University of Mannheim: Payment deferrals for developing countries

The Global South is currently on the verge of a new wave of debt crises. The pandemic and rising commodity and food prices have hit many developing countries hard. Can you help these countries with debt relief? A new study shows that the payment deferrals that many developing countries were granted at the beginning of the pandemic actually helped: countries that were allowed to repay their debt later benefited from better creditworthiness and thus from lower interest rates on the international capital market.

The study by Prof. Dr. Lang and his colleagues are examining the effects of the Debt Service Suspension Initiative (DSSI), a debt moratorium for developing countries that the G20 adopted at the beginning of the pandemic. The initiative allowed the world’s 77 poorest countries to suspend debt service from mid-2020 to late 2021. This enabled them to use freed funds to support the healthcare system and economy during the pandemic.

As with most debt relief in the past, there were early concerns that the initiative could do more harm than good to countries. By participating, the concern said, countries would signal to the markets that they were facing payment problems. This could deter investors and increase the cost of new loans. In fact, many of the eligible countries originally refused to even request a postponement.

However, the analysis of the data shows the exact opposite of these fears: a clear easing of tension in the eligible countries was observed just a few weeks after the start of the initiative. Instead of an increase, there was a decrease in the debt costs for the countries involved. For the analysis, the scientists used daily data from the bond market and constructed a statistical double for each eligible country, which provided information on how interest rates on government bonds would have developed without the payment deferrals. In all cases, the situation improved as a result of the payment deferral. The improvement was particularly strong for countries granted longer deferrals.

In view of the increasingly critical debt burden in many poorer countries, these results are also important for upcoming political decisions. According to the International Monetary Fund (IMF), more than half of all low-income countries are currently in or on the verge of a debt crisis. Demands for debt relief for these countries are getting louder. However, since lenders often refuse to waive debts in whole or in part, haircuts are usually difficult to implement politically. However, granting deferrals does not reduce the amount of debt. So when lenders aren’t willing to forgo repayments, simply deferring repayments can be an effective first step – potentially even in the debt crises to come.