Over the last two decades, one of the most significant changes in emerging, and some frontier, markets was the development of the domestic capital markets. They became more attractive to both local and international investors thanks to the low interest rates abroad and domestic factors, such as the expansion and privatization of pension programs, improvements in clearing systems, expansion of the financial systems, and an improvement in government debt management and transparency in many countries.

But since 2019, as a result of global economic shocks, gross general government debt levels across the 137 sovereigns we rate increased by 8 percentage points of GDP on average, and by 13 percentage points of GDP for sovereigns rated 'B-' or below (see chart). At the same time, the cost of servicing debt continues to rise sharply. These dynamics have led to capital outflows out of local currency markets.

As a consequence, debt distress has been on the rise. Restructurings that include domestic debt are growing given that domestic debt has a heavier weight in the overall stock of debt, as well as higher cost and shorter maturities. Domestic restructurings, if not well implemented, can cause harm because they usually involve a large share of the domestic financial system.

Here we examine how we assess debt restructurings and look at examples of domestic exchanges and their implications.

Frequently Asked Questions

How does S&P Global Ratings assess domestic debt restructurings?

Not all debt restructurings have the same impact on the sovereign ratings. We look at all debt restructurings, local and external, on a case-by-case basis, guided by paragraphs 221-236 of "S&P Global Ratings Definitions."

The general principle is that we would consider a debt restructuring--such as an exchange, a repurchase, or a term amendment--distressed, and lower the rating to 'SD' (selective default), if it meets both of the following conditions:

• We believe that the debt restructuring implies the investor will receive less value than promised when the original debt was issued.
• We believe that if the debt restructuring does not take place, there is a realistic possibility of a conventional default (that is, the entity could file for bankruptcy or similar proceedings, become insolvent, or fall into payment default) on the instrument subject to the debt restructuring, over the near to medium term. Conversely, we view a debt restructuring as opportunistic, rather than distressed, if we believe the issuer would be able to avoid insolvency or bankruptcy in the near to medium term even if the debt restructuring did not take place. For example, an entity that is a strong credit may offer to exchange or repurchase its bonds for below par value if changes in market interest rates or other factors have caused its bonds to trade at a discount.

We would consider additional factors--that will inform the rating trajectory--in determining whether a debt exchange is distressed.

Exchanges that involve only intragovernmental (public-sector entities) or bilateral debt (from another sovereign) as well as multilateral debt (from a multilateral lending institution) will not be considered distressed since we rate only commercial debt.

Also, we look at the rating level on the entity in advance of the debt exchange as a strong indicator of the rationale for the transaction:

• If the issuer credit rating is 'BB-' or higher, we ordinarily would not characterize the debt restructuring as distressed.
• If the issuer credit rating is 'B+' or 'B', we would consider market prices or other cues in our assessment.
• If the issuer credit rating is 'B-' or lower, we ordinarily would view the debt restructuring as distressed.

What are the implications of domestic debt restructurings, and how do they affect ratings?

While more recently most domestic restructurings have taken place in sub-Saharan Africa and South Asia, many past debt exchanges have occurred in other regions, including Europe and the Americas.

The traditional thinking was that since sovereigns have the capacity to print their own currency, they should not need to restructure debt in local currency. In practice, however, only a few developed sovereigns can temporarily--and credibly--increase the supply of local currency without generating an inflationary spiral. Given current global economic dynamics, even governments best positioned to deploy quantitative easing are still grappling with the aftermath, as central banks shrink their balance sheets in the face of stubborn underlying inflation.

When confronted with a fiscal crisis, and the need to write down public debt, governments prefer to restructure debt held by nonresidents, rather than the domestic financial sector. Write-downs of domestically held debt typically create a capital shortfall in the domestic financial sector that imposes large additional fiscal and economic costs. However, in several recent cases, governments have been unable to avoid a domestic debt restructuring, given the weight, cost, and short maturity of the debt.

