Default and restructuring
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There has been serious fallacy about the two most talked about concepts in recent times - “default” and “restructuring”.
These’re discussed in every household these days and it’s imperative to understand what does these terminologies exactly mean before we commence giving conclusive remarks on them and that also in a rather flippant way. These’re very serious matters and shall not be commented loosely without grasping the true meaning and implications of them.
Let me begin by clarifying that “roll-overs” are “no defaults”. Default triggers when the borrower stops from meeting its “contractual obligations” of both interest and/ or principal. This could be willful or due to genuine cashflow constraints and it’s always unilateral.
On the other hand, roll-overs are always achieved with mutual consent and it may or may not be necessitated due to cashflow constraints of borrowers.
In fact, ideally under cashflow stress, roll-overs shall not be accepted by the lender until and unless she’s sure of getting her money back at the maturity of the rolled-over period. There maybe other considerations to allow roll-overs, like friendly relationship, etc.
Monetarily or otherwise, there’re always legitimate considerations for roll-overs. Therefore, they shall not be bracketed with defaults.
Defaults are also different from refusing or delaying payments which are “non-contractual” in nature. Contrarily and interestingly, refusal or delay in payment construes default on contractual payments only.
Having said that refusal or delays or even roll-over of debt payment/ repayment could be treated as “technical default” under very specific circumstances but defining these specific circumstances are a moot point, judgmental and subjective in nature; therefore, it’s better to stick to the literal explanation of default rather than deviating from it and making our own conclusive assessments about it.
In case of Pakistan, we need to appreciate that there’s no default and there will not be a default until there’s a refusal or delay in compliance on contractual obligations, or if anyone sets off a formal default process.
The next such obligation which can’t be delayed or refused or rolled over is Eurobond, falling due in April 2024 for $1 billion. Until then, as long as we continue to service or roll over our other debts/ obligations, albeit bilateral or multilateral or commercial including letters of credit, there will be no default in strictest sense of the word.
Our own individual definition of default or technical default are meaningless and serves no purpose except for creating confusing and unnecessary anxiety amongst markets/ people who don’t understand what default exactly denote.
Now, to talk about restructuring. There’s is a subtle but significant contrast between restructuring and reprofiling. Restructuring connotes that there’s explicit haircut (partial waiver or write-off of repayment of principal and/ or interest) on debt with or without stretching the originally agreed tenor.
Restructuring often involves negotiations between the debtor and the creditor, and it can include actions, such as, reducing the principal amount, extending the repayment period, adjusting interest rates, or even converting debt into equity.
Debt restructuring generally happens after a country defaults on its contractual obligations. We have the example of Argentina, which has gone through two sovereign debt restructuring processes, first in 2005 and then in 2020. The government ended up issuing new securities to the creditors and the creditors had to take haircuts.
Ghana defaulted on external debt payments in 2022 and has reached an agreement with bilateral countries to restructure its debt obligations. It has also reached an agreement with domestic banks to restructure its local currency debt.
On the other hand, there’s no “explicit” wavier or write-off of the sorts involved in the case of reprofiling. There maybe an implied waiver/ write-off due to tenor extension of contractual payment/ repayment, possibly due to time value of money (arising from interest rate on the reprofiled debt lower than inflation rate), but there’s no explicit waiver or write-off on the outstanding payment due, as such.
The G20 Debt Service Suspension Initiative (DSSI) launched in the aftermath of the Covid-19 pandemic helped more than 48 countries to reprofile nearly $13 billion of debt owed to the G20 countries.
Pakistan was the primary beneficiary of G20 DSSI with nearly $4 billion of debt payments suspended for a period of four years including one-year grace period. The DSSI provided a Net Present Value (NPV)-neutral debt-service rescheduling with no haircuts. Zambia is the most recent beneficiary of reprofiling under DSSI.
We need to comprehend under which situations restructuring is required and where reprofiling works. Typically, restructuring is required when the borrower is unable to repay the contractual obligations even when the tenor is drawn-out within the restructuring appetite of the lender.
Reprofiling is considered, instead, when the lender is reasonably sure that the borrower will be able to service the contractual obligations without any delay when the elongated time period breather is granted to it, or where due to statutory limitations or political considerations of the lender waiver or write-off is not possible.
In the later situation, the tenor has to be lengthened to the extent where the debt servicing becomes feasible to the borrower – a win-win for both the parties.
In summary, restructuring involves more extensive changes to the terms and structure of debt, while reprofiling typically involves adjusting the payment schedule or timeline without altering the fundamental terms of the debt.
While at it, would like to also take the opportunity to clarify another phrase - “rescheduling” – that’s been floating around. It’s a broader nomenclature which covers both restructuring and reprofiling.
Pakistan don’t necessarily require debt waiver or write-off, the reprofiling will work just fine given the nature and the pedigree of our external debts and due to lumping-in of payments/ repayments falling due in the immediate future.
Of course, this all hinges on our ability to commit and resolve our fiscal account to extend necessary support to enhance our export flows.
The proposition of reprofiling is generally acceptable to lenders across the board (barring bond-holders). Therefore, as long as, we consider reprofiling (and not restructuring) of our 92% of external debts (other than bonds), we should be fine in managing the market sentiments and remaining engaged with our lenders in a meaningful and mutually beneficial manner.
Although the process of pulling off reprofiling is a relatively easier but even it’s a long, painful, and protracted one and it takes years to materialise given the involvement of complex analysis of future cashflows and that too with multiple stakeholders, so one needs to be mentally ready to show patience and restraint during the process.
The fact is that at the end of the day we’re not the only country in the globe in this quagmire. There’re 38 countries assessed by the World Bank which are running the risk of sovereign event currently.
This is also a reality that reprofiling is no longer a stigma. This is a norm across emerging markets due to exceptionally unusual environment across the planet. This could perhaps be a sliver-lining to put our house in order which has long been pending.
I am an inveterate optimist, and I have all the reason to be one, and will remain one under these severe, unprecedented headwinds as well, given that our challenges are very much in our own control to address.
The writer is a development and social-impact focused banker. He’s presently serving as President & CEO of The Bank of Punjab
Published in The Express Tribune, July 3rd, 2023.
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