In late June, Greece became the first advanced economy to miss a debt repayment to the IMF. At the same time, the government decided to fully repay a yen-denominated bond held by private investors. This is remarkable, since the IMF is a lender of last resort and typically insists on full repayment before any other creditor. However, the IMF’s senior status is not written in law, but is merely a market convention – IMF seniority only prevails if market participants believe in it. The Greek decision to temporarily default on the IMF could therefore have important repercussions for the pricing of sovereign debt and for the IMF’s role in the international financial architecture.
In addition, there are now widespread demands for the governments of Europe to grant deep debt relief to Greece, following the haircut on private bonds in March 2012 and several rounds of maturity extensions on the stock of Eurozone rescue loans to Greece. Asking for debt relief in Greece effectively means asking for a subordination of official (government-to-government) loans. This demand is made explicit in a new paper by Buchheit and Gulati (2015), who propose to legally subordinate official sector debt in Greece, with the aim of facilitating fresh lending by private creditors who would be granted a super-senior status.
How do these developments compare to historical experience? Is it true that the IMF and other multilateral organisations are de facto senior creditors? Are bilateral government-to-government loans also senior to debts owed to private sector creditors? And if not, how do governments in distress discriminate between different types of creditors?
Despite the debate and relevance of seniority in sovereign debt markets, there is very little systematic evidence on seniority in practice. This is surprising, because the sovereign context is particularly interesting. Unlike corporate debt markets, there are no legal rules of priority and seniority, such as Chapter 11. Given the lack of a sovereign bankruptcy procedure, every government can decide which creditor group to service and to what degree. Seniority is a discretionary decision and may not be legally enforceable. This makes an analysis of sovereign debt markets all the more relevant.
Previous research by Roubini and Setser (2003), Gelpern (2004), Sturzenegger and Zettelmeyer (2007), and Bolton and Jeanne (2009) utilises case studies of individual debt crisis cases and shows a mixed picture of sovereign debt seniority. Among private sector foreign creditors, sovereign bonds have often been treated preferentially to sovereign bank debt, but this seems not to be generally true. Domestic creditors are often portrayed as being senior to foreign creditors, although the evidence is again mixed (see Broner et al. 2010, Erce and Diaz-Cassou 2010, Erce 2012, Broner et al. 2014 and Steinkamp and Westermann 2014). Moreover, the official sector – including the IMF, the World Bank, and the Paris Club of individual creditor country governments – is generally seen as being a senior creditor class in sovereign debt markets.
New evidence: Measuring seniority
In a new paper (Schlegl et al. 2015), we move beyond case studies and provide the first comprehensive empirical analysis of seniority patterns in sovereign debt markets. Using data from the World Bank’s Debtor Reporting System and from the IMF, we compile a new dataset on missed payments – payment arrears – towards six different groups of external creditors. The data covers 116 countries over the period 1979-2006 and includes external long-term public and publicly guaranteed debt to the following external creditor groups (using the World Bank definitions):
- The IMF;
- Multilateral creditors, in particular the World Bank, the African Development Bank and other regional development banks;
- Bilateral creditors, in particular loans from other governments;
- Banks, mostly syndicated loans to the government;
- Trade creditors and suppliers, who provided goods to the government or government owned enterprises.
We construct two measures of seniority. First, we compare the scope of arrears towards each creditor group to the stock of debt outstanding to that creditor. The arrears-to-debt ratio is a simple and intuitive measure that accounts for the variation in the amount of lending by different groups. Second, we use a more refined measure that measures seniority in relative terms – the relative percentage in arrears ratio. This is defined as the difference between the arrears-to-debt ratio for the country’s entire debt stock and the arrears-to-debt ratio of a specific creditor group. The measure thus accounts for the overall level of government arrears and helps to separate the question of why countries run into arrears from the question of how arrears are distributed across creditors.
The pecking order of external sovereign debt
The resulting seniority patterns are illustrated in Figure 1, which shows the average arrears to debt ratio, and Figure 2, which illustrates the average the Relative Percentage in Arrears, for each creditor group. Both figures convey the same message – there is a clear seniority structure in sovereign debt markets. Unsurprisingly, the IMF, as a lender of last resort, is the most senior creditor because it faces relatively lower arrears overall, with arrears totaling less than 3% of the outstanding stock of debt (Figure 1) which is more than 6 percentage points lower than the average arrears to debt ratio (Figure 2). Multilateral creditors such as the World Bank trail behind closely.
