A former president of the Central Bank of Ireland called for the IMF to stop charging high rates to over-indebted countries

FILE PHOTO: The International Monetary Fund (IMF) headquarters building is seen ahead of the IMF/World Bank spring meetings in Washington, U.S., April 8, 2019. REUTERS/Yuri Gripas/File Photo

The Economist Patrick Honohan, former president of the Central Bank of Ireland and member of the Board of Directors of the European Central Bank, warned that If the International Monetary Fund (IMF) does not establish a reduction in the surcharges on the rates that highly indebted countries must face, the risks of forcing debt restructuring and default situations would increase., particularly in middle-income countries, such as Argentina.

With a long academic career at prestigious universities, such as the London School of Economics (LSE), Honohan set out his position in an article published by the Peterson Institute for International Economics, a major Washington-based think tank.

Patrick Honohan, former Chairman of the Central Bank of Ireland
Patrick Honohan, former Chairman of the Central Bank of Ireland

Under the title “The IMF should suspend surcharges on interest rates for indebted countries”This article is transcribed in full below:

With interest rates moving higher, past experience tells us that emerging markets and other stressed borrowers will face interest rates that are well above wholesale rates in advanced and financially sound economies. Fear of default in emerging markets can also be self-fulfilling if creditors charge high-risk premiums.

To help avoid this trap, the International Monetary Fund (IMF) needs to take the lead in protecting debt sustainability by reassessing its policy on rate surcharges for the large loans that will likely be needed after the pandemic.

In early January, a group of progressives from the Democratic Party in the US Congress asked the Secretary of the Treasury, Janet Yellen, to put an end to the surcharge policy because “discourages investment in public health by developing countries” and threatens global economic recovery. But the Treasury has reiterated its support for the surcharges, saying it is necessary to protect the “financial integrity” of the IMF.

“There are many countries with such high debt levels that an increase in interest rates within historical ranges could tip them towards unsustainable debt loads, with potentially painful consequences.”

With interest rates still low, most countries have found it easy to pay off the debts they have accumulated. Public debt servicing in emerging middle-income economies has been running at only about 2 percent of GDP. And the G20 Debt Service Suspension Initiative, which ran until December 2021, bought time for many low-income countries.

But now there are many countries with debt levels so high that an increase in interest rates within historical ranges could tip them towards unsustainable debt loadswith potentially painful consequences.

The half dozen cases of debt default in recent years may be a harbinger of worse problems. In fact, some three dozen countries are on the World Bank’s list of countries at high risk of debt distress. About 40 countries have public debt ratios above 100 percent of their GDP, including a dozen advanced economies. Even ignoring the smallest countries (with populations under five million), we still find more than 20 emerging or developing economies with a share of over 80 percent.

Some of these cases will not be fully resolved without debt restructuring, something that typically takes years to negotiate, and the delay leads to significant production losses.

“The fear of default in emerging markets can also be self-fulfilling if creditors charge high-risk premiums”

Other cases may depend for their survival on investor confidence or be doomed if creditors fail to demand a reasonable premium for default. Unfortunately, due to the combination of low interest rates and rapid debt accumulation in the pandemic, the factors for a self-fulfilling pessimism are present in which a growing default risk premium leads a country directly to that default, which both creditors and debtors want to avoid. Indeed, anticipating such a self-fulfilling expectation trap, astute investors are likely to back out, closing off the country’s access to international finance.

Countries facing such a risk will seek assistance from the IMF. The Fund can take advantage of the return of private financing to countries whose debt is potentially sustainable through the approval of a credible recovery program. It can also be an important catalyst in organizing debt restructurings or moratoria. But the more indebted a country is to a preferred creditor like the IMF, the more minor creditors have to fear a debt restructuring.

“The fear of default in emerging markets can also be self-fulfilling if afeedores charge high-risk premiums”

Ironically, however, the Fund itself incorporates interest rate penalties for large or prolonged loans from financial facilities offered to struggling middle-income countries. In high-debt, interest-sensitive situations, these surcharges go against the sustainability of the debt, especially if the IMF’s interest charge becomes the benchmark for the cost of cofinancing from other creditors.[2]

The level of indebtedness that triggers the IMF surcharges depends on the “quota” of the debtor member country. Surcharges can be high for large loans, especially if they extend beyond three years. In practice, a 2 per cent surcharge is applied to loans of more than twice (actually 187.5 per cent) the installment. An additional percentage point is added when the indebtedness has been ongoing for more than three years. With the base rate for Special Drawing Rights (SDR) currently at just over 1%, these surcharges bring the total charge rate to 4% per year.

Of course, the surcharges are there for a reason, in particular to discourage countries from becoming too dependent on Fund assistance and to help ensure that its renewable resources are available for all new cases. Surcharges encourage early payment and return to private sector loans.

The IMF has been looking for other ways to address the pandemic-related debt overhang. For example, it has a mechanism to relieve the debt of low-income countries with over-indebtedness. It has been examining the potential role of state-contingent debt instruments.

“The more indebted a country is to a preferred creditor like the IMF, the more minor creditors should fear a debt restructuring”

To avoid self-fulfilling pessimism that could result in a disruptive default, other creditors may also have to accept lower refinance rates. It would be easier for the IMF to push other creditors in this direction if it also charged lower rates. Even if such a reduction were only temporary, it could ease a likely post-pandemic debt crisis.

The IMF can afford to do this. It is true that flight attendants have contributed a considerable part of their income in recent years. But even without them, it would still have a net income of $600 million in the last fiscal year and be on track to make even more this year.

Unilateral action by the Fund would not completely eliminate the threat of costly and disruptive debt restructurings, but it would directly help and encourage action by other creditors, public and private.

Prompted by the G20, the IMF Board recently discussed surcharges, but only hinted at a “more holistic and timely review of surcharge policies.” Now seems to be an appropriate time to act.


Changes in energy policy in the 1990s and today
Pension policy: we are not the worst, but we are far from being the best
How much will the dollar and inflation reach this year, amid uncertainty over the debt with the IMF
Markets: bonds and shares rebounded after the negative streak due to the lack of progress with the IMF


Leave a Comment