G20’s debt moratorium worth up to $14 billion for poor countries has it’s pitfalls

G20’s debt moratorium worth up to $14 billion for poor countries has it’s pitfalls

Financial leaders of the 20 largest economies (G20) are brainstorming on how to mitigate the burden faced by poor countries by shouldering their debt obligations to the tune of $14 billion, a senior German official said on Tuesday.

The debt moratorium, suggested by the International Monetary Fund and the World Bank, will likely be the key part of an action plan that the Group of 20 finance ministers are expected to fine-tune and present on Wednesday, the official said.

“Germany is assuming responsibility not only at home and in Europe, but also in the world - and that’s why we support the debt moratorium proposed by the IMF and World Bank to help the poorest countries in the world,” said the official who spoke on condition of anonymity.

The plan to immediately suspend debt payments is supported by all G20 creditor countries as well as the members of the Paris Club of public-sector creditors, the official said.

“We’re talking here about a total sum of up to $14 billion which the poorest countries will be allowed to pay back later and therefore can be spent on measures related to COVID-19,” the official said, adding: “This can certainly be called a historic step.”

The question of debt reduction should be discussed later this year when there is more clarity about the economic impact of the coronavirus pandemic, the official said.

The IMF said on Monday it would provide immediate debt relief to 25 member countries under its Catastrophe Containment and Relief Trust (CCRT) to allow them to focus more financial resources on fighting the coronavirus pandemic.

What are the Costs and Implications of Debt Restructurings?

In most crisis cases, restructurings mark the end of a debt crisis episode, because the exchange of old into new debt puts the country back on the path of debt sustainability. However, restructurings do not always put an end to debt distress. Some countries continue to incur arrears after a completed restructuring process and there are many examples in which sovereigns implemented a series of subsequent restructurings, in particular during the 1980s debt crisis

Pitfalls in the Restructuring Process

The last decades have shown that a high share of external debt in government debt portfolios can significantly increase the risk of sovereign default. In the past, emerging economies issued large shares of public debt in foreign currency, making them vulnerable to exchange rate shocks and currency mismatches. Major depreciations endangered debt sustainability, mostly because governments continue to collect most of their revenue in domestic currency. However, the debt of advanced, industrialized countries is largely denominated in domestic currency. Currency crises may thus only have indirect effects on debt sustainability.

For these reasons, a restructuring can endanger financial stability and, in the worst case, trigger bank failures and bank recapitalization needs. These effects can additionally result in a credit crunch and less domestic lending, as well as in cross-border risk spillovers.