Figure 1. Measuring seniority part I: Arrears to debt ratio by creditor group
Note: This figure shows the average level of arrears as a fraction of the debt stock of the respective creditor group (ranging from a minimum of zero to a maximum of 100%). Comparisons are based on unweighted country averages. Lower values indicate seniority relative to other creditor groups.
Next in line are bondholders, who are the most senior type of private creditors. In contrast, commercial banks and trade creditors are junior, with relatively more arrears for each unit borrowed. The most surprising finding is that bilateral creditors are in the bottom half of the pecking order. Government to government loans are clearly junior, with arrears to debt around 11%, both compared to other types of official lending (arrears to debt around 3%), but also towards bonds (arrears to debt around 5%).
Figure 2. Measuring seniority part II: Relative percentage in arrears by creditor group
Note: This figure shows the average difference between the total arrears to debt ratio of a country and the arrears to debt ratio of each creditor group. Comparisons are based on unweighted country averages. Higher values indicate seniority relative to other creditor groups.
In ongoing work, we find that the pecking order conveyed in Figures 1 and 2 is remarkably robust across countries and when conducting a counterfactual decomposition analysis. Of course there is a large variation in arrears levels, with arrears being higher in low-income and highly indebted countries. However, the relative ranking of creditor repayments holds once we control for country characteristics, time effects and a large set of economic and political fundamentals. The seniority patterns are also very stable across time, as illustrated in Figure 3. Finally, preliminary results indicate that the pecking order we observe also holds once we compare actual creditor losses (haircuts) of private and official creditors.
Figure 3. Sovereign debt seniority over time: The pecking order
Note: This figure plots the development of the relative percentage in arrears ratios by creditor group over time. Averages are calculated over all countries for each year. Higher values indicate seniority relative to other creditor groups.
We have documented an implicit seniority structure of external sovereign debt. Moreover, we conclude that creditor-specific factors seem to drive the repayment patterns. Country characteristics or economic fundamentals cannot easily explain the pecking order we observe.
In light of this historical evidence, Greece in 2015 is clearly an outlier case, having defaulted on the most senior creditor (the IMF), while continuing to service historically more junior creditors. The evidence also suggests that the Eurozone rescue loans, which are essentially bilateral (government-to-government) credit, are likely to be a junior creditor class going forward. The evidence also rationalises why Greece may have an interest in exchanging the debt it owes to the IMF and the ECB into loans to the European Stability Mechanism, which is likely to be junior debt in the future, as discussed in the run-up to the July Eurozone summits. Policymakers should be aware of the associated changes in seniority and repayment incentives.
Bolton, P and O Jeanne (2009), “Structuring and restructuring sovereign debt: The role of seniority”, Review of Economic Studies 76.
Broner, F, A Martin and J Ventura (2010), "Sovereign risk and secondary markets", The American Economic Review 100.
Broner, F, A Erce, A Martin and J Ventura (2014), “Sovereign debt markets in turbulent times: creditor discrimination and crowding-out effects”, Journal of Monetary Economics 61.
Buchheit, L and M Gulati (2015), “Targeted subordination of official sector debt”, Mimeo, SSRN.
Erce, A (2012), “Selective sovereign defaults”, Federal Reserve Bank of Dallas, Working Paper, 127.
Erce, A and J Diaz-Cassou (2010), “Creditor discrimination during sovereign debt restructurings”, Banco de Espana, Documentos de Trabajo, No. 1027.
Gelpern, A (2004), “Building a better seating chart for sovereign restructurings”, Emory Law Journal 53.
Roubini, N and B Setser (2003), “Seniority of sovereign debts”, Chapter 7 in Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies, Peterson Institute for International Economics.
Schlegl, M, C Trebesch and M Wright (2015), “The seniority structure of sovereign Debt”, ongoing work.
Steinkamp, S and F Westermann (2014), “The role of creditor seniority in Europe's sovereign debt crisis”, Economic Policy 29.
Sturzenegger, F and J Zettelmeyer (2007), Debt Defaults and Lessons from a Decade of Crises, Cambridge and London: MIT Press.