Managing sovereign debt and resolving sovereign debt distress Effective management of sovereign debt can reduce pressure on government finances, free up resources for urgent fiscal expenditures, and avert the large social and economic costs of a full-blown debt crisis.39 This section reviews tools that governments can use to better manage elevated levels of sovereign debt and resolve distress when it materializes. It also looks at the longer-term policies and reforms that can make government finances more resilient to unanticipated shocks such as the one resulting from the COVID-19 crisis. At times, similar tools can be used for both managing elevated levels of sovereign debt and for resolving debt distress. The difference is often the degree to which the available tools are applied and which combination of available policy options is chosen. The degree of relevance of these tools depends on countries’ individual circumstances—for example, their degree of market access and their income level—as well as macroeconomic factors such as the exchange rate regime. Most of the options presented in what follows are applicable across the spectrum because the basic principles of timely recognition of the problem, negotiation, and burden reduction are relevant to all types of debt. A critical first step is to identify a country's risk of falling into debt distress. International financial institutions typically play a central role in providing debt sustainability analyses (DSAs),40 which are the basis for classifying debt risks and designing strategies for debt reduction. For example, DSAs are an integral part of Paris Club debt restructurings and often play a key role in restructurings with private creditors as well. Because a reliable DSA is the basis for successful debt management and debt reduction, it is critical that such an analysis be based on accurate information as well as transparent and realistic assumptions. Accurate assumptions are crucial in three areas. The first is growth, comparing expected growth rates with historical growth rates and allowing for realistic worst-case scenarios, especially in fragile, lowincome, and commodity-exporting economies. The second is fiscal. Assumptions should take into account the expenditures needed to achieve development goals—such as reducing poverty, adapting to climate change, meeting the Sustainable Development Goals (SDGs)—as well as assumptions on the amounts and terms of the debt instruments used to fill future funding gaps. The third is realistic discount rates. Assumptions should differentiate between debt due now and debt due in the future.41 To do this, DSAs use present value estimates, which discount future payments by a given discount rate. Unrealistic discount rate assumptions are often overlooked as a reason that expectations and reality diverge. The use of overly optimistic discount rates that make the present value of a sovereign’s liabilities look manageable can lead to surprises when the economic environment turns out to be less benign than the forecast and insufficient relief if debt distress materializes.
Managing sovereign debt Countries at high risk of debt distress, as opposed to countries already in debt distress, have a number of policy options for making their repayment obligations more manageable. Sovereigns at high risk of default can, for example, modify the structure of their liabilities and the schedule of future payments through negotiations with creditors and the effective use of refinancing tools—whether these creditors are private or official. In this way, proactive debt management can reduce the risk of default and free up the fiscal resources needed to support the recovery from the pandemic.
Debt reprofiling to temporarily free up fiscal resources One of the primary tools governments have at their disposal to manage debt pressures before they become untenable is debt reprofiling. In debt reprofiling, the sovereign issues new debt in order to change
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