The Acting Chair’s Summing Up—The Fund’s Lending Framework and Sovereign Debt—Further Considerations, Executive Board Meeting 16/4, January 20, 2016

Executive Directors welcomed today’s discussion of proposed reforms to the Fund’s exceptional access framework, one of the issues under the sovereign debt restructuring work program that was endorsed by the Executive Board in May 2013. Directors supported the broad objectives underlying the proposed reforms. They agreed that, by modifying this framework to allow responses that are better calibrated to a member’s debt vulnerabilities, the reforms would help promote more efficient resolution of sovereign debt problems and avoid unnecessary costs for the member, its creditors, and the overall system. At the same time, they would enable the Fund—consistent with its mandate—to continue providing financing to assist members in resolving their balance of payments problems, including in the presence of spillover and contagion risks.

In this context, Directors generally favored the removal of the systemic exemption. It was recognized that the removal of the systemic exemption is critical for several reasons. First, to the extent that a member faces significant debt vulnerabilities despite its planned adjustment efforts, the use of the systemic exemption to delay remedial measures risks impairing the member’s prospects for success and undermining safeguards for the Fund’s resources. Second, from the perspective of creditors, the replacement of maturing private sector claims with official claims, in particular Fund credit, will effectively result in the subordination of remaining private sector claims in the event of a restructuring. Third, the systemic exemption aggravates moral hazard in the international financial system and may exacerbate market uncertainty in periods of sovereign stress. Finally, it is far from clear that invoking the systemic exemption to defer necessary measures on debt can be relied upon to limit contagion, since the source of the problem—namely, market concerns about underlying debt vulnerabilities—is left unaddressed.

Directors agreed that staff’s proposed approach addresses more robustly the rigidities in the exceptional access framework, while ensuring that debt vulnerabilities are addressed in an appropriately calibrated way. Specifically:

• • When the Fund is confident that debt is sustainable with high probability, it would continue to provide financing in support of a strong adjustment program that envisages payment of outstanding obligations as they fall due. These cases would include those where, although a member may have lost market access, the Fund is confident that this loss is temporary and that debt is sustainable.

• • By contrast, when debt is clearly unsustainable, prompt and definitive action to restructure debt and restore debt sustainability with high probability remains the least-cost approach.

• • However, when a member’s debt is assessed to be sustainable but not with high probability, requiring a definitive debt restructuring could incur unnecessary costs. In such situations, it would be appropriate for the Fund to grant exceptional access so long as the member also receives financing from other sources during the program on a scale and terms such that the policies implemented with program support and associated financing, although they may not restore projected debt sustainability with a high probability, improve debt sustainability and sufficiently enhance the safeguards for Fund resources.

Directors noted that, in applying this more flexible standard in circumstances where debt is assessed to be sustainable but not with high probability, there would be a range of options that could meet the prescribed requirements. There would be no presumption that any particular option would apply. Rather, the choice would depend on the circumstances of the particular case, and would need to be justified accordingly. In particular:

• • In situations where the member retains market access, or where the volume of private claims falling due during the program is small, sufficient private exposure could be maintained without the need for a restructuring of their claims.

• • If the member has lost market access and private claims falling due during the program would constitute a significant drain on available resources, a reprofiling of existing claims (that is, a short extension of maturities falling due during the program, with normally no reduction in principal or coupons) would typically be appropriate. This could allow a somewhat less stringent adjustment path while also reducing the needed level of access. Although a reprofiling is a form of debt restructuring, it was recognized that, in these circumstances, it will likely be less costly to the debtor, the creditors, and the system than a definitive debt restructuring. In this context, the scope of debt to be reprofiled would be determined on a case-by-case basis, recognizing that it would not be advisable to reprofile a particular category of debt if the costs for the member of doing so—including risks to domestic financial stability—outweighed the potential benefits. Notably, short-term debt instruments (by original maturity), trade credits, and local currency-denominated debt had not been included in most past restructurings.

• • Similarly, financing from official bilateral creditors, where necessary, could be provided either through an extension of maturities on existing claims and/or in the form of new financing commitments.

As is the case with all debt restructurings under Fund-supported programs, a reprofiling, where it is needed, should ideally be undertaken before the approval of the Fund arrangement. However, there may be circumstances under which more flexibility is warranted, so that the conclusion of the debt operation is contemplated at a later date. Against this background, it would not be necessary to hold up Fund support until there is complete clarity regarding the terms of this financing.

