February 25, 2021

Africa

SUB-SAHARAN AFRICA: DSSI ‘common framework’ risks facing private creditors

BY Malte Liewerscheidt, Anne Frühauf

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Ethiopia’s upcoming debt restructuring negotiations will be closely watched by other sovereigns in the region and private creditors alike. While private sector involvement seems very likely, this could take the form of debt reprofiling rather than outright haircuts, particularly in cases where debt treatment requests are driven more by liquidity than solvency problems. A likely focus on short-and-shallow debt treatments may carry the risk of serial defaults over the next decade. The outcome of Ethiopia’s 29 January request to restructure its external debt under the G20’s ‘Common Framework for Debt Treatments beyond the Debt Service Suspension Initiative (DSSI)’ will be eagerly watched by other DSSI-eligible countries and private investors alike. Unlike a similar request from Zambia , which had already defaulted on its Eurobond obligations prior to the release of the ‘common framework,’ and Chad, whose access to private credit has been largely restricted to resource-backed loans, Ethiopia’s case could serve as a blueprint for the region’s remaining 11 DSSI-eligible sovereigns with outstanding Eurobonds (Angola, Benin, Cameroon, Republic of Congo, Cote d’Ivoire, Ghana, Kenya, Mozambique, Nigeria, Rwanda, Senegal).

However, it is too early to tell whether a flurry of ‘common framework’ requests will ensue. Particularly in view of the ratings action that Ethiopia’s announcement has triggered, countries in similarly constrained or borderline positions might think twice about announcing their intent to access the framework before they absolutely have to. Besides, apart from a few general principles, it is still unclear how the framework will be applied in practice. Potential ‘candidates’ will likely wait and see what kind of deal the ‘early adopters’ may be able to secure.

Among the DSSI-eligible economies, countries that might eventually attempt to take the ‘common framework’ route could include Angola, Republic of Congo, Cameroon, and perhaps Mozambique. By contrast, larger economies like Ghana and Kenya, despite also featuring as ‘high risk of debt distress’ according to the International Monetary Fund (IMF), appear less likely to pursue this route as their debt management strategies hinge on tapping the Eurobond market this year. The IMF’s mandatory involvement in the ‘common framework’ (see below) would arguably also curb any potential interest in Nigeria in seeking such debt treatment, given Abuja’s longstanding feud with the IMF over its trade and currency regime. The least likely countries to require pursuing the CF path among the group of DSSI-eligible Eurobond issuers appear to be Benin, Cote d’Ivoire, Rwanda, and Senegal, going by their IMF classification as “moderate” risk of debt distress.

Next steps in Ethiopia’s ‘common framework’ request Following Ethiopia’s official request, according to the ‘common framework,’ the next step involves a debt sustainability analysis (DSA) carried out by the IMF and the World Bank Group (WBG), which will inform subsequent negotiations between G20 and Paris Club (PC) creditors, and Ethiopia. Since Ethiopia entered an IMF Extended Credit Facility (ECF) as well as an Extended Fund Facility (EFF) in December 2019, the DSA process does not start from scratch but would merely require an update of calculations as recent as May 2020. Even though an IMF spokesperson shied away from committing to a concrete completion date during a 4 February presser , one would assume that the DSA process could be completed fairly quickly. This will likely contrast with Zambia’s case, which has pursued talks with the IMF on and off for several years, and where the Fund needs to overcome major concerns regarding debt transparency as part of any DSA exercise.

Yet, completion of the DSA merely forms the necessary precondition for potentially protracted negotiations to commence. According to the ‘common framework,’ the 31 G20 and Paris Club creditors – “as well as any other willing official bilateral creditor with claims on the country” – will jointly agree on debt restructuring terms subsequently extended to Ethiopia. While the ‘common framework’ is silent on the negotiations’ procedural aspects, these will likely follow the Paris Club’s established six principles , which also seem to inform other key aspects of the framework. Of these principles, the consensus requirement suggests ‘holdout creditors’ may potentially block progress at this stage. Given China’s outsized profile in the upcoming negotiations – in 2021, 45% of Ethiopia’s external debt payments are due to the Chinese government and state-owned entities – China may conceivably use its leverage to insist on the involvement of private-sector creditors in return.

This would further reinforce the stronger wording regarding private creditor involvement, which, as analyzed previously , constituted one of the key changes in the ‘common framework’ compared to the original DSSI. Debtor countries are now “required to seek from […] private creditors a treatment at least as favorable as the one agreed” with G20/PC creditors [emphasis added]. Again, this is in line with the Paris Club requirement for ‘comparability of treatment,’ which was also reinforced by its chairman Emmanuel Moulin during a 14 February interview in which he stated that private creditors would have to participate although there may be “very limited and specific exceptions.” It remains to be seen how exactly private creditors could be forced to the table. However, it is plausible that IMF disbursements could be made contingent on the conclusion of debt restructuring agreements with private creditors or that bilateral and private creditor talks could be sequenced in such a way so as to force participation.

What, then, can private creditors expect? While private sector involvement is thus likely to feature as a matter of principle regardless of their actual importance in the context of Ethiopia’s debt profile, whether this may take the form of (possibly NPV-neutral) maturity extensions or outright haircuts will be crucially informed by the outcome of the DSA. Should the IMF determine that Ethiopia is primarily facing a liquidity, rather than a solvency crisis, this would strengthen the case for ‘short and shallow’ debt relief, i.e., maturity extensions for amounts of principal or interest falling due, rather than principal haircuts or coupon adjustments. Historically, it is noteworthy that Paris Club creditors have taken a particularly lenient approach vis-à-vis low-income countries such as Ethiopia, with debt treatments for this country group featuring an average haircut of 74.9%.

Nevertheless, the overall dynamics at play suggest Ethiopia may find it harder to secure outright debt cancellations than on previous occasions, especially because the cast of actors has changed (see table below). While the ‘common framework’ heavily draws on Paris Club language, this is not an exclusive PC event. It will, as shown, require consensus among PC and non-PC G20 members, most notably China. As analyzed previously , Beijing traditionally favors reprofiling over outright debt write-downs and forgiveness.

Furthermore, the language in the ‘common framework,’ reserving “debt write-off or cancellation” to “the most difficult cases,” also reflects Paris Club practice over the past decade. In the interview cited above, Moulin also hinted in that direction, suggesting that private sector participation may not “necessarily entail a reduction in net present value terms; you can also have reprofiling.”

Besides, the extraordinary uncertainty regarding the future induced by the Covid-19 pandemic – which already characterized the piecemeal, six-month approach of the original DSSI – will likely also curtail any official creditor interest in providing permanent, substantial debt relief at this stage. The uncertainty will also undermine the validity of the underlying DSA, which, to paraphrase veteran sovereign debt negotiator Lee Buchheit, even in normal times represents little more than an educated guess. Against this background, the main risk for private creditors may not necessarily stem from large write-offs in the short term but from serial defaults over the next decade as ‘common framework’ debt treatments may turn out too shallow to resolve a debtor country’s underlying liquidity and solvency problems sustainably.

 

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