Debt Rescheduling Essay

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Debt  rescheduling  is the  reorganization  of an outstanding debt amount  (stock) and/or  its terms. Debt rescheduling  is undertaken in situations  where  the debtor  faces serious obstacles in repaying the debt, either on time or at all. Often this procedure is referred to as debt reprogramming. In most instances  when debt rescheduling is undertaken it eases the position of the debtor, addressing the issues of his/her  liquidity and the potential  of insolvency. The rescheduling of the debt may address the amount that is borrowed, where the creditor may reduce the principal in order to facilitate the debt service, but all the other conditions of the original contract  remain in force. Or, the creditor may focus more on the servicing of the debt and facilitation of the repayment process, allowing the deferral of payments due, reducing the interest  rate, extending the maturity, etc. In critical situations, the rescheduling  may target  both  the  outstanding debt stock and the conditions  of contract.  The creditor  is interested  in saving as much  as possible of his/her own money and also ensuring the economic viability of the debtor, as a potential future client as well.

Debt rescheduling is a contract  that alters the previous debt contract  and requires  the full consent  of both  contractual  parties.  Both  creditor  and  debtor have to agree on new terms and conditions  in order to have this contract  concluded. Often it is assumed that unilateral  actions are debt rescheduling  modes, but this is not the case. Unilateral actions are usually undertaken by the creditor in situations where it is difficult, if not impossible, to gain consent of the debtor, and where the debtor’s situation  is virtually hopeless and it is necessary to undertake  measures that would ease its position, even without consent. This on a few occasions has been the case with the least developed countries   (LDCs), where  their  inability  to  service loans has been endemic and the only way forward was to write off part of the loan, or arrears, or sometimes both. Even if a new credit follows unilateral action of the creditor,  these two consequent  contracts  should be regarded separately. Debt rescheduling is just one of the modalities of debt restructuring (reprogramming).  Rescheduling  entails  the  changes  in  terms for repayment of the principal and/or interest of the signed contract,  or deferment  of some  or all payments until some mutually agreed future date. In the case of deferment,  one can focus on flow rescheduling or stock rescheduling.  If debt rescheduling  is entertained, the debtor may find it a temporary relief, but if the structural  problems are not addressed, the eventual  capitalization  of interest  and  future  possible successive rescheduling agreements may prove far too costly to be done in the future. Rescheduling of debt in a narrow sense of the term means changing  the  conditions  of the  contract  and  not  really addressing  the  underlying  problems  of inability to meet payments either on time or in general.

Debt refinancing is another  modality of debt rescheduling in a wider sense, and in the case of refinancing, the debtor is getting a new loan that would consolidate all existing debts, and/or  will provide full accounting  support  for the activities. In the case of refinancing the client would look for favorable (lower) interest rates and/or  longer maturities. In the case of increased competition  in the banking sectors worldwide, it is likely that some new entrants  in the market would attempt  to penetrate  the market  with underpricing, and therefore these refinanced credits can prove to be a time bomb. Refinancing options can be either  voluntary  or involuntary.  In the  former  case the country is short of cash, foreign reserves, etc. and simply cannot  meet  the payments; while in the latter case the country is just following the market conditions, and if a country  can raise the money in the financial markets cheaper, it will be prone to repaying the costly debt and looking for another, cheaper one.

One  of the  possibilities  for  rescheduling  is the debt buyback. In this case the debtor may purchase its own debt at a discount. The creditor would agree to this transaction,  in order to salvage at least some of the costs invested. Most recently Nigeria has repurchased  a significant amount of public debt due to the unexpected  revenues from oil. The debt buyback model is promoted  by the International Development Association (IDA), which targets the world’s poorest nations; IDA provides support  if requested. IDA has created a special debt reduction facility that gives grant  funding  either  alone or in partnership with some of the players.

Another  instrument for debt restructuring is debt conversion  and  swaps. Swaps offer a possibility of exchanging the loan in foreign currency for a loan in domestic currency and in this way reduces the risks of foreign exchange rates. A number  of conversions/ swaps can take place: debt-for-equity  swaps, debt-for nature swaps, debt-for-development swaps, debt-for-education,  and  debt-for-debt swaps. Although  debt swaps may be attractive,  they may have a series of disadvantages,  such  as the  fiscal impact  of prepayment, associated inflationary risk, and high transaction costs in the case of a bespoke service.

Although debt rescheduling is a two-way process, either of the contractual  parties may initiate the process. Often  the  debtor  is the  one who initiates  the change in terms and proposes the amendments to the existing contract. Usually both sides begin with negotiations as to how to change the current  contract  to reflect the current  situation and immediate future (in economic  terms)  of the debtor.  The debtor  can also put  forward  a finalized proposal  and  ask creditors to adhere to it. In the case of Dominica in 2003, the preemptive  restructuring was intended  to  head  off the default on public debt. The government of Dominica had approached  all creditors  (multilateral, bilateral, private, and so on) and offered the exchange of the bonds that were in default for three new classes of bonds.  Because the  situation  was rather  serious, almost three-quarters of all creditors  have endorsed the proposal.

In the  end,  debt  restructuring may have several outcomes. Debt rescheduling is usually seen as short-term relief, as is refinancing, while write-off (although a unilateral  action) and various swaps are perceived to have contributed to the  permanent reduction  in debt exposure. Both the London (a group of creditors representing  commercial banks) and the Paris Clubs (a group  of creditors  consisting  of national  governments, official bilateral creditors)  have endorsed  the policy of debt restructuring (rescheduling)  from the late 1980s, when the  problem  of high international indebtedness  emerged. In a number of instances, without the well-designed model, many countries would have defaulted on their  credits, and it would have led to a serious systemic shake-up of the international financial system. Debt rescheduling (restructuring) is now accepted as a common practice.

Bibliography:   

  1. Berg and J. Sachs, “The Debt Crisis,” Journal of Development Economics (v.29, 1988);
  2. Katy Cornwell and Brett Inder, “Evidence for the Ineffectiveness of Debt Rescheduling as a Policy Instrument,” Applied Economics (v.39/17, 2007);
  3. C-T. Ebenroth, Maina Peter, and M. J. Kemner, “Rescheduling of the Sovereign Debt: A New Role for the Paris Club,” Journal of International  Banking Law (v.10, 1995);
  4. Claude Fluet and Paolo G. Garella, Relying on the Information of Others: Debt Rescheduling with Multiple Lenders (Centro Studi Luca d’Agliano, 2007);
  5. Chris Jochnick and Fraser A. Preston, Sovereign Debt at the Crossroads: Challenges and  Proposals for Resolving the Third World Debt Crisis (Oxford University Press, 2006);
  6. Marchesi, Adoption of an IMF Programme and Debt Rescheduling: An Empirical Analysis, Warwick Economic Research Papers (University of Warwick, 1999).

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