The COVID pandemic already placed public finances in many emerging markets under severe strain. The invasion of Ukraine, the increase in food, fertilizer and energy prices, as well as the global tightening of monetary conditions—with the resulting, sustained strength in the U.S. dollar—have further deteriorated the outlook for many EMs, especially for low-income countries.
It’s within this context that we anticipate an increase in EM sovereign debt restructurings. Given this anticipation, we expect that these processes will largely unfold under the Common Framework (CF), which the G20 launched in November 2020.1 The initiative is viewed as the next step after the end of the Debt Suspension Initiative with the recognition that “there is a lack of participation from private creditors, and we strongly encourage them to participate on comparable terms when requested by eligible countries."2
The goals of the Common Framework are:
- provide debt relief;
- include China et al., together with the Paris Club creditors, in order to avoid free riding;
- and, offer comparable treatment, i.e., to avoid the bail out of private creditors.
Main Features of the Common Framework
The CF divides creditors into two groups: official bilateral and private creditors. Multilateral creditors maintain their status of “super-seniority,” and their loans cannot be restructured.
The official creditors include Paris Club members and non-Paris Club creditors, mainly: China, India, and Saudi Arabia. Countries that were eligible for the Debt Service Suspension Initiative (DSSI) can ask for the implementation of the Common Framework as part of an International Monetary Fund (IMF) program in case their external debt is deemed as unsustainable by the IMF-World Bank, who are responsible for the technical analysis.3
Private and official creditors are not involved in the process to identify the amount of debt relief necessary to bring government debt back to a sustainable path. They participate in the details of the restructuring, including those pertaining to maturity extension, coupons, etc.
Implementation, thus Far
At this point, three countries have requested the use of the CF for debt reduction: Chad, Ethiopia, and Zambia. No agreement has yet been achieved, despite Chad’s negotiations having started in January 2021. Many operational/institutional issues in implementing the CF are being discovered as the framework is being applied to countries in need of debt restructuring. In the meantime, an IMF program may remain operational even if an agreement under the CF is not agreed upon as long as negotiations continue in good faith (the IMF’s “lending into arrears” clause). The extent to which this process can continue and what constitutes “good faith” remain open questions.
What Countries are Most Likely to Request Use of the Common Framework?
There are 15 Countries (plus Zambia, that has already defaulted and has already started the Common Framework procedure) in the benchmark sovereign debt index (J.P. Morgan’s EMBIGD) that are eligible for the Common Framework, and we focus our attention on these countries only. These countries face aggregate Eurobond redemptions worth a little more than $14 billion between now and the end of 2025. At present, none of them can be deemed as having market access. Figure 1 shows the distribution of these Eurobond redemptions, which are large in Pakistan, Mongolia, and Kenya. Mozambique, Papua New Guinea, and Tajikistan have no redemptions.
Bloomberg as of November 7, 2022.
Small redemptions do not imply that the country might not require a debt restructuring, though. In order to identify the countries that are most at risk, and therefore the more likely possible candidates for requesting the application of the Common Framework, we have built a simple heatmap (Figure 2). For simplicity of exposure, we have highlighted the critical values of the variables only with the usual methodology: the darker the cell, the worse the country’s metric, with green being the most positive reading. We have also used the median as the pivot to assess the relative country position.
Countries Most and Least Likely to Ask for Inclusion in the Common Framework
PGIM Fixed Income, IMF WEO, The World Bank.
Ghana, Kenya, and Mongolia stand out as countries that need more analysis to assess their debt sustainability. Nigeria presents the lowest debt burden, but it is also the worst country in terms of forecast growth, and we recommend caution on this credit since growth is a crucial component for achieving/maintaining debt sustainability. Ethiopia emerges as the least likely candidate to ask for inclusion in the Common Framework, but it has already asked to be part of it, highlighting the many factors surrounding the adoption of the framework (we have excluded Zambia from the analysis since it has already defaulted).
The Common Framework is still in its infancy and “growing pains” are emerging, as the prolonged negotiation in the case of Chad indicates. Other, more comprehensive and inclusive, measures to reduce the debt burden for emerging markets have been suggested and might be adopted in the coming months. Market participants and debtor countries would probably sign up for a Brady Plan-style solution, for example, although the current lack of international co-operation does not appear to be conducive to such a solution in the near term. Other possible solutions are the inclusion of “Most Favored Creditor” clauses, an auction-based mechanism, or an enhanced Common Framework where the DSA is done jointly by the IMF+WB, official creditors, and private creditors.4,5
1 G20 Saudi Arabia 2020, “Common Framework for Debt Treatments beyond the DSSI,” Club de Paris.
2 G20 Leaders’ Declaration, Riyadh Summit, November 21, 2020.
3 The list of DSSI-eligible countries can be found here: Debt Service Suspension Initiative (worldbank.org).
4 Lee Buchheit and Mitu Gulati, “Breaking the Sovereign Debt Impasse,” Financial Times, September 26, 2022.
5 Tim Willems, “A Proposal For An Auction-Based Sovereign Debt Restructuring Mechanism,” Centre for Economic Policy Research, November 17, 2020.