Directors broadly concurred with staff’s analysis on the nature and type of cross-border spillovers that could result from a debt restructuring. They recognized that some spillovers, insofar as they reflect a repricing of risk in line with fundamentals, should be accommodated and complementary policy actions should be taken if necessary to counter market fluctuations that are not rooted in fundamentals.

Nevertheless, Directors took note of the fact that, if a rare tail-event case were to arise where any restructuring of private claims, even a reprofiling, is judged to pose unmanageable risks, either for domestic financial stability or in terms of possible cross-border spillovers, the reformed framework creates the flexibility for the Fund to approve exceptional access to Fund resources without such a restructuring so long as official sector partners are willing to provide the necessary financing. Such financing would need to be on terms sufficiently favorable to improve sustainability and enhance safeguards for Fund resources, and, accordingly, the Fund would need assurances that the terms could be modified in future if the outlook for debt sustainability were to deteriorate significantly. If official creditors were unwilling to provide such assurances, the terms of the financing would need to be sufficiently generous upfront to restore debt sustainability with high probability. In circumstances where debt is unsustainable, the terms of the financing provided by official bilateral creditors would similarly need to be sufficiently favorable to restore debt sustainability with high probability. This could take the form of loans with long tenors and concessional rates, grants, or other instruments. Directors noted that these requirements would be implemented flexibly. The Fund could proceed on the basis of political commitments to backstop debt sustainability without necessarily requiring all the specific modalities to be spelt out. Directors concurred that, while this alternative approach for rare tail-risk cases does not allay moral hazard concerns, it would be more effective than the systemic exemption, as it would help the member address its debt problems, mitigate contagion at its source, and provide safeguards for Fund resources. Some Directors noted the expectation that the approach would be used only rarely and emphasized that the decision to resort to this approach should be made in an evenhanded manner. A few Directors expressed the view that the approach described in this paragraph could be feasible even in less extreme circumstances rather than just in rare tail-events characterized by unmanageable risks.

Directors observed that the Fund’s assessment of debt sustainability will continue to play a central role in the exceptional access framework. In this regard, they emphasized that, notwithstanding continued improvements in the Fund’s toolkit for making debt sustainability assessments, the determination of where a country’s debt prospects lie on the spectrum of probabilities will continue to involve a significant element of judgment. Specifically, the determination, which is inherently forward-looking, would take into account all relevant information, including country-specific information on prospects for policy implementation, growth opportunities, contingent liabilities, the nature of the creditor base and indicators of investor confidence; as well as the outlook for the global economic environment. Directors noted that, taking these considerations into account, the levels of debt that are consistent with sustainability could vary significantly across programs.

With regard to the third criterion under the exceptional access framework, namely the condition related to market access, Directors supported staff’s view that this condition needs to be met even in cases involving open-ended commitments of official support beyond the program period. They agreed that the resolution of a member’s balance of payments problem and the achievement of medium-term external viability is a key objective of Fund lending, and a member’s ability (as distinct from its need) to access private capital markets is inherent to this resolution. While official financing commitments can provide a useful backstop against downside risk, they do not render the market access criterion moot. Directors emphasized, nonetheless, that staff should take into account the positive impact that commitments of official support may have on a member’s ability to access markets, on a case-by-case basis, when assessing whether the third criterion is met.

Directors also broadly supported staff’s clarification on the timeframe within which to establish market access. Specifically, they noted that the Fund has generally expected that a member gain or regain market access within a timeframe that facilitates the repayment of all of its obligations to the Fund—not just the last one that is due, as the current wording of the third criterion might suggest.

The changes to the Fund’s exceptional access framework will enter into effect immediately and will apply to all future completion of reviews under existing arrangements or approval of new Fund arrangements.

Looking ahead, Directors called on staff to continue its work on ensuring that the Fund’s lending toolkit is effective in addressing systemic crises and contagion. They looked forward to the upcoming review of issues relating to debtor-creditor engagement, including the Fund’s lending into arrears policy. This would complete the program of work aimed at facilitating the timely and orderly resolution of sovereign debt problems.

BUFF/16/9, Cor. 1 (1/27/2016)

January 27, 2016