Bringing Buybacks Back: A Known Debt Restructuring Tool with a Principled Twist

By Daniel Bradlow, Marina Zucker-Marques and Kevin P. Gallagher

Many developing countries are experiencing what the World Bank has termed the “silent” sovereign debt crisis.

It is silent because the international community has seemingly been hoping the creeping crisis will resolve itself on its own without ambitious intervention. Fifty-four countries are spending more than 10 percent of revenue on servicing their debt and 48 spend more on debt service than on health or education. The international community has not yet found a viable solution to this human crisis.

The current approach, the Group of 20’s (G20) Common Framework, involves prolonged debt restructuring processes—more than three and half years for Zambia—that has condemned debtor nations to financial limbo and functions sub-optimally for actors across the global economy.

Dealing with bondholders, who are the major creditors for developing countries as a whole, has proven to be particularly challenging. During restructuring processes, bondholders have been reluctant contributors to debt relief, even though many charged a precautionary premium upfront for lending to developing countries, have been repaid more than official creditors and enjoy de facto senior creditor status.  Now faced with the prospect of interest rate cuts and perceived global uncertainties, they prefer cash to refinancing distressed developing country bonds, a preference made explicit by bondholders’ practice of frontloading the principal amortization.

For many developing countries, the situation is becoming increasingly challenging as debt service obligations pile up while access to markets remains constrained. Though a potential interest rate cut by the US Federal Reserve could help, it remains uncertain whether this would be enough to generate the necessary volume of finance at a sustainable cost, without further undermining the debt sustainability of these countries. As analysis by the International Monetary Fund (IMF) has shown – see figures below – since COVID-19 pandemic higher US Treasury yields drove down the bond issuances from emerging markets’ developing economies. Currently, these countries face a dual challenge: costly borrowing and limited access to external finance.

Figure 1: US Treasury Yields Drive Down Bond Issuances for Emerging Market and Developing Economies, 2017-2024

Ahead of next week’s Global Sovereign Debt Roundtable, we propose a two-pronged strategy to free some fiscal space for developing countries in a manner that is fair to debtors, creditors and their respective stakeholders alike.

The first leg of the strategy is to create a strategic “buyer of last resort” who steps in to purchase distressed (and expensive) debt at a discount from bondholders and then reselling it to the debtor country on more manageable terms. This method could create a win-win scenario, wherein bondholders receive immediate cash, debtor countries benefit from substantial debt relief and improved sustainability, and official creditors avoid the complexities of negotiating with numerous stakeholders.

The idea has strong precedent and has, in fact, been done before. In 1989, the World Bank Group established the Debt Reduction Facility (DRF), which provided grant funding to eligible governments to repurchase external commercial debt at deep discounts. The DRF has facilitated 25 buy-back operations across 22 countries that borrow from the Bank’s International Development Association, erasing approximately $10.3 billion in debt principal and over $3.5 billion in interest arrears, and reducing the number of litigating creditors.

More recently, countries with sufficient sovereign reserves have used debt buybacks as a unilateral strategy. For example, in 2009, Ecuador utilized its foreign reserves to repurchase 93 percent of its defaulted debt at a deep discount. This strategy reduced Ecuador’s external debt stock by 27 percent, enabling increased public spending and fostering economic growth in subsequent years.

However, many countries in debt distress currently lack sufficient foreign reserves to pursue such a strategy on their own. They need a “friendly” buyer of last resort (rather than a vulture fund) to purchase their bonds and subsequently on-lend to them. Notably, Nobel laureate Joseph E. Stiglitz proposed during the COVID-19 pandemic the idea of a multilateral buyback facility that could be administered by the IMF.

The IMF could create such a facility using a mix of its own resources and donor-funding, including a portion of the $100 billion in Special Drawing Rights (SDRs), the Fund’s reserve asset, that advanced economies committed in 2021 to re-channeling for development purposes. Such a facility, for example, would have enabled Kenya to refinance its debts at the SDR interest rate, currently at 3.75 percent per year, rather than having to do so at the double-digit rates in the financial market. It is noteworthy that the 47 low-income countries identified as in need of debt relief have just $60 billion of outstanding debts to bondholders.

The second leg of our proposal is that both debtors and creditors should commit to a set of shared principles, based on internationally accepted norms and standards that promote a debt restructuring process that is transparent and fair to all stakeholders and results in an agreement that supports economically, financially, socially and environmentally sustainable and inclusive development in the debtor country.

Such an approach could guide the decisions and actions of parties directly involved in a sovereign debt restructuring. Second, the principles could be used by the parties and stakeholders to fairly assess if the results of the debt restructuring offers each, consistent with their respective rights, obligations and responsibilities, the best possible mix of economic, financial, environmental, social, human rights and governance outcomes.

This two-pronged strategy is not risk-free. However, it offers a principled and feasible approach to dealing with the debt crisis that does not undermine international efforts to address global challenges as climate change, poverty and inequality.

While buybacks may not be suitable in every case, they can be used to unlock the large pool of currently unused SDRs to match bondholders’ preferences for immediate cash. Additionally, buybacks can help reach the shared desire among creditors and debtors to both reduce developing countries’ debt burdens and address their social, economic and environmental challenges in a transparent and principled way.

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Daniel Bradlow is Professor and Senior Research Fellow of the Centre for Advancement of Scholarship, University of Pretoria.