What are some examples of historical domestic debt exchanges, and how does S&P Global Ratings view them?

Jamaica (2010 and 2013)

What happened:  Jamaica's public finances become unsustainable in 2010, with general government debt at 130% of GDP and interest payments consuming around 60% of government revenues. Local banks and nonbank financial institutions held much of the sovereign debt.

The government undertook a debt exchange in 2010 that excluded debt issued abroad but did include local and foreign currency debt issued domestically, which represented around 50% of all public debt. The government and the financial community agreed on a debt restructuring plan, officially proposed by domestic creditors. The plan was designed to offer enough debt relief to make the sovereign's debt burden sustainable while limiting the losses to the financial sector. The estimated fiscal savings for the government from the debt exchange was 4% of GDP. The restructured debt had the same face value but lower interest rates and longer maturities.

In 2013, with debt levels stubbornly high at around 115% of GDP and an interest burden of close to 46% of government revenues, Jamaica undertook a similar debt exchange. As in the first debt exchange, there was no reduction in face value but there were lower interest rates and longer maturities.

How we view the debt exchanges:  We treated both debt exchanges as distressed because we concluded that both aspects of a distressed exchange were met. Investors received less value than originally promised given the lower interest rates and maturities of the new bonds. Also, we concluded that the government would not have been able to avoid default without the exchange.

Both debt exchanges marked the beginning of strong fiscal consolidation in Jamaica. As of July 2023, general government debt was 68% of GDP, and the interest burden was 18% of general government revenues.

Greece (two distressed exchanges in 2012)

What happened:  In the years leading up to its sovereign debt crisis, Greece enjoyed an economic boom. However, as the economic tides turned following the global financial crisis, structural imbalances in the Greek economy became increasingly alarming. Following a sharp negative data revision to fiscal statistics, which showed the fiscal deficit was 13% of GDP rather than the previously reported 5%, Greece's debt sustainability came into question. By the end of 2011, debt reached 175% of GDP, debt service occupied 17.2% of general government revenues, and the government no longer had market access.

In February 2012, the government unilaterally and retroactively inserted collective action clauses (CACs) into the documentation of certain series of its sovereign debt. The CACs bind all bondholders to amended bond payment terms in the event that creditors have agreed to do so.

How we view the debt exchange:  In our opinion, Greece's retroactive insertion of CACs materially changed the original terms of the affected debt and constituted the launch of a distressed debt restructuring. Our belief was, if a sufficient number of bondholders didn't accept the exchange offer, Greece would face a payment default owing to the lack of access to market funding and the likely unavailability of additional official financing. We therefore lowered our sovereign credit rating on Greece to 'SD' and our ratings on the affected debt issues to 'D' pending completion of the exchange.

What happened:  Later, on Dec. 3, 2012, Greece launched a series of debt buyback options.

How we view the debt exchange:  While the invitation to participate in the debt buyback was voluntary, we considered this a second distressed exchange because it satisfied our two conditions, namely that:

• Investors would receive less than the originally promised amount, since the debt was repurchased at a significant discount, and
• The exchange was distressed and not purely opportunistic.

Even though investors willingly accepted the offer, we believed that investors were motivated to accept because of concerns that they stood to fare even worse should the buyback fail. We therefore once again lowered the rating to 'SD' in December 2012.

While Greece's debt stock remains high in nominal terms, at an estimated 159% of GDP this year, the bailout packages the country received following its crisis allowed for a significant terming out and lowering of the interests costs to more sustainable levels. Greece today pays an amount equivalent to an estimated 4.9% of general government revenues, and it has a weighted average maturity of 17.2 years, one of the longest of the sovereigns we rate.

Portugal (2012 and 2013)

What happened:  Following Portugal's adoption of the euro in 1999, the country began to more closely integrate with the EU, and interest rates narrowed significantly. However, spending accelerated, debt ballooned, and structural reforms were limited. In 2010, the fiscal deficit widened to 11% of GDP.

