LONDON—Restructuring local sovereign debt burdens will likely play an increasingly important part in emerging markets, according to the International Monetary Fund (IMF), though governments need to take measures to limit the hit on local banks and investors.
The share of debt issued by developing nations in their local markets has risen from 31 percent to 46 percent over the past two decades, the IMF’s Peter Breuer, Anna Ilyina, and Hoang Pham found in a blog published on Wednesday.
“On the one hand, domestic debt restructuring may be easier to accomplish,” the authors wrote, adding this could be achieved through changing the terms of debt contracts in domestic law.
This would also avoid some costs such as the loss of access to international capital markets during a restructuring of external debt, often contracted under New York or English law.
However, with much of local debt held by domestic creditors, sovereign debt distress can easily spread to a country’s banks, pension funds, households, and other parts of the economy, and authorities needed to take pre-emptive action to minimize spillovers.
“For example, the impact on banks can be limited by extending the maturities and/or lowering the interest rate rather than reducing the nominal amount of the outstanding claims,” the authors said. “Losses should be recognized early and may need to be paired with a strategy to restore banks’ capital buffers.”
Emergency support measures allowing lenders to convert illiquid assets into cash may be needed as well as temporary measures to slow “panic-driven deposit withdrawals and capital outflows”.
