Better Debt Shock Absorbers for Poor Countries: A Proposal

Our analysis confirms that poor countries are subject to a broad range of exogenous shocks – not under their control and not just those that are climate-related – and that those shocks can have large consequences for growth, debt-carrying capacity, and liquidity. The current major global shock, the Iran war, is the most recent example. Our proposal for the temporary suspension of external debt service payments would help prevent liquidity crises from escalating into solvency crises. By providing immediate fiscal space, it would allow low-income countries to avoid default and undertake countercyclical or reconstruction spending, thereby limiting long-term economic damage and preserving creditworthiness. The proposal has five distinctive features:

• Triggers for DSC activation focus on the magnitude of the shock, not the source.
• Benchmarks for clause activation are simple, standardized, and quantitative. The four-part activation test includes benchmarks for solvency, liquidity, debt service fiscal burden, and growth impact.
• Clause activation would not require creditor approval if triggers are met and verified.
• Clauses would apply to sovereign debt owed to both public and private creditors—to ensure comparable treatment amid the rising public creditor share of poor country debt stocks.
• The issuing country may spend the temporarily freed-up resources as it likes—different from debt for nature or debt for development swaps.

This proposal is meant to complement, not substitute for, ongoing work to deal with liquidity shortages, to make the debt restructuring process more efficient and to explore refinancing options for poor countries’ current high-cost debt. The aim is better long-term solutions to strengthen the resilience of poor countries and to help avoid a recurrence of today’s pervasive debt strains. We know these countries will continue to be subject to frequent exogenous shocks. A forward-looking approach of building better debt contracts for poor country sovereign borrowing should be a prominent part of the debt relief arsenal.