Portugal entered a rescue program from the IMF and EU--it lasted from 2011-2014 and came to €78 billion. The intention was to bring Portugal's finances back on track. Strong ownership of the program, along with broad acceptance of the need for fiscal and economic reforms, allowed for a relatively successful program implementation.

IGCP, Portugal's debt management agency, continued to issue debt throughout its crisis, albeit focusing on Treasury bills, since medium-term debt had become highly expensive. In October 2012, IGCP launched a voluntary debt buyback offer on a bond coming due in September 2013. It ultimately swapped €3.75 billion out of the roughly €9.6 billion outstanding for new debt maturing in October 2015 and with the same par value and a slightly higher yield. A similar operation occurred in December 2013.

How we view the debt exchanges:  On both occasions, we did not consider the exchanges to be distressed debt restructurings. IGCP, like many other European debt management agencies, regularly undertakes liability management exercises akin to these. Although Portugal was part of a rescue program, we viewed Portugal as fundamentally solvent at the time of both exchanges. Our rating at the time of both offers was 'BB,' albeit with a negative outlook in 2012 and on CreditWatch negative in 2013. In our opinion, the failure of these exchanges was not as likely to cause a conventional default as it otherwise could have been because, among other reasons, Portugal was still able to regularly issue Treasury bills, and external support appeared forthcoming.

Cyprus (2013)

What happened:  In the years leading up to the eurozone crisis, Cypriot banks had bloated to over 5x GDP, taken increasingly leveraged bets on domestic real estate, and become highly exposed to Greek residents and the government. The subsequent reversal of Cyprus' housing boom, followed by the restructuring of Greek government debt, led to a serious capitalization problem at Cypriot banks.

With markets shunning Cypriot sovereign debt, the government secured a €10 billion bailout program in March 2023 from the Troika, which involved a controversial bail-in. As part of the bailout, Cyprus committed to refinance €1 billion worth of government debt held by domestic investors at extended maturities and existing coupon rates. Indeed, in June 2013, the government initiated a voluntary debt exchange on 18 local law securities collectively worth €1 billion.

How we view the debt exchange:  Despite the voluntary nature of this exchange, we lowered our sovereign ratings on Cyprus to 'SD'. In our view, the extension of maturities without adequate offsetting compensation meant the new debt was on less favorable terms than the existing debt. Moreover, we considered the offer as distressed, rather than purely opportunistic, given limited financing options available to the government and our 'CCC' rating on the government's debt at the time of the restructuring.

Cyprus's debt remains high today, at an estimated 80% of GDP this year. Although, this is down from a pandemic peak of 114% in 2020 and a eurozone crisis peak of 107% of GDP. Plus, it does not reflect the notable liquid assets built up following its default and through the pandemic, standing at 14% of GDP this year. The interest burden has also come down significantly since the eurozone crisis and will reach an estimated 4% of general government revenues this year.

Ethiopia (2019, 2022, and 2023)

What happened:  In June 2019, the Ethiopian government converted Ethiopian birr (ETB) 149 billion ($2.7 billion) worth of Treasury bills into newly introduced medium-term Treasury notes. The Treasury notes were subsequently switched into a long-term bond upon maturity in early 2023, with no change to the composition of the bondholders.

Separately, the government converted direct advances from the National Bank of Ethiopia into long-term government bonds in both June 2019 and December 2022.

How we view the debt exchanges:  While these transactions reflected underlying debt distress, which we incorporated into our ratings, we did not classify them as commercial defaults because we viewed them as intragovernmental exchanges.

Our current 'CCC/C' sovereign credit ratings on Ethiopia reflect our assessment that Ethiopia is highly vulnerable to nonpayment, due to spillovers from its internal conflicts, heightened external financing pressures in the context of limited foreign funding avenues, and subsequent increased reliance on domestic funding.

Argentina (various)

What happened:  Argentina has been prolific when it comes to debt restructurings. A notable restructuring was in 2005 when it cured its default from 2001, involving both external and domestic debt. It did the same again in 2014 and 2016.

