33 Trillion Dollars at Stake.. Proposal to Freeze Debt of Emerging Countries in Times of Crisis

SadaNews - A group of prominent bondholders in emerging markets has proposed granting developing countries a grace period to repay their debts in the event of disasters.

The proposal came as the annual meetings of the International Monetary Fund kicked off in Washington, allowing governments to suspend interest payments in the event of natural disasters, pandemics, armed conflicts, or major economic shocks. In return, countries provide more protection for bondholders and offer more detailed data about their debts.

This trend reflects Wall Street's concern over the potential collapse of emerging economies burdened with debts totaling 33 trillion dollars, making them susceptible to crises if they face new setbacks. The shocks that the world has witnessed over the past five years, starting from the "COVID" pandemic to the war in Ukraine, and culminating in the tightening of global monetary policies, have pushed fragile economies into financial crises, forcing their governments to cut spending on vital sectors such as education and health, while some countries have slipped into default.

Anticipating a Debt Crisis

Sami Mouawadi, head of emerging markets fixed income at T. Rowe Price Associates and a member of the task force that prepared the proposal, said, "We are trying to preempt the next crisis. We have seen that low-income countries are affected by macroeconomic fluctuations, and what we are offering here are more flexible and robust contracts."

The group is calling for a new clause to be included in sovereign bond contracts allowing governments to suspend interest payments for up to one year after a significant event occurs. Island nations in the Caribbean have adopted such a formula due to their exposure to hurricanes. Grenada's bonds were not affected when the country activated this clause in 2024 following Hurricane "Beryl," nor was the performance of Barbados bonds adversely impacted when it became the first country to include this condition in an initial issuance last June, with subscription requests exceeding the amount offered by five times.

The latest version of the proposals, which is supported by companies such as Grantham Mayo Van Otterloo & Co. LLC and Aberdeen Asset Management, expands the range of events that can trigger this clause to include, in addition to natural disasters, armed conflicts and global economic disruptions.

In such cases, the government announces the occurrence of the disaster, then bondholders vote to suspend payments. In return, borrowers commit to enhancing transparency by holding quarterly meetings between investors and key officials and publishing detailed data on debts, with the possibility of amending the law governing bonds if legal changes occur in New York or the UK.

Transparency in Debt

The International Monetary Fund has called for greater transparency in debts in recent years following the defaults of countries like Sri Lanka and Zambia and their entry into complicated and lengthy negotiations to restructure their obligations. An IMF report issued on October 7 noted that "the lack of transparency in debt hampers creditors' ability to assess the principle of equitable treatment in restructuring and delays the process."

It explained that the average duration of eight sovereign debt restructuring cases in the past five years rose to 2.5 years compared to 1.1 years previously, adding that "improving transparency in debt yields long-term benefits, including reducing yield spreads on bonds."

Investors propose that deferred payments be added to the principal of the debt later with interest calculated on them. Deferrals cannot be applied during the last year of the bond's life or if more than half of bondholders reject it. It is also stipulated that the deferral must include at least 60% of commercial creditors and official lending institutions that do not provide concessional loans to ensure that available funds are used to support economic recovery rather than repaying other debts. New conditions can be applied when issuing bonds, managing obligations, or during restructuring.

According to Abby McKenna, senior advisor and program director at the Emerging Markets Investors Alliance, which participated in drafting the proposal with other experts such as Ben Heller, portfolio manager at HBK Capital Management, this wording provides countries with liquidity during crises without increasing borrowing costs.

McKenna said, "The number of default cases will be less in the long run. We hope this unified liquidity solution provides a predictable and measurable tool for managing risks, benefiting both issuers and investors alike."