversion programs

The number of countries participating in debt conversions and the face value of debt restructured increased rapidly after May 1985, when Chile established the first institutionalized debt-for-equity swap program. Since 1985 debt-equity conversions have totaled $38.6 billion (table A3.5).

Debt conversion activities declined during 1992–96, however. Debt-for-equity swaps totaled just $100 million in 1996, and debt-for-development swaps totaled less than $100 million. Several factors contributed to the drop in debt conversions. Investor interest in debt conversion programs declined as rising secondary market prices of several countries’ commercial bank debt reduced the discount that could be captured. A significant amount of debt conversion activity was linked to specific privatization programs that have turned to other instruments or have been winding down. And Brady operations, which have enabled debtor countries to regularize relations with commercial bank creditors, have permitted more flexibility in debt management and reduced some governments’ interest in conversion programs.

After a general decline during 1992–96, debt-for-development swaps rebounded in 1997, reaching $108 million. Led by Mexico and Nigeria, this increase is expected to be sustained in the next few years. Low-income countries are expected to contribute to the expansion, which not only contributes to development but also suggests evidence of proactive debt management by countries in complementing action plans developed under the Heavily Indebted Poor Countries Debt Initiative. Debt conversions are permitted under both the Paris Club minutes and within the Enterprise for the Americas Initiative.

Debt for equity

Debt-for-equity swaps generally involve the purchase of debt by the investor at a discount in the secondary market and the sale of the debt to the central bank for funds that are used to acquire public assets or invest in private equity. Debt-for-equity conversions can be a useful tool for accelerating a country’s privatization program, as has been done in Argentina, Mexico, and the Philippines.

Debt-for-equity swaps were negligible in 1995, however. The only two sizable operations were in Latin America, both in Peru. The privatization of EDEGEL (the electric utility company of Lima) generated $524 million, of which $100 million was debt-for-equity. The privatization of Banco Continental delivered $255 million to the Peruvian Treasury, of which $60 million was converted debt.

Debt-for-equity swaps were also used on a small scale in Mexico as part of the debt relief and recapitalization measures adopted by the government in 1995-96 to contain the banking crisis. Through these swaps, banks acquired major shares of several companies, including Mexicana and Aeromexico (airlines) and Grupo Gigante (retail). Two small debt-equity operations in FYR Macedonia accounted for $ 0.1 million.

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Debt for development

In debt-for-development swaps an international organization (usually a nongovernmental organization, or NGO) purchases sovereign debt in the secondary market at a deep discount and then exchanges the debt at a redemption price negotiated with the country. The funds are then used for a development project approved by the country and managed by the NGO.

Debt for nature. Debt-for-nature operations are used to reduce developing countries’ debt and allocate funds to the protection of nature preserves. Since 1987, when Conservation International and Bolivia signed the first debt-for-nature agreement, 15 countries have retired $152.7 million in face value of debt though such programs, at an average discount of 69.8 percent (table A3.6). Since 1994 Mexico has converted $3.7 million in face value of debt through nine debt-for-nature operations.

The magnitude of debt-for-nature swaps has been declining over time, however. After reaching $43.9 million in 1989, debt-for-nature swaps declined to $576,000 in 1997—two operations effected by Mexico.

Other debt-for-development swaps. Three organizations—Finance for Development, New York Bay, and the United Nations Children Fund (UNICEF)—have been the main participants in debt-for-development swaps that provide local currency funds for projects other than nature preserves. Finance for Development and New York Bay have swapped $566.7 million since 1992, of which $107.8 million was swapped in 1997 (table A3.7). The funds have been invested in various sectors, including health, population, agriculture, ecotourism, and low-income housing.

By 1995 UNICEF, a pioneer in debt-for-development swaps, had completed 21 transactions, generating $52.9 million in local currency while helping participating countries reduce their external debt stock by $199.3 million (table A3.8). (Although UNICEF is planning additional debt conversion operations in developing countries, no operations have been carried out since 1995.) A wide range of entities has been involved in these transactions, including an IDA Debt Reduction Facility operation for Zambia. The funds used come from national committees for UNICEF in industrial countries. These funds help finance programs for primary education, women in development, children in especially difficult circumstances, primary health, and water supply and sanitation.

Role of the Debt Reduction Facility in debt conversions. Through the IDA Debt Reduction Facility, the World Bank has expanded the menu of debt reduction options to include provision for debt-for-development swaps. Under this provision commercial banks can choose to donate or tender debt to be repurchased by NGOs (at the same price as the debt buyback option). NGOs can then convert the debt into local currency to finance development projects. Two countries, Bolivia (1993) and Zambia (1994), have implemented such options. No debt-for-development swap has been concluded through the Debt Reduction Facility since 1994.

Notes

1. For details, see page 27, World Debt Tables 1990–91.
2. For details, see box A2.2, World Debt Tables 1994–95.
3. In 1997 per capita income was estimated at $1,079.

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