More recently, in September 2020, Argentina concluded a restructuring of $66 billion in foreign law foreign currency debt and over $40 billion in local law foreign currency debt, both of which entailed minor decreases in face value and--more importantly--a significant reduction in coupons and debt service relief over the next three years.

How we view the debt exchanges:  Argentina had already defaulted on local currency debt following a debt exchange in January 2020 that we had deemed to be distressed. Following the restructuring in September, we raised the long-term local and foreign currency ratings to 'CCC+' from 'SD'.

What happened:  After its default in September 2020, Argentina faced mainly local currency debt maturities. However, its poor fiscal and macro situation made it difficult for the government to roll over its domestic law local currency debt. In response, the government announced a debt exchange, offering new local currency debt to creditors whose holdings of local currency sovereign debt were going to mature in the coming few months.

How we view the debt exchanges:  We deemed that there would have been a conventional default--absent participation of creditors--given the sovereign's pronounced macroeconomic vulnerabilities and very limited ability to extend maturity and place paper in the local market without continued reliance on exchanges. Subsequently, in January, March, and June 2023, the government undertook three more local currency debt exchanges that we deemed distressed exchanges. As a result, we lowered our local currency rating to 'SD'.

Argentina's inability to implement, in a sustained manner, a fiscal consolidation program has eroded any benefit from all of the debt exchanges. General government debt was 71% of GDP when Argentina defaulted in 2001, 54% in 2016, and about 101% of in 2020. Today, it's close to 90% of GDP.

Kenya (2020 and 2023)

What happened:  The Kenyan government initiated a voluntary switch transaction in January 2023 that invited select market participants to convert Kenyan shilling (KES) 88 billion ($602 million) worth of maturing Treasury bills and Treasury bonds into a tax-free, six-year infrastructure bond. It also converted KES20 billion ($138 million) worth of Treasury bills into a long-term bond in November 2020. We understand that 80% of investors participated in the 2023 exchange, and the nonconverted redemptions were settled on time and in full.

How we view the debt exchange:  We did not consider the debt liability management exercises a distressed exchange owing to the new instrument's higher yield, which helped compensate for the longer maturity. Also, we believed that a failure of the exchange would not have caused a conventional default. The government's longer maturity profile allowed Kenya to manage some of its short-term refinancing risks.

Uganda (2021-2023)

What happened:  Uganda, through its central bank, has regularly carried out "bond switches" since 2021. Most recently, it did on Feb. 8 (see "Uganda Bond Conversion Not Distressed But Highlights Medium-Term Fiscal And Monetary Risks"). In Uganda's bond switches, existing holders of a particular bond are invited to voluntarily exchange their ownership of the bond for another preferred bond issued by Uganda.

How we view the debt exchanges:  We assess each of these bond switches on a case-by-case basis but have so far considered all to be opportunistic rather than distressed. The exchanges have been offered on a voluntary basis, and we have considered credible the commitment that for those who chose not to participate, repayment will happen on time and in full. Additionally, despite new bonds taken typically being of longer maturity, the higher yield provides some offsetting compensation.

Angola (2022)

What happened:  Looking to improve its public debt profile, Angola undertook a liability management exercise that concluded on Aug. 12, 2022. The Banco Nacional de Angola offered to exchange a series of Treasury bonds. In total, 32 exchange rate-linked bonds were offered for exchange along with a set of fixed-rate local currency bonds (called of Obrigações do Tesouro Não Reajustáveis, or OTNRs) coming due over 2023 and 2024. All exchange rate-linked bonds and OTNRs were exchanged for OTNRs with longer maturities.

How we view the debt exchange:  We understand only two of the 22 holders of these bonds accepted the exchange. Although these two investors held a majority of the outstanding bonds offered for exchange, the government has since remained current on repayments to those 20 investors. Additionally, investors were offered 3%-5% above par on average.

