Debt treated

The debt of developing countries

External debt is a source of financing for developing countries

Developing countries can raise funds from the international financial community and finance their development through a number of instruments, including attracting equity (notably foreign direct investment), receiving grants from donors, or borrowing from foreign lenders.

According to the Word Bank, net flows of capital received by low- and middle-income countries in 2023 reached $359 billion in the form of foreign direct investments, $21 billion in equity flows, $223 billion in new lending and $183 billion in grants.

Among these four instruments, debt results directly in future obligations for the borrower (debt must be repaid). This makes it necessary for the borrower to make sure that it will, in the future, be in a position to repay its debt, notably through an efficient use of the loans, in order to generate income that will be used to repay the debt. This is why debt is often considered as a development tool. However, for the poorest and most indebted countries, the accumulated debt burden has become a drawback for development; this is why the international financial community designed the Heavily Indebted Poor Countries (HIPC) Initiative, and most Paris Club member governments decided to provide financing to these countries mostly through grants.

Creditworthiness varies significantly from country to country

The creditworthiness of a country is the assessment by potential lenders of the country's capacity to repay its external debt. Being creditworthy is a key to success for developing countries because they can borrow larger amounts to finance growth and development. In addition, a creditworthy debtor is in a position to borrow funds used to refinance its existing debt obligations.

Governments of debtor countries have a significant impact on the creditworthiness of all borrowers of developing countries, since a government default can have consequences for the capacity of other borrowers to repay their debt.

A number of factors influence creditworthiness. Some are linked to economic factors, such as the capacity of the country to generate balance-of-payment receipts, and the volatility of these receipts. Others are financial factors, such as the debt repayment profile. Political factors also play a role in the creditworthiness of a debtor country, when its government considers the cost of paying debt to be too high. 

Creditworthiness usually takes a long time to build, as lenders tend to assess over time the capacity of the debtor to repay its debt before entering into large lending. In contrast, failure to fulfil debt obligations can rapidly damage creditworthiness. Under circumstances where debt restructuring cannot be avoided, countries that do not accumulate arrears and take preventive steps to reach a coordinated solution with their creditors, notably in the Paris Club, can restore their creditworthiness more rapidly afterwards. In contrast, debtors that declare a unilateral moratorium tend to lose access to new financing for some time.

Debt categories

The debt owed by a country can be divided into various categories. Each organisation compiling and publishing debt figures may have slightly different ways to categorize and to measure debt. The main categorizations used in the framework of the Paris Club are the following:

External debt and domestic debt

External debt is generally defined using a residency criterion: it is debt owed by public and private entities resident in a country to non-residents. This type of debt has a direct impact on the balance of payments of the debtor country. The domestic debt, on the contrary, is debt owed by resident entities to other resident entities in the country.

However, for practical purposes, external debt is sometimes compiled according to the currency of the debt and without using a residency criterion (being then similar to foreign currency debt).

Classification by categories of debtors: Private and public debt

External debt may be owed by public sector entities or by private sector entities of the debtor country. In the first case, it is called public debt, in the second case, private debt. Debt owed by private sector entities but guaranteed by public sector entities is often included in the public debt (which is sometimes called "public and publicly guaranteed debt").

Public debt may be owed by the government or by other public sector entities, including public enterprises.

Classification by creditor: multilateral, bilateral and private debt

Multilateral creditors
Claims granted by international financial institutions (mainly the IMF, the World Bank or regional development banks) constitute multilateral debt.

Official bilateral creditors
Claims granted by official bilateral creditors i.e. States (governments or their appropriate institutions, especially export credit agencies) constitute bilateral debt. The Paris Club brings official bilateral creditors together. Although not all official bilateral creditors are members of the Paris Club, Paris Club creditors hold the majority of official bilateral claims worldwide. Other official bilateral creditors may participate in Paris Club sessions on an ad-hoc basis.

Official bilateral claims result from two types of financing:

  • credits guaranteed by the Governments or their institutions. In most cases, these credits were commercial credits granted to finance imports by the debtor country;
  • direct loans from the Governments or their institutions to the government or other public entities of the debtor country.

Government loans may be granted under "Official Development Assistance" (ODA) conditions, as defined by the OECD (low interest loans aimed at supporting the development of the debtor country).

Private creditors
All creditors not mentioned as multilateral or official bilateral creditors are considered private creditors. These include suppliers, commercial banks and bondholders.

The debt treated in the Paris Club agreements

The debt treated in the framework of Paris Club agreements constitutes only a part of the total external debt of developing countries, as regards the categories of debt as well as the time period taken into account (flow or stock treatments).

Among the different types of debt, Paris Club agreements generally concern only:

  • public debts, as the agreement is signed with the government of the debtor country unable to meet its external obligations. Debts owed by private entities and guaranteed by the public sector are considered to be part of the public debts. On the creditor side, the debts treated are credits and loans granted by Paris Club creditors' governments or relevant institutions, as well as commercial credits guaranteed by them.
  • medium- and long-term debts. Short-term debts (debts with a maturity of one year or less) are usually excluded from the treatments, as their restructuring can significantly undermine the debtor country's capacity to participate in international trade.
  • debts granted before the initial date set when the debtor country meets with the Paris Club, also known as the cut-off date.

 

Flow treatments

Flow treatments aim to close the debtor country's financing gap identified by the IMF in the framework of its programs. The gap is the result of external resources - exports, reserves, revenue from foreign assets, remittances, foreign direct investment (FDI), loans and grants - not covering external needs - imports, debt service, repatriation of dividends produced by FDI.

Paris Club agreements usually coincide with the period of time covered by the IMF program, which demonstrates a financing gap that can only be covered by debt rescheduling. This period is called the "consolidation period".

Only maturities owed to Paris Club creditors and falling due during this period are treated. However, in some cases, arrears accumulated as of the start of the “consolidation period” are also treated.

Stock treatments

Some Paris Club treatments apply not only to the payments due over a given period of time, but to the entire stock of debt. The aim of agreements covering the stock of debt is to provide a country with a final Paris Club treatment called an exit treatment. Such agreements are used in two cases:

  • Under the HIPC initiative, the action taken by Paris Club creditors in accordance with this initiative takes the form of a stock treatment granted at completion point;
  • In other cases, stock treatments may be granted, on a case-by-case basis, for countries that have a satisfactory track record with both the Paris Club and the IMF and where there is sufficient confidence in the debtor country's ability to meet its obligations under the debt agreement.