Exchange operations play increasing role in managing liability and dealing with crises
| Author | Jens Nystedt |
| Position | IMF Global Markets Unit |
| Pages | 208-209 |
Page 208
Arecord number of debt exchange operations or swaps occurred in emerging debt markets in 2000. In 2001, the pace has accelerated-most recently with Argentina's $30 billion "mega" debt swap.What are debt swaps? What purposes do they serve? How do they affect emerging debt markets?
A debt swap is an operation in which bondholders agree to sell their bonds to the issuer in exchange for a package of new bonds and, possibly, some cash.
Sometimes, the value of the new bonds and cash received exceeds the value of the old bonds, thereby inducing the bondholder to voluntarily exchange bonds and receive the up-front "sweetener." In other instances, however, an issuer close (or perceived to be close) to default may approach bondholders with an offer that would imply an up-front loss, if accepted.
Clearly, if bondholders are better off refusing rather than accepting, they will do so. Then, the exchange proceeds only if the issuer has some form of mechanism to "force" bondholders to accept.
Some debt swaps involve both a government's domestic and its external debt (such as Argentina's swaps in February and early June), while others focus only on domestic debt (Turkey is currently considering this), and others include only external debt (the common Brady bond-to-eurobond swaps).
Debt swaps are not cost free; the issuer that enters into them replaces bonds issued at one interest rate with new bonds issued at the prevailing market interest rate. If the new interest rate is higher than the original interest rate, clearly the operation entails a cost.
However, there are also benefits, depending on what the main purpose of the operation is:
* Liability management. These swaps capture inefficiencies in the market's pricing of sovereign debt (realize net present value gains for the issuer), and/or release the collateral of some types of bonds, and/or extend the maturity of government bonds to enhance the debt profile.
The most frequent type of exchange, the Brady bond-eurobond swap, falls into this category.
* Up-front debt-service relief. These transactions alleviate a temporary bunching of maturities in the near term. They often entail actual net present value costs for the issuer, because debt maturing in the near term is replaced by often more expensive debt maturing in the medium to...
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