The sharp appreciation in the kwanza ahead of the exchange supported our view that the offer was opportunistic, particularly because the updated terms did not obviously imply investors would receive less than originally promised. The substantial number of holdouts that we expected would still be paid in full and on time also supported this view.

Ghana (2022)

What happened and how we view the debt exchange:  Ghana's Ministry of Finance at the end of 2022 offered a domestic debt restructuring, with the objective of lowering interest costs and back-loading refinancing requirements. We lowered our local currency long-term sovereign credit rating on Ghana to 'SD'. We viewed Ghana's debt restructuring as distressed rather than opportunistic due to the government's weak market access and the very high level and cost of debt in local currency terms.

In our view, the completion of the domestic debt exchange, together with Ghana's suspension of foreign commercial and official (except multilateral) debt servicing, should reduce interest expenditure. Moreover, the maturity extension of Ghana's domestic debt profile, alongside the suspension of principal and interest payments on foreign commercial and bilateral debt, will reduce general government gross borrowing requirements.

Nigeria (2023)

What happened:  After several years of discussion, in early May 2023, Nigeria's Ministry of Finance and Central Bank of Nigeria agreed to securitize long-standing central bank financing that had been provided to the Ministry of Finance. The securitization will reduce the government's interest expenses, further supporting fiscal consolidation.

The government restructured several years of debt amassed via borrowing from the central bank. The Ministry of Finance and central bank agreed to the securitization of this debt into an instrument with 40 years tenure, with a moratorium on principal repayment for three years and a 9% interest rate. The previous interest rate was about 20% (monetary policy rate + 1%-3%).

How we view the debt exchange:  We incorporate the impact of this securitization deal in our interest expenditure, which, along with the projected revenue increase, reduces interest cost as a percentage of revenue to 20% of general government revenue in 2023, from 31% in 2022. We do not consider the securitization of the obligations to the central bank as a default under our criteria. Our ratings speak to the timely repayment of commercial debt obligations--and we classify borrowing from the central bank as non-commercial.

Sri Lanka (2023)

What happened and how we view the debt exchange:  The government of Sri Lanka earlier this year announced that it will restructure some of its local currency bonds. We subsequently lowered our local currency sovereign credit ratings.

We expect the government to undertake two separate restructuring exercises that will affect debt held by the Central Bank of Sri Lanka and superannuation funds. We believe the exchange offer proposed to bondholders, some of which are likely to be commercial creditors, implies that participants will receive less than the original promise offered by their current notes.

The new notes will carry a step down in interest rate, from 12% through 2025, to 9% thereafter, and an implied extension of maturity in receiving the basket of new maturities. In our view, these changes will cause investors to receive less than the original promise on the existing obligations. In addition, while the majority of the debt is intragovernmental, a small portion of the bondholders is likely to be commercial.

Sri Lanka's local currency debt obligations account for the majority of the government's interest payments, contributing to its very high interest burden. A restructuring of part of the outstanding debt stock could therefore support the restoration of the government's public financial position.

Domestic Debt Exchanges Present A Tricky Trade-Off

In most cases, domestic debt exchanges are part of normal asset liability management exercises across the developed and developing world. But sometimes, domestic exchanges happen when sovereigns run out of financing options or otherwise become insolvent, forcing governments to use their local law advantage to push through a change in terms.

While domestic exchanges usually offer a sensible level of cash flow relief for the government, they also could cause serious pain for the domestic economy. This balancing act is idiosyncratic to domestic exchanges. Local debtholders are usually domestic institutions, whose welfare is much more strongly correlated with domestic activity and growth prospects than nonresident holders of foreign currency debt.

Domestic exchanges can offer fiscal breathing room in times of stress, but as the cases of Jamaica and Argentina showed, the results can be quite different. Even more important for the return to fiscal sustainability is governments' capacity and willingness to implement and sustain fiscal consolidation programs over time that restore market confidence and economic growth.