The Debt Restructuring Conundrum and Finding the Right Clarification

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For the first time in Ghana’s history, a debt restructuring program is set to take place due to the country’s unsustainable level of debt, threatening the prospects of its economy.

This has become imminent in order to mitigate the negative impact of the huge debt on the economic fundamentals of the country, especially the real sector of the economy, inflation, exchange rate and money supply. However, this can only be done after the completion of the debt sustainability analysis by the International Monetary Fund and the World Bank.

But for many, debt restructuring is practically new to them due to its unprecedented outcome.

Debt restructuring, according to Investopedia, is a process used by companies, individuals and sovereign nations to avoid the risk of default on their existing debts, for example by negotiating lower interest rates. It provides a less expensive alternative to bankruptcy when a debtor is in financial difficulty, and it can benefit both the borrower and the lender.

It can also be defined as an exchange of outstanding sovereign debt instruments, such as loans or bonds, for new debt instruments or cash through a judicial process”.

To constitute a debt restructuring, one or both of the following types of exchange must take place: debt rescheduling, which consists of extending contractual payments into the future and possibly reducing the interest rates on these payments and debt reduction, which includes reducing the face value of outstanding debt.

Typically, restructuring occurs after loan default, but early debt restructuring that anticipates default is also possible. In addition to economic variables, the type, timing and terms of a debt swap are largely determined by negotiations between the sovereign debtor and its creditors.

Effects of debt restructuring on the economy

The planned debt restructuring will cover longer term financial instruments including Eurobonds, Government of Ghana bonds, arrears and energy debts.

Sovereign debt is not just a financial issue. It has social, political, economic, cultural and environmental implications.

This requires a holistic approach that incorporates all relevant stakeholders. This includes citizens of debtor states, multilateral creditors, bilateral creditors and private creditors such as bondholders, institutional investors and pension funds.

Once debt restructuring is complete, the program is expected to revitalize the economy by increasing tax revenue, increasing social spending and improving income equality.

Banking consultancy, Dr. Richmond Atuahene, wants the government to scale back some of its flagship programs and continue streamlining staff across ministries, departments and agencies to free up resources to undertake capital and investment projects .

Obtaining net present value debt relief is likely to show a lasting improvement in the country’s external balance, he said.

Meanwhile, restructuring debt can damage a sovereign nation’s or borrower’s credit rating because borrowers fail to honor the original agreement. “It can hurt the score for up to three years after the final payment.

Steps guiding debt restructuring

Debt Transparency

Debt transparency strengthens disclosure requirements through a number of transparent and participatory procedures. The objective is to empower the decision-makers concerned.

This is the cornerstone of debt management reform.

To this end, several debtors are advised to follow well-known, predictable and binding legal procedures to enter into new financial obligations.

One example is resource-backed loans. The repayment of these loans is either made in natural resources or guaranteed by the income generated by the sale of the natural resource.

Debt brake or ceiling or limit

The debt brake, ceiling or limits are usually instituted in the constitution to control the extent of the abuse of borrowing by governments.

An example is the introduction of a cap or ceiling of 50% of gross domestic product to prevent governments from borrowing above this limit.

good governance

The third step to guide debt restructuring is ggood governance.

This involves strengthening national debt management policies to address governance issues.

Transparency alone will not guarantee responsible borrowing.

Debt management frameworks and practices should comply with all principles of good governance. The list includes transparency, participation, accountability, effective decision making and institutional arrangements.

Legal predictability

This is to reinforce contractual provisions in debt contracts.

Debt is a contractual relationship. It is therefore important – for debtors and creditors – to conclude contracts that are as comprehensive as possible.

This means that contracts must fairly distribute the risks between the parties. This would mean, for example, accommodating those who are more able and willing to accept risk.

In addition, contracts should provide the parties with clear answers to issues that may arise between them.

This would require policy makers to provide guidance to their debt managers on the terms and conditions they can agree to in contract negotiations.

Debt restructuring process

The process of debt restructuring can reduce interest rates on loans or extend the terms for repaying them.

A debt restructuring can include a debt-for-equity swap, in which creditors agree to cancel some or all of the outstanding debt in exchange for equity in the business.

The IMF describes domestic debt restructuring as surgery, saying “you only do it if you have to, and you avoid it if it might do more harm than good.”

Benefits of Debt Restructuring

There is cash released, either by deferral and/or reduction of installments.

The process of debt restructuring may also reduce interest rates on loans or extend the terms for repaying them.

It can be a debt-for-equity swap, in which creditors agree to cancel some or all of the outstanding debt in exchange for equity in the business.

Disadvantages of Debt Restructuring

Negative impact on credit rating. This means that loans registered under the one-time loan restructuring program have a negative impact on the borrower’s credit history and lead to rigorous financial scrutiny in case they apply for another loan.

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