LONDON (Reuters) – The world’s poorest countries could soon be facing a tough decision — double up on debt relief from the G20 with the caveat they must default on private creditors, or quit the programme to try to keep financial markets on side.

Rich countries on Friday backed an extension of the G20’s Debt Service Suspension Initiative (DSSI), approved in April to help developing nations survive the coronavirus pandemic and which has seen 43 of a potential 73 eligible countries https://www.worldbank.org/en/topic/debt/brief/covid-19-debt-service-suspension-initiative defer $5 billion in ‘official sector’ debt payments.

The European Network on Debt and Development (Eurodad), comprising 50 non-governmental organisations, estimates that extending that temporary freeze by six months would provide a further $6.4 billion of relief, rising to $11.4 billion if the extension runs to the end of 2021.

That would be just over a quarter of next year’s combined debt payments for countries already signed up to the DSSI, and worth up to 4.3% of GDP for nations like Angola, according to Fitch Ratings.

But a significant string may be attached.

Amid warnings the pandemic could push 100 million people into extreme poverty, World Bank President David Malpass is calling for banks and investment funds that have lent to DSSI countries to be involved too.

“The relief so far is too shallow to provide light at the end of the debt tunnel,” Malpass told the United Nations on Tuesday. “Commercial creditors are not participating in the moratorium, draining the financing provided by multilateral institutions.”

Kevin Daly of Aberdeen Standard Investments, who is part of a joint-private sector response to the DSSI proposals, thinks views like Malpass’s mean private sector involvement (PSI) — writedowns for bondholders — could become “mandatory” under the expected extension.

Such a change could be flagged at next month’s IMF meetings.

Eurodad calculates DSSI countries are due to pay private sector bondholders $6.4 billion and other private lenders $7.1 billion next year — a combined $13.5 billion that exceeds what the signed-up countries owe to G20 governments.

“We have already heard there is a strong possibility that this (PSI) can be the case,” said Angola’s secretary of state for budget and investment, Aia-Eza Silva, while adding that Angola’s main focus remains bilateral creditors like China.

(Graphic: How much debt relief will DSSI provide countries – https://fingfx.thomsonreuters.com/gfx/mkt/xklpyqjbwpg/Pasted%20image%201601420726673.png)

Charity groups estimate that 121 low- and middle-income governments spent more last year servicing external debt than on public health systems that are now at breaking point, making a powerful moral case for relief.

There are other complicating factors, however.

Credit rating agencies S&P Global, Moody’s and Fitch have warned that if countries do suspend or defer debt payments to the private sector it would almost certainly be classed as restructuring and default under their criteria.

Restructurings are complex and typically take far longer than stricken countries now have. It would also mean poorer nations that have battled to gain international market access over the last decade lose it just as they face huge challenges.

Moody’s reckons they face a combined $40 billion funding gap this year. The Institute of International Finance estimates that external debt of DSSI countries has more than doubled since 2010 to over $750 billion and now averages nearly 50% of GDP — high for their stage of development.

A total of 23 DSSI-eligible countries have sold Eurobonds, but only a few, like Honduras and Mongolia, have done so since the programme’s launch in April. Pakistan wants to sell $1.5 billion of bonds but creditors would baulk if PSI was looming.

“It is hugely unlikely that any country that has been part of it (DSSI) this year would put their market access at risk,” said Aberdeen’s Kevin Daly. “I wouldn’t think any of them would want to take part.”

(Graphic: DSSI debt country bonds – https://fingfx.thomsonreuters.com/gfx/mkt/xklpyqlkrpg/Pasted%20image%201601460240507.png)

Poverty action groups say the private sector is overstating the issue, pointing to the speed with which Argentina sold a 100-year bond after one of its restructurings.

A potential ‘carrot’ for countries and their creditors could be Brady bond-style debt swaps, where investors write off some loans in return for new credit-enhanced bonds with full or part guarantees from the G20 or multilateral development banks.

J.P. Morgan’s bond index arm fanned talk of such a plan when it announced this month that credit-enhanced debt would be eligible for its top emerging markets benchmark from mid-October, just after key IMF and G20 DSSI meetings.

Eurodad’s Iolanda Fresnillo said debt swaps could be a solution for many countries although the hardest-hit nations would need more extreme measures.

“This is not just a liquidity crisis, we need to tackle debt sustainability and go for debt cancellation,” Fresnillo said.

“By just postponing the payments you are not solving the problems these countries are facing.”

(Additional reporting by Andrea Shalal in Washington and Karin Strohecker in London; Editing by Catherine Evans)

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