IMF policy paper for an approach framework to debt swaps (2024)

https://www.imf.org/en/Publications/Policy-Papers/Issues/2024/08/05/Debt-for-Development-Swaps-An-Approach-Framework-553146?cid=em-COM-123-48852

[excerpts from executive summary]

This note provides a framework for evaluating and enhancing debt swaps. It focuses on two critical aspects: (1) appropriateness of the use of debt swaps, that is, in what debt situations and countries are debt swaps useful and (2) adequate and enhanced design of the expenditure program commitments, from the standpoint of fiscal policy and sectoral programs.

Appropriateness of the Use of Debt for Development Swaps 

Each proposed debt for development swap should undergo a comprehensive evaluation to validate whether it is viable and beneficial for the country. From a debt and financial perspective, key criteria include: (i) the country’s initial debt position and the swap’s effects on debt sustainability, (ii) the net financial gains for the debtor, (iii) the country’s debt management capacity and commitment to transparency; and (iv) the opportunity costs for the borrower and donors. 

Countries that are potentially good candidates for swaps are those at “moderate” or “high” risk of debt distress with a sustainable outlook facing temporary liquidity pressures, usually smaller economies, and where the transaction can be impactful in providing critical short-term relief and improving debt sustainability prospects. For those countries, debt swaps can help smooth debt amortization profiles and represent sound liability management, while supporting high-impact development projects. Countries need to have strong debt management capacity to record and report on the swap, and grasp the transaction’s financial, fiscal, spending management, legal, and operational implications. Swaps are intrinsically complex, and all parties involved need to be committed to providing the highest levels of transparency to adequately assess the benefits of swaps, and to provide for scrutiny by relevant stakeholders, including civil society.

Countries with unsustainable debt levels or those requiring (or already undergoing) comprehensive debt restructuring are not suitable candidates for debt swaps, which are not appropriate tools for restoring debt sustainability. In these cases, substantial debt reduction from all creditors and a fully funded macroeconomic adjustment program are necessary. However, debt swaps could be considered as a "top-up" measure after restructuring.

For countries with strong credit and low risk of debt distress, buyback swaps (where market debt is bought back with lower-cost debt) are likely inefficient as the cost difference between existing and new debt is likely to be small while transaction costs are high. Nevertheless, bilateral swaps (where official bilateral debt is written off or exchanged) may still be viable options.

Adequate and Enhanced Design of Expenditure Program Commitments

The key criteria for making adequate spending commitments while enhancing the efficiency and effectiveness of debt-for-development swaps are the alignment of the expenditure program with national priorities, adequacy from an expenditure efficiency perspective (including allocative efficiency), and fiscal sustainability within the country's broader expenditure envelope. […]

This note proposes a new, more flexible approach to spending commitments that aims at development results and outcomes rather than focusing on inputs. It also advocates for greater reliance on country systems for supervision and monitoring. […]

Overall, less heavy-handed earmarking and greater dependence on country systems and institutions, with support from International Financial Institutions such as the World Bank and continued support from NGOs and other agencies, are likely to enhance country ownership. This, in turn, should lead to better implementation, results, and ultimately sustainability of the desired programs over time, even beyond the contractual period. Such transactions would also be less costly, thereby improving the value proposition of debt swaps.