External Debt stress and Domestic Debt Restructuring: Resolving a paradox C. P. Chandrasekhar

The ongoing sovereign debt crisis in LMICs was signalled by instances of failure to meet external debt obligations denominated in hard currencies. The policy response has included attempts to restructure domestic sovereign debt issued largely in domestic currencies, justified by identifying the crisis as one of excessive aggregate public debt rather than just unsustainable levels of external debt. It is argued that debt stressed governments having high levels of aggregate public debt need to reduce their gross financing needs (foreign and domestic).

This assertion ignores the difference between the stress associated with servicing debt in domestic and foreign currency. Governments can mobilise domestic resources through taxes and central banks have control over domestic currency supply, whereas both have little control over foreign currency availability.

Additionally, domestic sovereign debt holders include citizens deploying their savings to invest, and commercial banks parking resources in ‘safe investments’; restructuring that debt through haircuts is bound to be economically destabilising by eroding past savings, being inimical to balance sheets of banks, and thus depressing consumption and investment. This makes implementation of domestic debt restructuring costly and difficult.

Given this context, the paper examines why IMF and global finance insist on domestic debt restructuring by LDCs facing external debt stress as part of conditions associated with provision of emergency BoP finance/restructuring of foreign debt.

02_2024 (Download the full text in PDF format)