When the central bank of a country is unable to obtain the necessary foreign exchange so as to remit debit service payments, a country subsequently fails to meet its debt service obligations. As a consequence, countries are forced to secure debt relief. Creditor groups have opted to establish multilateral mechanisms to deal with debt relief. Multilateral agreements have greatly helped debtor countries deal with unsustainable debt arrears and defaults. This however comes at a cost: countries that have applied for debt relief have found it difficult to reintroduce commercial borrowing facilities. Since 1981, multilateral agreements have enabled more than fifty countries renegotiate their debts.
Currently, debts to official creditors are restructured solely through the Paris Club. The Paris Club is an adhoc creditor-country organization that is responsible for responding to requests made for debt relief with respect to inter government loans and guaranteed export credits. However, loans obtained from multilateral organizations are not subject to debt relief. Debts to banks are renegotiated through bank advisory committees. Both the commercial bank advisory committees and the Paris Club maintain that the debt relief they offer be matched by other creditors, in other words, “equal treatment of creditors.” Unless it is absolutely necessary, debt restructuring should be avoided.
The process of obtaining debt relief is quite easy and straight forward. Countries faced by the danger of default will approach the Paris Club president and request to be considered for relief. The creditors will then agree to hear the country’s petition at their monthly meeting. The negotiations which are face-to-face last a day after which the representatives of creditor countries at the Paris Club decide over which period the debt relief will be provided. Interest payments and scheduled amortization are restructured. However, only the principal is occasionally scheduled.
Interest on rescheduled debt is not agreed on at the Paris Club. It is negotiated bilaterally. Each national credit insurance agency is required to charge an interest rate reflecting its cost of borrowing. Debt relief coverage and repayment terms vary, based on the circumstances facing the debtor country. For example, middle income countries are able to reschedule debts with ten years maturity. Hugely indebted countries on the other hand receive far more generous terms.
Consolidation periods normally last one year, although a country may arrange for a consolidation period of three years if there is an IMF(International Monetary Fund) Extended Fund Facility available or, in the case of low income countries, an enhanced Structural Adjustment Facility.
In case the resolution of the problem appears unlikely during the consolidation period, creditors will consider more debt relief if the country still has an IMF supported adjustment program. The Paris Club creditor countries will establish a “cut-off” date at the start of the debt relief process, which ensures that loan contracts signed after that date will not be valid or eligible for debt relief by the Paris Club. Special arrangements are made for hugely indebted low and middle income countries that owe most of their debts to official creditors. Creditor countries choose repayment from the following two options:
*A third of the consolidation debt is cancelled. The remainder is repaid with maturity of 14 years.
*Repayment terms of 25 years with a grace period of 14 years.
In both cases above, the moratorium interest rates are market related.