Spain calls for disaster ‘break clauses’ on debt of developing nations

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Spain is pushing other rich countries to allow developing countries hit by famine, drought and hurricanes to suspend debt repayments as climate change increases the threat of natural disasters.

Paula Conthe, head of Spain’s Treasury, told the Financial Times that official and private lenders should include so-called emergency break clauses for natural disasters in all loans to poor countries, after Grenada became the first country in the world to used such a clause last month. .

The Caribbean nation was able to suspend payments on a $112 million bond for a year after damage from Hurricane Beryl, which struck in July, triggered a clause in the terms of the debt agreed nearly a decade ago. The interest will be added to the principal of the bond. However, such clauses are currently rare in debt documents.

The loan clauses that Spain puts into its own debt documents will suspend debt service for 12 months after a trigger event. Conthe said the Covid-19 pandemic showed how an exogenous shock can threaten a fiscally prudent country’s ability to repay short-term debt.

More severe and frequent droughts and floods are compounding debt crises, especially in Africa. Zambia emerged from a bond default only this year and found its finances further strained by South Africa’s worst El Niño drought in four decades.

Spain wants to use its influence as a member of the Paris Club of rich country creditors to push for wider adoption of similar clauses and for more types of disasters that can affect developing countries.

“Otherwise, they could go into a negative debt spiral where their liquidity problems would turn into solvency problems,” she said.

Madrid also wanted to make the breaks a standard feature of a common G20 framework for loans to poor nations as well as some middle-income ones, Conthe added. It plans to include these agreements in all concessional and commercial loans to low-income countries.

Spain has weight as a member of multilateral development banks active in emerging markets, including the Asian Infrastructure Investment Bank, the Central American Bank for Economic Integration and CAF, the Development Bank of Latin America and the Caribbean.

Spain has already introduced food crisis-related break provisions in loans to Rwanda and Senegal this year. The clauses will only be able to provide “real relief” to borrowers if they are widely adopted, Conthe said.

Some analysts say it is very difficult to design break clauses that derive specific triggers from disasters such as drought, which can be harder to measure. Beyond Grenada, few countries have adopted clauses even for risks such as hurricanes, which can be quantified relatively easily.

However, Brad Setser, a senior fellow at the Council on Foreign Relations, said such clauses would be beneficial to both lenders and borrowers and would not add much to a developing country’s borrowing costs.

“The ability to stop payments for a year in the face of an act of God, so to speak, helps the debtor and helps the creditor. It helps avoid default and means the borrower does not have to worry about getting funds during a disaster,” he said.

“All insurance comes at a price,” Setser added, but the likely cost for loan moratoriums made at issuance would be tens of basis points, not percentage points, he said.